FIL 351 LIFE INSURANCE

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FIL 351 LIFE INSURANCE

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Title: FIL 351 LIFE INSURANCE


1
FIL 351LIFE INSURANCE
  • Prof. George Flanigan
  • Insurance Industry Professor.

2
  • HLV
  • Needs Approach
  • Single People.
  • Single Parent Families
  • Two income Earners
  • Traditional Families
  • Blended Families
  • Sandwiched Family.

3
NEEDS ANALYSIS CHART
4
FEDERAL ESTATE TAX
  • The federal estate tax, also known as a death
    tax, is a tax imposed on wealth transfers made at
    the holders death.
  • Virtually from the time it was enacted in 1917,
    there has been pressure for repeal of the federal
    estate tax.
  • Congress enacted legislation to repeal the tax in
    2000, but President Clinton vetoed the bill.

5
PRE-EGTRRA - 2001 ESTATE TAX
  • The federal estate tax applies to ones taxable
    estate the gross estate minus allowable
    deduction, but any tax payable is subject to a
    unified credit that reduces the actual tax
    payable.
  • The unified credit was 229,550 in 2001, which
    exempted 675,000 from the estate tax.
  • The equivalent exemption was scheduled to
    increase to 1 million in 2006.

6
PRE-EGTRRA - 2001 ESTATE TAX
  • Estates in excess of the exempt amount were taxed
    at rates from 37 percent to 55 percent
    (applicable to estates in excess of 3 million).
  • A 5 percent surtax applied to estates from 10
    million to 21 million.

7
(No Transcript)
8
ESTATE PLANNING STRATEGIES
  • Marital Deduction.
  • Maximizing effect of unified gift-estate tax
    credit.
  • Reduce value of the estate by gifts prior to
    death.

9
PROBABILITIES OF DEATH AND DISABILITIES
10
ELIGIBILITY AND QUALIFICATION
  • Quarter of coverage one quarter for 870 in
    earnings in 2002.
  • Fully insured status 40 quarters of coverage.
  • Currently insured status 6 of the last 13
    quarters.

11
FINANCING
  • FICA tax originally 1, 7.65 by 2002 (payable
    by employer and employee).
  • The tax base originally 3,000, 84,900 by
    2002.
  • Medicare tax is not subject to the wage base. It
    applies to total earned income without limit.

12
AMOUNT OF BENEFITS
  • All benefits are based on Primary Insurance
    Amount (PIA).
  • PIA is amount to which worker would be entitled
    for retirement at age 65.
  • PIA is based on workers average earnings during
    period of employment, subject to certain
    adjustments.

13
COMPUTING THE PIA
  • Computation period
  • year worker reaches age 22 until year before
    worker reaches age 62, dies, or is disabled.
  • Up to 5 years may be dropped. Minimum 2 years in
    computation.
  • Earnings are indexed to determine Average Indexed
    Monthly Earnings (AIME).
  • Primary Insurance Amount is computed from AIME by
    formula.

14
LOSS OF BENEFITS DISQUALIFYING INCOME
  • Disqualifying income is not a needs test but a
    retirement test.
  • Beginning in 1999, loss of benefits for
    disqualifying income applies only to persons
    under age 65.
  • Under age 65, 11,280 was exempt in 2002.
  • If earnings exceed exempt amount, benefit is
    reduced by 1 for each 2 the exempt amount is
    exceeded.

15
TAXATION OF SOCIAL SECURITY BENEFITS
  • Amount of benefits subject to tax depends on
    combined income and filing status.
  • Combined income is the sum of adjusted gross
    income, tax exempt interest, and one-half the
    social security benefit.
  • If combined income is between 25,000 and
    34,000, up to 50 of social security benefits
    may be taxed.
  • If combined income is over 34,000, up to 85 of
    the benefits may be taxed.
  • For those filing joint returns, break points are
    32,000 and 44,000.

16
FUTURE PROJECTIONS
  • Trust funds have increased from about 45 billion
    in 1982 to more than 1 trillion in 2001.
  • Based on intermediate assumptions, trust funds
    will peak at about 3.5 trillion in 2016.
  • After 2016, deficits will deplete the Trust funds
    by 2038.

17
PROPOSALS FOR CHANGE
  • Change in system of financing.
  • Change in benefit levels
  • Original retirement age was 65.
  • It is scheduled to increase to 67 by 2022.
  • Some have recommended further increase.
  • Proposal for privatization would allow workers
    to invest in private alternatives to social
    security (i.e. invest in the private sector).

18
PRINCIPLES OF WORKERS COMPENSATION
  • Negligence is no longer a factor in determining
    liability.
  • Indemnity is partial but final.
  • Periodic payments are made to workers.
  • Cost of the program is made a cost of production.
  • Insurance is required.

19
OVERVIEW OF WORKERS COMPENSATION LAWS
  • Persons covered
  • None of the laws cover all employees.
  • Most frequently excluded classes are agricultural
    and domestic employees.
  • Laws permit employer of persons excluded to bring
    these workers under the law voluntarily.

20
WORKERS COMPENSATION BENEFITS
  • Medical Expenses.
  • Total Temporary Disability.
  • Partial Temporary Disability.
  • Total Permanent Disability.
  • Partial Permanent Disability.
  • Survivors Death Benefit.
  • Rehabilitation Benefits.

21
SOME UNIQUE CHARACTERISTICS OF LIFE INSURANCE
  • The event insured is an eventual certainty and
    the probability of loss increases from year to
    year.
  • Life insurance does not violate requisites of an
    insurable risk it is not the possibility of
    death that is insured, but of untimely death.
  • No possibility of partial loss. All policies are
    cash payment policies.

22
LIFE INSURANCE NOT A CONTRACT OF INDEMNITY
  • Principle of indemnity applies on a modified
    basis in the case of life insurance.
  • When person taking out the policy is the insured,
    insurable interest is not an issue.
  • every individual has an unlimited insurable
    interest in his or her own life.
  • that insurable interest may be freely assigned.
  • Persons other than insured must have an insurable
    interest only at inception of policy.

23
TYPES OF LIFE INSURANCE

Term Insurance Cash
Value Insurance Pure
Protection Insurance and
Savings
24
RATIONALE FOR DIFFERENT FORMS
  • 1. Premium eventually becomes unaffordable for
    person who wants to continue coverage
  • age 21 1.07
  • age 30 1.35
  • age 40 2.42
  • age 50 4.96
  • age 60 9.47
  • age 70 22.11
  • age 80 65.99
  • age 90 190.75
  • 2. Insurers developed the principle of the level
    premium as a practical method of providing
    lifetime insurance.

25
COMPARISON OF TERM WHOLE LIFE PREMIUMS
  • Level premium reflects an overcharge during the
    early years of the policy, which is offset by an
    undercharge in later years.
  • Reserve does not increase and then diminish,
    because overpayments by those who die are
    forfeited to the reserve for the survivors.

Increasing term premium

26
INCREASE IN RESERVE ON WHOLE LIFE POLICY
1,000
Decreasing Amount of Protection
Increasing Savings Element
Insureds Age
27
TAX TREATMENT OF LIFE INSURANCE
  • Life insurance policies are granted favorable tax
    treatment in two ways
  • Amounts payable to beneficiary at the death of
    the insured are not generally included in taxable
    income.
  • Income earned on the cash surrender value is not
    taxed until the policy is terminated and the gain
    is received.
  • Further, the cost of life insurance is deductible
    as part of the basis in computing taxable gain.

28
TAX TREATMENT OF LIFE INSURANCE
  • Favorable tax treatment is allowed only for
    contracts that meet the Internal Revenue Code
    definition of life insurance.
  • Internal Revenue Code establishes two tests to
    determine if a contract is life insurance.
  • If the contract fails to meet one of the two
    tests, earnings on the cash surrender value is
    currently taxable to the insured.

29
CASH VALUE ACCUMULATION TEST
  • Cash Value Accumulation test will be met if cash
    surrender value of the policy does not at any
    time exceed the Net Single Premium that is
    required to fund future benefits, assuming
    maturity no earlier than age 95.
  • Computation uses the greater of a 4 interest
    rate or the rate guaranteed by the contract.
  • CASH VALUE CORRIDOR TEST

30
PERCENTAGES FOR CASH VALUE CORRIDOR TEST
31
CURRENT LIFE INSURANCE PRODUCTS
  • Renewable term guarantees the insured the right
    to continue coverage for a number of additional
    periods.
  • Convertible term guarantees the insured the
    right to exchange the policy for some type of
    permanent insurance.
  • Advantages and disadvantages of term
  • provides greatest amount of protection for
  • given dollar outlay.
  • temporary protection only.

32
CURRENT LIFE INSURANCE PRODUCTS
  • Whole Life
  • Straight whole life provides protection for
    insureds entire lifetime (until age 100) with
    premiums payable for lifetime.
  • Limited-pay whole life provides protection for
    entire lifetime (until age 100) with (higher)
    premiums payable for a shorter time.
  • Single Premium Life.

33
CURRENT LIFE INSURANCE PRODUCTS
  • Universal Life
  • Introduced in 1979 by a brokerage firm.
  • Subject to specified limitations, premium, cash
    value, and level of protection can be adjusted up
    or down to meet insureds needs.
  • Premiums are credited to a fund, which is
    credited with policys share of investment
    earnings.
  • Fund provides source of funds to pay cost of pure
    protection (term) under the policy.

34
CURRENT LIFE INSURANCE PRODUCTS
  • Variable Life Insurance
  • A whole life contract in which insured has the
    right to direct how cash value will be invested.
  • Insured bears the investment risk in the form of
    fluctuations in cash value and amount of
    protection.
  • Amount of premium is fixed, but cash value and
    face amount vary, subject to a minimum.
  • Variable universal life combines features of
    universal and variable life insurance.

35
CURRENT LIFE INSURANCE PRODUCTS
  • Endowment Life Insurance
  • Endowment contracts no longer meet the Internal
    Revenue Code definition of life insurance.
  • Endowment policies are issued for a term period
    such as 10 or 20 years.
  • Endowment policies promise to pay face amount if
    the insured dies during the policy period and
    also to pay the face amount if the insured
    survives the policy period.

36
PARTICIPATING NON-PARTICIPATING LIFE INSURANCE
  • Participating policies pay dividends.
  • Originally issued only by mutual insurers.
  • Dividend varies from margin built into premium.

37
GENERAL CLASSIFICATIONS OF LIFE INSURANCE
  • Ordinary life 58.8 of insurance in force.
  • Industrial less than 1 (0.2) today, compared
    with 10 at one time.
  • Group life 40 of life insurance in force.
  • Credit life insurance about 1.2.
  • Total life insurance in force exceeds 15
    trillion.

38
OTHER TYPES OF LIFE INSURANCE
  • Besides life insurance issued by legal reserve
    insurers, a small amount (about 2.5) of life
    insurance is written by other types of insurers.
  • Savings bank life insurance (NY, Mass, Conn).
  • Fraternal life insurance.
  • Veterans life insurance.
  • Wisconsin state life insurance fund.

39
LIFE INSURANCE PREMIUM COMPUTATION
  • Mortality 1980 CSO Table (separate tables for
    male/female).
  • Interest time value of money.
  • Loading for insurer expenses, taxes, profit.

40
COMMISSIONERS 1980 STANDARD ORDINARY MORTALITY
TABLE
41
ONE YEAR TERM POLICY
  • Alive at age 21 9,810,509
  • Number who will die 10,497
  • 1 year term policy without interest
  • 10,497,000
  • 9,810,509 1.07
  • 1 year term policy with interest
  • 10,497,780 x 0.95694
  • 9,810,509
    1.02

42
ANNUAL TERM FOR FIVE YEARS

43
NET SINGLE PREMIUM 5-YEAR TERM POLICY
5-year term net single premium 47,787,890
9,810,509 4.8710
44
NET SINGLE PREMIUM 5-YEAR ANNUITY DUE
5-year annuity due premium 44,912,264
9,810,509 4.5779
45
NET SINGLE PREMIUM WHOLE LIFE POLICY
Whole Life net single premium 1,052,972,752
9,810,509 1.07.33
46
NET LEVEL PREMIUM CONVERSION
  • 4.5779 is the actuarial equivalent of
  • 1 now and a 1 payment.
  • every year for 4 years.
  • Therefore,
  • 4.5779 4.8710 1 X
  • X 1.064

47
RESERVE ON LIFE INSURANCE POLICIES
  • Reserve Present Value of -
    Present Value of
  • Future Benefits
    Future Premiums

48
POLICY RESERVES VARIOUS CONTRACTS
49
BENEFIT CERTAIN CONTRACTS
  • Benefit Certain Contracts are those under which,
    if the insured persists in premium payments, the
    policy will eventually mature and benefits will
    be payable.
  • Cash value policies, under which benefits are
    payable whether the insured lives or dies are
    benefit certain contracts.
  • Ignoring the interest on premiums paid, the net
    single premium on benefit certain policies equals
    the face of the policy.

50
BENEFIT UNCERTAIN CONTRACTS
  • Benefit uncertain contracts are those under
    which, if the insured persists in premium
    payments for the entire policy period, the
    insurer may or may not be obligated to make
    payment.

51
  • One year term rate

52
  • Five year term rate

53
  • Five Year Endowment

54
  • Five Year Annuity due

Annual premium 5-year endowment 3.865 1
520 X X 134.50
55
GENERAL PROVISIONS IN LIFE INSURANCE CONTRACTS
  • Entire contract clause.
  • Ownership clause.
  • Beneficiary clause.
  • Incontestable clause.
  • Misstatement of age clause.
  • Grace period clause.
  • Reinstatement clause.
  • Suicide clause.
  • Aviation exclusions.
  • War clause.

56
OWNERSHIP CLAUSE
  • Ownership rights
  • right to assign or transfer the policy.
  • right to receive cash value and dividends.
  • right to borrow against the policy.
  • Usually, the insured is the owner.
  • In the event of the death of the insured, the
    beneficiary becomes the owner.

57
INCEPTION OF THE LIFE CONTRACT
  • If the application is submitted without the
    initial premium, the insurer makes an offer to
    the insured and no contract until offer is
    accepted.
  • If the initial premium is submitted with the
    application, the insurer acknowledges receipt of
    the premium with a conditional binding receipt.
  • Conditional binding receipt makes the policy
    effective at date of application if the applicant
    is found to have met the insurers underwriting
    standards.

58
BENEFICIARY DESIGNATIONS
  • Primary Contingent
  • Revocable Irrevocable

59
REINSTATEMENT
  • If a lapsed policy has not been surrendered for
    its cash value, it may be reinstated within 5
    years from the date of lapse.
  • Reinstatement requires that the insured
  • provide evidence of insurability.
  • pay overdue premiums plus interest.
  • reinstate any indebtedness with interest.

60
SETTLEMENT OPTIONS
  • The interest option.
  • Installments for a fixed period.
  • Installments for a fixed amount.
  • Life income options.

61
TABLE 14.1 Installments for a Fixed Period
1 84.65 11 9.09
21 5.56 2 43.05 12
8.46 22 5.39 3 29.19
13 7.94 23
5.24 4 22.27 14 7.49
24 5.07 5 18.12 15
7.10 25 4.93 6 15.35
16 6.76 26 4.84 7
13.38 17 6.47
27 4.73 8 11.90 18
6.20 28 4.63 9 10.75
19 5.97 29 4.53 10
9.83 20 5.75 30 4.45
62
LIFE INCOME OPTIONS
  • Straight life income.
  • Life income with period certain.
  • Life income with cash refund.
  • Life income with installment refund.
  • Joint and survivor income.

63
CHAPTER 14 THE LIFE INSURANCE CONTRACT GENERAL
PROVISIONS
64
JOINT AND SURVIVOR LIFE INCOME OPTION
65
TAXATION OF POLICY PROCEEDS
  • Benefits under a life insurance policy are not
    subject to the federal income tax, except for
    post-death interest on the policy proceeds.
  • Monthly proceeds for 10 years on a 100,000 death
    benefit will be 983, or 11,796 annually.
  • 10,000 annually is the tax-exempt death benefit.
  • The 1,796 annually represents taxable interest.
  • When proceeds are payable under a life income
    option, the taxable interest is determined based
    on the beneficiarys life expectancy using IRS
    mortality tables.

66

TABLE OF GUARANTEED VALUES END OF
100,000 POLICY CASH PAID-UP EXTENDED
TERM YEAR JANUARY 1 VALUE INSURANCE
INSURANCE TO 1 1987
0 0
2 1988 1,078 5,000
3 1989 2,201
9,800 4 1990 3,371
14,400 5 1991
4,588 18,700 6
1992 5,852 22,900
7 1993 7,165 26,800
8 1994 8,528
30,500 9 1995
9,942 34,100 10
1996 11,411 37,400
11 1997 12,933 40,600
12 1998 14,515 43,700
13 1999 16,156
46,600 14 2000
17,860 49,300 15
2001 19,629 51,900
16 2002 21,466 54,400
17 2003 23,370
56,800 18 2004 25,341
59,000 19 2005
27,380 61,100 20
2006 29,486 63,100 AGE 60
2011 38,328 71,800 AGE
65 2016 47,545 78,800
AGE 70 2021 56,741 84,400

67
POLICY LOAN PROVISION
  • Insured may obtain a loan from the insurer equal
    to the policy cash value.
  • Loan is subject to a delay clause, up to 6
    months.
  • Interest of 5 or 6 on older contracts, 8 on
    newer contracts.
  • Since 1980, NAIC rules allow variable interest
    rate on policy loans.

68
DIVIDEND PROVISIONS
  • Cash.
  • Applied to payment of current premium.
  • Purchase paid up additions.
  • Left to accumulate.

69
  • 500,000 90 Life
  • For Joe Client Age 30 Male
  • Contract Premium 6,210.00
  • Premiums Annual Mo. ISA
    Annual Income
  • _at_60 39,084
    _at_65 64,306
    _at_76 187,750
  • Insurance
    6,210.00 540.27 Based on current
    (2-16-03)

  • Installment Refund rates may change
  • Indexed Protection 370.00
    32.19
  • Disability Waiver 150.00 13.05
  • IPB Waiver 85.00
    7.40
  • 300,000 Accidental Death
    216.00 18.80
  • 100,000 Additional Purchase 150.00
    13.05
  • Subject to underwriting limits
  • Premium included throughout
  • Non-guaranteed illustrated values and benefits
    include dividends. Dividends assume no loans

70


71
DISABILITY WAIVER OF PREMIUM
  • Insurer agrees to waive all premiums coming due
    after the insured has become totally and
    permanently disabled as a result of sickness or
    bodily injury.
  • Disability must commence before some specified
    age, usually age 55 or 50, but as high as 65 in
    some contracts.
  • Disability must have lasted for six months.
  • Premiums are waived from commencement of the
    disability, including the first six months.

72
DISABILITY WAIVER OF PREMIUM
  • One of the most important aspects of the
    disability waiver of premium provision is the
    definition of disability.
  • Disability usually defined as the inability of
    the insured to engage in his or her own
    occupation during the first two years of
    incapacity.
  • Thereafter, disability is defined in terms of an
    occupation for which the insured is reasonably
    fitted by education, training, or experience.

73
ACCIDENTAL DEATH BENEFIT
  • Commonly known as double indemnity
  • Pays an additional sum equal to the face of the
    policy if the death of the insured is caused by
    accident.
  • Death must result, directly and independently of
    all other causes, from accidental bodily injury
    and within 90 days after the injury.
  • The accidental bodily injury and death must occur
    before a specified age, usually age 70.

74
GUARANTEED INSURABILITY OPTION
  • Permits an insured to purchase additional amounts
    of insurance at stated intervals without
    providing evidence of insurability.
  • The customary option dates are at ages 25, 28,
    31, 34, 37, and 40.
  • The option amount is limited to the face amount
    of the basic policy or a specified option amount,
    whichever is the smaller.
  • The maximum amount of each option was originally
    10,000, but limits of 25,000 and higher are now
    available.

75
COMMON DISASTER CLAUSE
  • Uniform Simultaneous Death Act provides that
    where the insured and the beneficiary have died
    and there is no evidence that they died other
    than simultaneously, life insurance proceeds
    shall be distributed as if the insured survived
    the beneficiary.
  • Where there is evidence that the beneficiary
    survived the insured, even for a short time, the
    life insurance proceeds go to the beneficiary and
    then to his or her estate.

76
SPENDTHRIFT CLAUSE
  • The Spendthrift Clause denies the beneficiary the
    right to commute, alienate, or assign his or her
    interest in the policy proceeds.
  • Used only in conjunction with an installment
    settlement option.
  • Provides some protection against the
    beneficiarys extravagance that might result in
    the dissipation of the policy proceeds.
  • Also provides some protection against claims made
    by creditors of the beneficiary.

77
COST-OF-LIVING RIDERS
  • Under a cost-of-living rider, the insurer offers
    the insured additional coverage (for which the
    insured pays an added premium) when the Consumer
    Price Index Increases.
  • Principal advantage is that the additional
    insurance is offered without evidence of
    insurability.
  • If the insured rejects any of the increases, the
    insurer may require evidence of insurability for
    the next increase.

78
MORTGAGE REDEMPTION POLICY
79
JOINT MORTGAGE REDEMPTION POLICY
  • Decreasing term, written on two lives.
  • Designed to cover mortgage obligation of a
    two-income couple in the event one dies.
  • Premium is slightly less than separate individual
    mortgage protection policies on each partner.

80
SURVIVORSHIP WHOLE LIFE
  • Also called second-to-die policy.
  • Insures two lives and pays only at the time of
    the second death.
  • Designed to cover estate taxes payable at the
    death of a surviving spouse, since marital
    deduction will not be available under the federal
    estate tax.

81
OTHER SPECIAL POLICIES
  • Return of Cash Value Policy.
  • Return of Premium Policy.
  • Family Protection Policy.
  • Family Income Policy.
  • Family Maintenance Policy.

82
MODIFIED WHOLE LIFE
  • Premium for first 3 to 5 years is slightly higher
    than premium for term.
  • At end of 3-to-5 year period, premium increases
    to slightly more than premium for whole life at
    inception, but less than whole life premium at
    the attained age.
  • First 5 Years Thereafter
  • 5-year term converted to whole life 4.23
    14.99
  • Modified Whole life
    4.58 13.54
  • Convertible Term

83
GRADED-PREMIUM WHOLE LIFE
  • Initial premium is quite low, but gradually
    increases and levels off sometime between the
    10th and 20th year.
  • Cash values do not develop until year 10 and are
    relatively low, even by year 20.

84
Modified Whole Life
Graded Premium Whole Life
Whole Life
85
SINGLE PREMIUM LIFE
  • Single premium creates an immediate cash value
    that is sufficient to fund cost of benefits over
    the life of the policy.
  • Written on both traditional whole life and
    variable life basis.
  • Rate of return on traditional policies may be
    guaranteed for
  • 1 to 5 years.
  • Earnings accumulate tax-free until the policy is
    cashed in.
  • Usually no front-loaded commission, but subject
    to surrender charge that diminishes and
    disappears after from 7 to 10 years.
  • Beware corridor rules.

86
PROTECTION AND CASH VALUE PER 100 PREMIUM
  • At age 25, a 100 premium will purchase



  • Cash Value
  • l Protection in 20 years
    l
  • Yearly-renewable term 78,000
    0
  • Ten-year term policy 57,000
    0
  • Whole life policy
    11,300 1,671
  • Paid-up at age 65
    10,250 1,695
  • Twenty-pay life policy 7,400
    1,798

87
BUY TERM AND INVEST THE DIFFERENCE
  • The choice between term and cash value life
    insurance is usually not a risk management
    decision, it is an investment decision.
  • The choice is not between term and cash value
    life insurance, but between cash value life
    insurance and other investments.
  • In making this choice, cash value life insurance
    should be judged against the same standards as
    other investments.

88
LIFE INSURANCE AS AN INVESTMENT
  • A considerable amount of literature much from
    vendors of competing investments condemns life
    insurance as an investment.
  • Much of this literature oversimplifies a complex
    issue.
  • There are some situations in which life insurance
    compares favorably with other investment
    alternatives.

89
LIFE INSURANCE AS AN INVESTMENT
  • Compulsion often cited as an advantage but not
    particularly compelling.
  • Tax treatment is more persuasive
  • Increments to cash value not taxed until
    received.
  • Insured allowed to deduct cost of protection in
    computing taxable gain.
  • Complementary function of protecting against
    premature death at the same time it provides an
    accumulation.

90

SAMPLE POLICY
  • Face Amount 100,000
  • Premium 1,533
  • CV20 29,486
  • 20 x 1,533 30,660
  • Net Cost 30,660
  • - 29,486
  • 1,174 (Net Cost)
  • Per year 58.70
  • Per year, per 1,000 0.59
  • Compare to Cost of Term
  • Year 35 2.50 per 1,000
  • Year 45 4.46 per 1,000
  • Year 54 7.79 per 1,000

91
  • ALLOW FOR TIME VALUE OF MONEY
  • PV 1st Premium
    1,533.00
  • PV of following 19 premium 18,526.79
  • 20,059.79
  • PV CV in 20 years - 11,112.98

  • 8,946.81

92
LIFE INSURANCE AS AN INVESTMENT - NEGATIVES
  • Life insurance policies have a relatively high
    expense component.
  • Front-loaded commissions make return during early
    years negative and in the long-run less
    attractive than alternatives.
  • Actual rate of return depends on the time for
    which the policy is held.
  • If insurance is considered as an investment, it
    should be considered only as a long-term
    investment.

93
MARKETING REFORM IN LIFE INSURANCE
  • In the mid-1990s, many segments of the life
    insurance industry were subject to extensive
    criticism for their market conduct.
  • Headlines referred to practices such as churning,
    or improper replacements.
  • Vanishing premiums that did not vanish.
  • Misrepresentations during the sales process.
  • Many insurers were subject to class action
    lawsuits and regulatory actions.

94
MARKETING REFORM IN LIFE INSURANCE
  • Two areas of concern were illustrations used in
    marketing and the replacement of older policies
    with the newer interest sensitive contracts.
  • In response, the NAIC developed new model
    regulations to address life insurance marketing
    practices.

95
LIFE INSURANCE AND DIVORCE AGREEMENTS
  • A divorce proceeding may require purchase of new
    insurance or may require continuation of existing
    insurance, or the transfer of existing insurance
    policies to a former spouse.
  • These transactions can have tax implications.
  • In general, tax treatment of premiums paid for
    life insurance follow the rules applicable to
    alimony payments.
  • Spouse who is obligated to pay alimony can fund
    future alimony payments through the purchase of
    an annuity for the spouse to whom the payments
    are due.

96
ANNUITIES AND PENSION BENEFITS AND RETIREMENT
  • ANNUITIES
  • Reverse application of the law of large numbers.
  • Lifetime guaranteed income to annuitant.
  • Persons who live longer offset those who live
    shorter.
  • Every payment to annuitant is part interest, part
    principal, and part survivorship benefit.
  • Fixed versus Variable.
  • Immediate versus Deferred.
  • Single Premium versus Installment.
  • Single Life versus Two or More Lives.
  • Pure Life Annuity versus Annuity Certain.

97
THE IMPORTANCE OF ANNUITIES
  • If Roy Peabody is 65 years old, has saved over
    the years 200,000, and the current rate of
    interest is 6, he has the following options

98
OPTION 2
  • Roy has decided that he has had enough of saving
    for the kids. He wants to live the good life in
    Florida, but will require 4,000 more annually to
    do so.

99
OPTION 3
  • Roy decides to move to Florida and discovers the
    joys of golf and fishing. He figures that he
    will not live much longer so 20,000 annually
    seems like a better retirement income.

100

OPTION 4
  • Roy has decided to see some of the world, in
    addition to golfing and fishing. He needs to
    increase his retirement income to 25,000
    annually.

101
OPTION 5
  • Roy decides to buy an annuity. An investment of
    200,000 made with Non-Qualified funds will
    provide an income under the following annuity
    options, age 65 male

102
ANNUITY CERTAIN CONTRACTS
  • Pure life annuity.
  • Life annuity with period certain.
  • Life annuity with installment refund.
  • Life annuity with cash refund.

103
SPECIALIZED ANNUITIES
  • Single-Premium Deferred Annuity
  • Increased popularity since TRA-86 eliminated
  • many tax shelters.
  • Currently taxed same as other annuities
    earnings accumulate on tax-deferred basis.
  • Some insurers sell SPDAs with deposit premium as
    low as 2,500, but more common minimum is 10,000.

104
VARIABLE ANNUITY
  • Designed as a means of coping with inflation.
  • Premiums invested in common stocks or similar
    investments.
  • Based on assumption that the value of a
    diversified
  • portfolio of common stocks will change in the
    same
  • direction as price level.
  • Variable annuity may be variable during
    accumulation
  • period and fixed during payout period or
    variable during both periods.

105
QUALIFIED RETIREMENT PLANS
  • A qualified retirement plan is one that
    conforms to the requirements of the Internal
    Revenue Code (I.R.C.) that must be met for
    favorable tax treatment.
  • Contributions tax-deductible by the employer when
    made.
  • Contributions and investment earnings both
    accumulate without tax until distributed to the
    employee, usually at retirement.

106
CONTRIBUTORY AND NONCONTRIBUTORY PLANS
  • Retirement plans may be noncontributory (entire
    cost paid by the employer) or contributory (with
    contributions added by the employee).
  • Employee contributions may be voluntary, or they
    may be required for participation.
  • Employee contributions not usually deductible by
    the employees, but investment income on such
    contributions is not taxed until distributed.

107
FEDERAL REGULATION OF PRIVATE RETIREMENT PLANS
  • The Employee Retirement Income Security Act
    (ERISA) of 1974 was the most sweeping overhaul of
    private pensions in the history of the country.
  • ERISA prescribes which employees must be included
    in a plan, sets minimum vesting requirements,
    specifies contribution limits, and sets minimum
    funding requirements.
  • ERISA also requires extensive reporting and
    disclosure information about pension and welfare
    programs to the Secretary of Labor, the IRS, and
    to those covered by the plan and their
    beneficiaries.

108
VESTING REQUIREMENTS
  • Vesting refers to the right of an employee to
    benefits accrued if employment terminates before
    retirement.
  • ERISA requires that a qualified plan meet one of
    the following schedules
  • No vesting for 3 years, with 100 vesting after 3
    years (called cliff vesting).
  • 20 vesting after 2 years of service, with 20
    per year thereafter, so that 100 vesting exists
    after 6 years of service.

109
TYPES OF QUALIFIED RETIREMENT PLANS
  • Defined Contribution.
  • Defined Benefit.
  • Qualified Profit-Sharing Plan.
  • Keogh Plan.
  • 401(k) Plans.
  • Employee Stock Ownership Plan.

110
SURS PLAN FOR YOUR PROFESSORS
  • 2.2 years of service Average High Four
  • Professor Tom
  • 1. Taught for 30 years
  • 2. His highest gross income was
  • 27 67,200
  • 28 69,900
  • 29 70,600
  • last year 72,000 l
  • Average 69,925
  • Pension Benefit 2.2
  • 30
  • 69,925
  • 46,150

111
PREMATURE DISTRIBUTIONS
  • 10 penalty prior to age 59 1/2 except for
  • Deductible medical expenses.
  • In form of lifetime annuity.
  • At age 55 by worker who meets plan requirements
    for retirement.

112
TAXATION OF DISTRIBUTIONS
  • Retirement benefits traditionally paid to
    participants in form of a lifetime annuity
    although many offer lump sum.
  • Installment distributions taxable only to the
    extent they exceed employees investment in the
    contract.
  • Lump-sum distributions may be rolled-over into an
    annuity and taxed under installment rules.

113
TRADITIONAL INDIVIDUAL RETIREMENT ACCOUNTS
  • Anyone with earned income less than 70 1/2 might
    be eligible to contribute to IRA account.
  • Limit is 3,000 spousal is 3,000 as well.
  • Contributions fully tax deductible if (1) not
    covered by a company sponsored or (2) covered by
    a pension plan but income less than 33,000
    (50,000).
  • Phase out in 2001 33,000 - 43,000.
  • Anyone with income over 43,000 is better off
    with Roth.

114
NEW ROTH IRA
  • Since January of 1998, contributions permitted to
    Roth IRA
  • Contributions made only on a non-deductible
    basis.
  • All earnings on the contributions compound
    tax-free as long as they are not withdrawn for a
    least five years and there are no taxes due when
    the funds are withdrawn for retirement (i.e.,
    after age 59 1/2).
  • Annual contributions of 100 of compensation up
    to 3,000 per individual may be permitted.
  • Single taxpayers with income of up to 95,000 or
    couples filing jointly with annual income up to
    150,000 can contribute full 3,000 annually.
  • No requirement that withdrawals commence at 70
    1/2 and contributions to a Roth IRA may continue
    after age 70 1/2 if the individual or spouse has
    earned income.
  • Individuals can have a Traditional IRA and a Roth
    IRA, but cannot contribute more than combined
    total of 3,000 per year between both of these
    accounts.

115
CHAPTER 20
  • HEALTH INSURANCE PERILS
  • Sickness.
  • Accident.
  • HEALTH INSURANCE LOSSES
  • Lost income (disability).
  • Extra expenses (medical expense).

116
GROUP INSURANCE WORKS BEST WHEN
  • Insurance is incidental to group.
  • Flow of persons through group.
  • Benefits not selected.
  • Minimum participation requirement (100
    noncontributing).
  • Part paid for by third party (employer, etc.)
  • MUCH OF HEALTH INSURANCE MARKET IS GROUP.

117
NEED FOR DISABILITY INCOME INSURANCE
  • Probability of disability at most ages before
    retirement is greater than the probability of
    death.
  • Disability can be both total and permanent.
    Disability ranks with death in severity.
  • When persons other than the disabled person were
    supported by the lost income, the problem is more
    severe.

118
PROTECTION FROM OTHER SOURCES
  • Workers Compensation for work-related
    disabilities.
  • Compulsory Temporary Disability programs in
    California, Hawaii, New Jersey, New York, Rhode
    Island, and Puerto Rico.
  • OASDI for total and permanent disability.
  • Demanding test.
  • Many applications rejected.
  • Total and permanent.
  • 6 month wait.
  • Employer-provided sick leave or cash benefits.

119
DISABILITY INCOME UNDERWRITING AND PRICING
  • Occupational Classes and Underwriting
  • Insurers divide risks into three general classes,
    in descending order of desirability
  • Professional.
  • White collar.
  • Blue collar.
  • In life insurance, group policies tend to be more
    liberal in disability income insurance,
    individual policies are generally more liberal.
  • Taxation if pay with after tax dollars,
    payments tax free.

120
DISABILITY INCOME CONTRACTS PERILS COVERED
  • Accident only generally called accident
    insurance.
  • Accident and sickness generally called
    disability income insurance.

121
DISABILITY INCOME CONTRACTS WAITING PERIODS
AND LIMITATIONS
  • Waiting Periods in disability income policies act
    like a deductible (60 or 90 days)
  • Insurers generally limit percentage of
    individuals income they will insure
  • About 60 of workers wage under short-term
  • policies (group).
  • 67 under long-term disability Northwestern
    Mutual.
  • To protect against possible malingering.

122
DEFINITIONS OF TOTAL DISABILITY
  • Own occupation.
  • Own occupation or occupation reasonably suited
    for on basis of background, training, experience,
    or income.
  • Any occupation social security definition.
  • Two-tier definition
  • Own (for 2, 5 years, or even until 65)
  • Then any or reasonably suited
  • Prime contracts give insured Your Choice, so
    after 2, 5 years can stop working altogether (no
    more partial, see below) or stop getting
    benefits
  • Lesser contract the claims adjuster determines
    whether you can go to work

123
DEFINITIONS OF TOTAL DISABILITY continued
  • Partial disability insured cannot work as much
    as used to before accident and can collect
    difference (called Loss of Earnings approach).
  • Pays partial on earnings now l
  • pre-loss
    earning.

124
DEFINITIONS OF SICKNESS PREEXISTING CONDITIONS
  • Sickness commencing after policy inception.
  • Sickness first manifesting itself after
    inception.
  • Group disability income plans tend to have no
    exclusions or less restrictive exclusions for
    preexisting conditions.
  • Prim individually underwritten contracts check
    today and ignore pre-existing condition.

125
OPTIONAL BENEFIT PROVISIONS
  • Guaranteed Insurability Option.
  • Cost-of-Living Adjustment Benefit.
  • Waiver of Premium (may be built in).

126
INDIVIDUAL HEALTH POLICY CONTINUANCE PROVISIONS
  • Noncancelable guaranteed renewable at
    guaranteed cost.
  • Guaranteed renewable cost can increase but only
    for entire group in rating category.
  • Conditionally renewable only if certain
    conditions like good health.
  • Renewable at company option.
  • Cancelable.

127
SELECTED UNIFORM PROVISIONS
  • Entire contract like life insurance.
  • Time limit on defenses incontestable.
  • Grace period similar to life but different days
    depending on frequency of payment period.
  • Reinstatement similar to life insurance.

128
SELECTED OPTIONAL PROVISIONS
  • Change of occupation changes benefit not in
    prime.
  • Misstatement of age changes benefit.
  • Relation of earnings to insurance reduces benefit
    if making less than when policy written.
  • Illegal occupation no coverage.
  • Intoxicants and narcotics, no coverage.

129
TAXATION OF DISABILITY INCOME BENEFITS
  • Benefits from individual disability income
    policies not subject to federal income tax.
  • Premiums paid by individuals for disability
    income insurance are not deductible for federal
    tax purposes.
  • Sick pay and other disability income payments
    that have been paid for by the employer treated
    as wages and taxable.

130
COST OF DISABILITY INCOME INSURANCE
  • Premium for disability income depends on
  • Occupation, age, and sex of the insured.
  • Period for which benefits are payable.
  • Amount of the weekly or monthly benefit.
  • Length of the waiting period.
  • Most disabilities are short-term coverage for
    longer periods of disability more economical.
  • Waiting period or elimination period
    significant influence on cost.

131
FEE FOR SERVICE
  • The coverage provided by Blue Cross and Blue
    Shield and insurance companies came to be called
    fee-for-service coverage.
  • Under this approach, insureds were free to choose
    doctors, hospitals and other health care
    providers, without insurer approval.
  • The provider and insured agreed on the level of
    care and the insurer would pay some or all of the
    providers changes, directly or by reimbursing the
    insured.

132
FEE FOR SERVICE
  • Initially, most fee for service plans provided
    first-dollar coverage (without participation in
    cost by the insured).
  • Eventually, insurers attempted to control costs
    through deductibles and share-loss coinsurance,
    under which the patient bears a part of the cost.

133
MEDICARE
  • In 1965, government entered the market when
    Congress established the Medicare program to
    provide medical expense insurance to persons over
    age 65.
  • The same legislation created Medicaid, a
    state-federal medical assistance program for
    low-income persons.
  • During the years immediately following Medicare
    in 1965, the cost of health care (and of private
    health insurance) increased dramatically.

134
MANAGED CARE ORGANIZATIONS
  • The solution was the concept of managed care,
    which represented a change not only in the
    financing of health care, but in its delivery as
    well.
  • New types of insurers, such as health
    maintenance organizations, not only provide for
    the financing of
  • health care, it also delivers that care.
  • The insurance element in HMOs lies in the way
    they
  • charge, called capitation.
  • In return for a fixed monthly fee, the individual
    receives virtually all required medical care,
    subject to a nominal charge when visiting a
    physician.

135
HEALTH MAINTENANCE ORGANIZATIONS
  • Whatever the arrangement with the physicians, the
    fee-for-service system is replaced by a system of
    capitation.
  • The subscriber chooses a primary-care physician
    (gatekeeper), who determines what care is
    received and when the patient is referred to
    specialists.
  • Emergency services are provided outside the
    network in case of a sudden illness or injury,
    which, if not treated, could jeopardize the
    subscribers life or health.

136
PREFERRED PROVIDER ORGANIZATIONS
  • A preferred provider organization is a network of
    providers (doctors and hospitals) with whom an
    insurance company contracts to provide services.
  • The provider offers to discount those services
    and to set up special utilization review programs
    to control medical expenses.
  • In return, the insurer promises to increase
    patient volume by providing higher rates of
    reimbursement when the care is received from the
    network.
  • The insured is permitted to seek care from other
    providers, but pays a penalty in the form of
    increased deductibles and coinsurance.

137
POINT-OF-SERVICE PLANS
  • Eventually some HMOs adopted procedures that made
    them more like PPOs, adopting what are known as
    point-of-service plans (POS).
  • A POS plan operates like a PPO, since the
    employee retains the right to use any provider,
    but pays a cost when using a provider outside the
    network.
  • At the same time, a POS plan is like an HMO,
    since care received through the network is
    managed by a primary care physician, or
    gatekeeper.
  • Penalties for using a non-network provider are
    usually greater than the penalties under a PPO.

138
DOMINANCE OF MANAGED CARE
  • HMOs, PPOs, and POS plans all involve an
    arrangement between the insurers and a network of
    providers and offer insureds financial incentives
    to use the providers in the network.
  • Thirty years ago, 90 percent of insureds had
    fee-for-service plans.
  • Today, 32 of employees are enrolled in PPOs, 33
    are enrolled in HMOs, 17 are enrolled in POS
    plans, and 18 are in fee-for-service plans.

139
ACCESS TO HEALTH CARE
  • It is estimated that 44 million Americans have no
    health insurance.
  • About three-fourths of the uninsured are
    employees and their dependents
  • About half of these workers have insurance
    available at their place of employment but elect
    not to purchase it.
  • Some of the uninsureds are unemployed and about
    one-third have incomes at or below the poverty
    level but do not qualify for Medicaid.

140
ACCESS TO HEALTH CARE
  • The problem of access is not limited to the
    economically disadvantaged.
  • It also exists for persons who are unable to
    obtain
  • health insurance in the standard market.
  • Plans of small employers may exclude coverage for
    some employees.
  • Persons who must purchase insurance individually
    sometimes find that they cannot obtain it.
  • It is estimated, however, that only 3 percent of
    uninsured lack insurance because they are unable
    to obtain it from a provider.

141
HIGH COST OF HEALTH CARE
  • National expenditures for health care, as a
    percentage of GNP, have increased from 4.4
    percent of GNP in 1950 to over 13 percent by
    2001.
  • The Aging Population.
  • Improved Medical Technology.
  • Excessive Capacity.
  • Defensive Medicine.

142
COBRA
  • Requires continuance of employer-sponsored group
    health insurance under specified circumstances
  • 18 months for terminated employees.
  • 36 months for spouses of deceased, divorced, or
    separated workers or dependent children whose
    eligibility for coverage ceases.
  • The COBRA participant pays a premium based on the
    existing group rate.

143
TRADITIONAL FORMS OF MEDICAL EXPENSE INSURANCE
  • Base Plan Coverage
  • Hospitalization Insurance
  • Surgical Expense and
  • Physicians Expense Insurance
  • Major Medical Insurance

144
MAJOR MEDICAL INSURANCE
  • High maximum (or unlimited).
  • Deductible.
  • Coinsurance or share-loss provision.

145
MAJOR MEDICAL EXAMPLE
  • Deductible 500
  • 80/20
  • Stop Loss (not deductible) 3,000
  • Expense 19,000
  • Insurer Pays 14,800 700
  • Insured Pays 500 3,000
  • (19,000 500) x 20 3,700

146
EXCLUSIONS UNDER HEALTH INSURANCE POLICIES
  • Individual policy exclusions tend to be more
    extensive than those in group policies and some
    group contracts contain more exclusions than
    others.
  • Exclusions typical of those in individual or
    group contracts include
  • Expenses payable under workers comp or any
    occupational disease law.
  • Personal comfort items (e.g., television,
    telephone, air conditioners).
  • Elective cosmetic surgery.
  • Routine medical care (e.g., annual physical,
    birth control, well-baby care).
  • Hearing aids and eyeglasses.
  • Dental work.

147
EXCLUSIONS UNDER HEALTH INSURANCE POLICIES
  • Experimental procedures.
  • Expenses resulting from self-inflicted injuries.
  • Expenses resulting from war or any act of war.
  • Expenses incurred while on active duty with the
    armed forces.
  • Services received in government hospital received
    without charge.
  • Expenses arising out of mental or nervous
    disorders.
  • (Some policies cover mental and nervous
    disorders subject to a lower maximum or only for
    a percentage of the costs covered.)

148
LIMITED HEALTH INSURANCE CONTRACTS
  • Dread disease policies.
  • Travel Accident.

149
SOME SPECIALIZED USES OF LIFE INSURANCE IN
BUSINESS
  • In addition to their use in fringe benefit
    programs and funding retirement benefits, life
    insurance serves several other functions in the
    business firm
  • funding business purchase agreements.
  • protecting the firm against the loss of a key
    employee.
  • additional compensation to executives and other
    valuable employees.

150
BUSINESS CONTINUATION INSURANCE
  • Death or disability of an owner can create
    serious problems for remaining owners.
  • Ideal solution is to arrange for sale of each
    owners interest prior to death through a
    buy-and-sell agreement
  • cross purchase plan.
  • entity plan.
  • Life insurance may be used to fund the
    buy-and-sell agreement.

151
KEY PERSON INSURANCE
  • An employee who make a significant contribution
    to success of the organization is a key person.
  • Death (or disability) of a key person can be a
    source of loss to the organization.
  • Key person life insurance is designed to
    compensate for such loss.
  • Greatest difficulty in insuring key persons is
    determining the amount for which they should be
    insured.

152
DEFERRED COMPENSATION
  • Employer agrees to make payments to an employee
    after retirement, or to employees spouse if the
    employee dies, if the employee continues his or
    her employment with the firm to a specified age.
  • Employee incurs no federal tax liability on the
    employers promise as long as there is no
    constructive receipt.
  • Employers often fund deferred comp arrangements
    through cash value life insurance.

153
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