Title: FIL 351 LIFE INSURANCE
1FIL 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.
3NEEDS ANALYSIS CHART
4FEDERAL 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.
5PRE-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.
6PRE-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)
8ESTATE PLANNING STRATEGIES
- Marital Deduction.
- Maximizing effect of unified gift-estate tax
credit. - Reduce value of the estate by gifts prior to
death.
9PROBABILITIES OF DEATH AND DISABILITIES
10ELIGIBILITY 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.
11FINANCING
- 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.
12AMOUNT 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.
13COMPUTING 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.
14LOSS 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.
15TAXATION 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.
16FUTURE 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.
17PROPOSALS 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).
18PRINCIPLES 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.
19OVERVIEW 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.
20WORKERS COMPENSATION BENEFITS
- Medical Expenses.
- Total Temporary Disability.
- Partial Temporary Disability.
- Total Permanent Disability.
- Partial Permanent Disability.
- Survivors Death Benefit.
- Rehabilitation Benefits.
21SOME 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.
22LIFE 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.
23TYPES OF LIFE INSURANCE
Term Insurance Cash
Value Insurance Pure
Protection Insurance and
Savings
24RATIONALE 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.
25COMPARISON 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
26INCREASE IN RESERVE ON WHOLE LIFE POLICY
1,000
Decreasing Amount of Protection
Increasing Savings Element
Insureds Age
27TAX 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.
28TAX 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.
29CASH 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
30PERCENTAGES FOR CASH VALUE CORRIDOR TEST
31CURRENT 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.
32CURRENT 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.
33CURRENT 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.
34CURRENT 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.
35CURRENT 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.
36PARTICIPATING NON-PARTICIPATING LIFE INSURANCE
- Participating policies pay dividends.
- Originally issued only by mutual insurers.
- Dividend varies from margin built into premium.
37GENERAL 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.
38OTHER 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.
39LIFE INSURANCE PREMIUM COMPUTATION
- Mortality 1980 CSO Table (separate tables for
male/female). - Interest time value of money.
- Loading for insurer expenses, taxes, profit.
40COMMISSIONERS 1980 STANDARD ORDINARY MORTALITY
TABLE
41ONE 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
42ANNUAL TERM FOR FIVE YEARS
43NET 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
46NET 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
47RESERVE ON LIFE INSURANCE POLICIES
- Reserve Present Value of -
Present Value of - Future Benefits
Future Premiums
48POLICY RESERVES VARIOUS CONTRACTS
49BENEFIT 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.
50BENEFIT 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 52 53 54Annual premium 5-year endowment 3.865 1
520 X X 134.50
55GENERAL 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.
56OWNERSHIP 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.
57INCEPTION 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.
58BENEFICIARY DESIGNATIONS
- Primary Contingent
- Revocable Irrevocable
59REINSTATEMENT
- 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.
60SETTLEMENT OPTIONS
- The interest option.
- Installments for a fixed period.
- Installments for a fixed amount.
- Life income options.
61TABLE 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
62LIFE INCOME OPTIONS
- Straight life income.
- Life income with period certain.
- Life income with cash refund.
- Life income with installment refund.
- Joint and survivor income.
63CHAPTER 14 THE LIFE INSURANCE CONTRACT GENERAL
PROVISIONS
64JOINT AND SURVIVOR LIFE INCOME OPTION
65TAXATION 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.
66TABLE 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
67POLICY 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.
68DIVIDEND 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 71DISABILITY 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.
72DISABILITY 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.
73ACCIDENTAL 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.
74GUARANTEED 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.
75COMMON 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.
76SPENDTHRIFT 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.
77COST-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.
78MORTGAGE REDEMPTION POLICY
79JOINT 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.
80SURVIVORSHIP 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.
81OTHER SPECIAL POLICIES
- Return of Cash Value Policy.
- Return of Premium Policy.
- Family Protection Policy.
- Family Income Policy.
- Family Maintenance Policy.
82MODIFIED 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
83GRADED-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.
84Modified Whole Life
Graded Premium Whole Life
Whole Life
85SINGLE 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.
86PROTECTION 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
87BUY 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.
88LIFE 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.
89LIFE 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.
90SAMPLE 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
92LIFE 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.
93MARKETING 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.
94MARKETING 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.
95LIFE 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.
96ANNUITIES 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.
97THE 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
98OPTION 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.
99OPTION 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.
100OPTION 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.
101OPTION 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
102ANNUITY CERTAIN CONTRACTS
- Pure life annuity.
- Life annuity with period certain.
- Life annuity with installment refund.
- Life annuity with cash refund.
103SPECIALIZED 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.
104VARIABLE 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.
105QUALIFIED 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.
106CONTRIBUTORY 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.
107FEDERAL 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.
108VESTING 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.
109TYPES OF QUALIFIED RETIREMENT PLANS
- Defined Contribution.
- Defined Benefit.
- Qualified Profit-Sharing Plan.
- Keogh Plan.
- 401(k) Plans.
- Employee Stock Ownership Plan.
110SURS 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
111PREMATURE 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.
112TAXATION 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.
113TRADITIONAL 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.
114NEW 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.
115CHAPTER 20
- HEALTH INSURANCE PERILS
- Sickness.
- Accident.
- HEALTH INSURANCE LOSSES
- Lost income (disability).
- Extra expenses (medical expense).
116GROUP 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.
117NEED 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.
118PROTECTION 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.
119DISABILITY 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.
120DISABILITY INCOME CONTRACTS PERILS COVERED
- Accident only generally called accident
insurance. - Accident and sickness generally called
disability income insurance.
121DISABILITY 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.
122DEFINITIONS 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
123DEFINITIONS 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.
124DEFINITIONS 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.
125OPTIONAL BENEFIT PROVISIONS
- Guaranteed Insurability Option.
- Cost-of-Living Adjustment Benefit.
- Waiver of Premium (may be built in).
126INDIVIDUAL 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.
127SELECTED 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.
128SELECTED 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.
129TAXATION 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.
130COST 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.
131FEE 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.
132FEE 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.
133MEDICARE
- 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.
134MANAGED 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.
135HEALTH 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.
136PREFERRED 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.
137POINT-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.
138DOMINANCE 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.
139ACCESS 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.
140ACCESS 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.
141HIGH 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.
142COBRA
- 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.
143TRADITIONAL FORMS OF MEDICAL EXPENSE INSURANCE
- Base Plan Coverage
- Hospitalization Insurance
- Surgical Expense and
- Physicians Expense Insurance
- Major Medical Insurance
144MAJOR MEDICAL INSURANCE
- High maximum (or unlimited).
- Deductible.
- Coinsurance or share-loss provision.
145MAJOR 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
146EXCLUSIONS 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.
147EXCLUSIONS 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.) -
148LIMITED HEALTH INSURANCE CONTRACTS
- Dread disease policies.
- Travel Accident.
149SOME 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.
150BUSINESS 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.
151KEY 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.
152DEFERRED 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