Life Insurance

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Life Insurance

• RMI 3500
• Intro. to Risk Mang. Ins.
• Robert Klein

Revised 10/14/07
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Topic Objectives

• Explain the purpose and basic characteristics of
  life insurance.

• Review different types of products.
• Important contract provisions.
• Determining life insurance needs.

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Why Buy Life Insurance?

• Why would a risk averse person purchase insurance
  against a certain event?

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Why Buy Life Insurance?

• Why would a risk averse person purchase insurance
  against a certain event?
• Timing is not known and premature death poses
  risk.
• Unfulfilled obligations to dependents others.

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Features of Life Insurance

• Purpose
• Meet financial needs of survivors.
• Savings?
• Distinguishing Features
• Valued policy.
• Payment is made to named beneficiary.
• Benefit is not taxable.
• Insurance against a certain event.

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Risk of Premature Death

• Cost of premature death
• Unfulfilled financial obligations
• Loss of income
• Funeral expenses
• Estate settlement expenses

When you say Do we have enough life insurance,
I assume you mean me.

• Impact of early death depends on type of family.

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Family Characteristics

• Number and ages of dependents.
• Employment status of heads of household wage
  earners.
• Age and health of wage earners.
• Income and assets.
• Special needs.
• 1 in 5 households have no life insurance.
• Median amount of life insurance purchased covers
  only 2 years of income.

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Mortality Rates
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How much life insurance?

• In general it depends on many things.
• How much income is lost?
• How much debt is there?
• Income goals
• Expected inflation

• Methods
• Human Life Value
• Needs Approach
• Capital Retention Approach

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Needs Approach

• Needs
• Cash Needs
• Income Needs
• Other
• Project needs of survivors over their remaining
  lives.
• Total Needs Assets
• Additional Life Insurance Needed

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Life Insurance Pricing

• Three Components
• Mortality charge
• Interest Adjustment
• Expense and profit loading
• Net Premium mortality charge with the interest
  adjustment
• Net Single Premium
• Net Level Premium

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Yearly vs. Level Pricing

• Yearly Pricing
• Premium is adjusted each year based on insureds
  age.
• Rates escalate rapidly with age.
• Used only for yearly term insurance.
• Level Pricing
• Level premium is charged through policy term.
• Can be used for term or permanent life insurance.
• Premiums income will be higher in early years and
  lower in later years remainder is invested into
  a legal reserve.
• Net amount at risk - difference between the face
  value of the policy minus the legal reserve.

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Example 1,000 Face Amount, Male 45, P 5/year
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Types of Life Policies
Term Insurance
Yearly
Multi-Year
Whole Life
Ordinary
Variable
Universal
Variable Universal
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Major Types of Life Insurance
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Term Insurance

• Characteristics
• Temporary
• Renewable
• Convertible
• Pure insurance protection only

• Types
• Yearly renewable
• X-year renewable
• Term to age A
• Decreasing term
• Re-entry term
• Advantages and disadvantages?
• Max protection for lowest cost.
• Not permanent, no forced savings.

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Whole Life Insurance

• Characteristics
• Lifetime protection
• Includes a savings and insurance element.
• Cash Value vs. Surrender Value.
• Savings element earns a stated investment return.
• Option to borrow against cash value at stated
  interest rate.

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Whole Life Insurance

• Types
• Ordinary life
• Limited payment life
• Participating vs. non-participating policies
• Advantages and disadvantages?
• Less protection for given premium.
• Permanent nature and savings element.

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Universal Life Insurance

• Characteristics
• Death benefit and cash values vary according to
  investment experience and premiums paid.
• Policyholder determines amount and frequency of
  premium payments, subject to minimums.

• Unbundling of components
• savings
• protection
• expense charges

Thank you, but Ive already provided for my
childrens education.
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Universal Life Insurance

• Advantages Disadvantages?
• flexibility, higher returns on investment
• complex, buyer misunderstanding

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Universal Life Flexibility

• Change death benefits.
• Change premium payments.
• Make partial cash withdrawals.
• Policy loans allowed at competitive interest
  rates.
• More competitive with term insurance investment
  of premium savings approach.

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Variable Life Insurance

• Variable Life
• Premiums fixed.
• Death benefit and cash value vary according to
  investment return on funds held in separate
  account by insurer.
• Variable Universal Life
• Policyowner determines how premiums are invested.
• No guaranteed minimum interest rate or cash value.

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Life Insurance Purchases in the United States
Percent of Face Value In Force by Type of Policy
(Individual)
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Major Contract Provisions

• Exclusions
• Beneficiary Designations
• Policy Loans
• Participation/Dividends
• Non-Forfeiture/Surrender
• Settlement Options
• Guaranteed Purchase Option

We cannot write a life policy for your husband,
Mrs. Blaine, because he is already dead. In
insurance terms, that is considered a prexisting
condition
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Significant Clauses

• Incontestable Clause
• Insurer cant contest policy after 2 years.
• Grace Period

• Reinstatement Clause
• Permits reinstatement of lapsed policy.
• Evidence of insurability required.
• Exclusions
• war, aviation

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Policy Loans

• Allows the insured to borrow the cash value of
  his/her policy.
• Insured must pay interest to cover the loss of
  interest income to insurer.
• Loan and interest must be repaid or deducted from
  benefits.

• Policy loans pose disintermediation risk to
  insurers.

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Non-Forfeiture Options

• If policy is surrendered, insured has some rights
  to cash value.
• Options
• cash
• reduced paid-up insurance
• extended term insurance
• Surrender charges discourage adverse selection,
  disintermediation.

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Guaranteed Purchase Option

• Insured can purchase additional amounts of life
  insurance at specified times in the future
  without evidence of insurability.

• Poses adverse selection risk to insurer.
• Restrictions on option limit risk to insurer.

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Speculating on Death

• Need for terminally ill people to collect all or
  a portion of their life insurance proceeds.
• Accelerated Death Benefits Rider
• Terminal Illness Rider
• Catastrophic Illness Rider
• Long-Term Care Rider
• Viatical Settlements
• Firms buy the life insurance policies of
  terminally ill insureds at a discount.
• Issues and Abuses

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Conclusions

• Life insurance decision determined by income,
  needs, family circumstances goals.
• Tradeoffs between term life vs. other life
  insurance products.
• Importance of contract provisions and flexibility.