Title: Class 11 Insurance and Risk Management
1Class 11Insurance and RiskManagement
-
- George D. Krempley
- Bus. Fin. 640
- Autumn Quarter 2006
2Premature Death
- Death of a family head with outstanding
unfulfilled financial obligations - Examples
- Dependants to support
- Children to educate
- Unpaid mortgage
3Life Expectancy
- Climbed to record high of 77.2 years in 2001
- Sharp reduction in chance of premature death
since 1900 due to - Significant medical breakthroughs
- Health improvements arising from better economic
conditions and higher incomes - Public health and sanitation improvements
4EXHIBIT 16.1 Improvements in Life Expectancy
over the Past Century
5Costs of Premature Death
- Family shares of deceaseds wage earnings lost
forever - Additional expenses
- Funeral expense
- Uninsured medical bills
- Estate settlement costs
- Federal estate taxes
6Costs of Premature Death (cont.)
- Insufficient income causes some families to
experience a reduced standard of living - Non-economic losses
- Emotional grief
- Loss of parental role model
- Loss of guidance and counseling for children
7What is the insured event?
- Life insurance is valued policy, not a contract
of indemnity. - The insured event is the uncertainty of the time
of death - Because of this uncertainty, the family head may
die with outstanding financial obligations
8Economic Justification of Life Insurance
- Economic justification arises if
- The Insured earns an income
- Others are dependent on that income for at least
part of their financial support - Premature death creates the loss of wage earning
ability upon which others are dependent
9Premature Death Financial Impact Depends on
Family Make-up
- Single People
- Single-Parent Families
- Two-Income Earners
- Traditional Families
- Blended Families
- Sandwiched Families
10Methods for Determining the Amount of Life
Insurance to Own
- Human life value approach
- Needs approach
- Capital retention approach
11Determining the Amount of Life Insurance to
OwnNeeds Approach
- Estate clearance fund
- Income during readjustment period
- Income during dependency period
- Life income to surviving spouse
- During blackout period
- After blackout period
- Special needs
- Mortgage redemption fund
- Educational fund
- Emergency fund
- Retirement Needs
12EXHIBIT 16.2 How Much Life Insurance Do You Need?
13Product Overview
- Term - Pure life insurance
- Cash value policies
- Pure life insurance Savings accumulation
- Examples
- whole life
- universal life
- variable life
14Product Overview
- Can obtain savings accumulation by surrendering
the policy - Why bundle death protection savings
accumulation? - Tax advantaged method of saving
15EXHIBIT 16.3 Relationship Between the Net Amount
at Risk and Legal Reserve
16Terminology
- Death benefit amount beneficiaries receive
- Cash value amount of savings accumulation
- Death protection amount of pure death
protection death benefit - cash value - Face amount stated amount of coverage
17Term Insurance
- ¼ of policies
- Almost ½ of death protection purchased
- Guaranteed renewable
- Premium increases over time
18Whole Life Insurance
- Policy period ends when insured reaches 100
- Equivalent to endowment policy to 100
- Premiums
- single premium
- limited pay
- continuous premium
19Whole Life Insurance
- Premiums generally do not increase over time
- Probability of dying increases over time
- Higher upfront premiums than with term
- Policyholder prepays part of the cost of future
death protection - entitled to prepayments if policy is surrendered
- this is the cash value (savings accumulation)
20Whole Life Insurance
- If insured dies,
- beneficiaries receive face amount
- death protection cash value
- Structured so
- cash value ? over time
- death protection ? over time
-
21Whole Life Insurance
22Tax Treatment of Life Insurance
- Death benefits are not taxed
- Income tax is not paid on increases in cash value
while the policy is in force - Upon surrender, income tax is paid on
- Cash surrender value - sum of all premiums
- sum of all policyholder dividends
23Implications of Tax Treatment
- Implicit returns on savings accumulation
- Escape taxation if insured dies
- Tax deferred if the policy is surrendered
- Partially taxed if policy is surrendered
- Amount which is taxed is less than implicit
return because part of premiums is cost of death
protection
24State Laws Require Rates To Be
- Adequate
- Not excessive
- Not unfairly discriminatory
25Business Rate-Making Objectives
- Simplicity
- Stability
- Responsiveness
- Encourage loss prevention
26EXHIBIT 27.1 Commissioners 1980 Standard
Ordinary Mortality Table, Male Lives
27EXHIBIT 27.1 (continued) Commissioners 1980
Standard Ordinary Mortality Table, Male Lives
28EXHIBIT 27.2 Present Value of 1 at 5 Percent
Compound Interest
29EXHIBIT 27.3 Figuring the NSP for a Five-Year
Term Insurance Policy