Life Insurance

1
CHAPTER 10
Financial Planning with Life Insurance
Buy Term and Invest the Difference! The Wealthy
Barber
2
An Introduction to Life Insurance

• Life insurance is obtained by purchasing a
  policy, with the insurance company promising to
  pay a lump sum at the time of the policy holders
  death
• Some types will pay while the policy holder is
  still alive if they live long enough
• (Whole life policies for stupid people)

uninformed
3
An Introduction to Life Insurance
(continued)

• The purpose of life insurance is to protect
  someone who depends on you from financial loss
  related to your death Other reasons are
• To make charitable bequests upon your death
• To leave as part of your estate / avoid estate
  taxes
• Careful! The IRS often looks unfavorably at some
  of these tactics (only affects the very wealthy)
• Usually promoted by unscrupulous insurance agents
• To save money for retirement or childrens
  education
• (Whole life policies for uninformed people)

4
An Introduction to Life Insurance
(continued)

• People should buy life insurance so that when
  they die, their assets combined with their
  insurance proceeds can allow for the proper
  winding down of their financial affairs, and
  provide the desired standard of living for their
  dependents.
• Really, life insurance is better termed
• financial protection for dependents or
• income replacement insurance.

The Wealthy Barber
5
The Basis of Life Insurance

• Mortality tables provide odds on your dying,
  based on your age and sex
• Your premium is based on your life expectancy and
  the projections for the payouts for persons who
  die
• You are essentially betting the insurance company
  that you will die
• It is a bet that you hope you lose
• And so does the insurance company
• They have a very good idea how many people will
  die and how many will live Actuaries

Lets Play The Longevity Game!
6
Two Types ofLife Insurance Companies

• Stock life insurance companies are owned by the
  shareholders
• 75 are of this type of company
• Sell non-participating policies
• 79 of policies are non-participating
• Amount of premium stays the same

2012 American Council of Life Insurers
www.acli.org
7
Two Types ofLife Insurance Companies
(continued)

• Mutual life insurance companies
• Owned by the policyholders
• 25 are of this type of company
• With participating policies the premiums are
  higher than non-participating policies
• 21 of policies are participating
• However part of the premium is refunded to the
  policyholders annually
• This is called the policy dividend
• Not the same as dividends from stocks or credit
  unions that are taxable
• They are non-taxable transactions since they are
  simply not charging you what they said they would
  charge you

8
Determining Your LifeInsurance Needs

• Do you need life insurance? Ask Yourself
• Are there any people who depend upon my income
  for their living expenses?
• If the answer is, Yes, then it is not a
  question of whether or not you need insurance
• It is how much life insurance you need!
• If the answer is, No, then you do not need life
  insurance!
• No matter what the life insurance agent says!

9
But Even If You Are Single, You Will Be Told By
An Insurance Agent

• Of course, you need life insurance!
• Your policy is acting as a savings vehicle
• Insurance is cheaper when you are younger
• You should buy insurance now while you are
  healthy and can get it
• Your response to each of these should be
• Nonsense! The rate of return is awful
• Nonsense! Why buy something you do not need?
• Nonsense! Only 2 of people are turned down

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And Do Not Ever Buy Life Insurance for a Child!

• Would you be devastated emotionally if your child
  dies?
• Yes!
• Would you be devastated financially if your child
  dies?
• No!
• Excuse me for being callous, but you will be
  better off financially if your child dies
• Do not ever buy life insurance for a child!

11
But If You Have Children

• Young married couples or single people with one
  or more children almost always need life
  insurance
• The question for them is not, Do we need it?
  but rather, How much do we need?
• Often the answer to that is, More Than You
  Think!

We will discuss how much in a bit
12
And Do Not Forget the Non-wage Earner Spouse

• Normally, it makes sense to have some insurance
  on a non-wage earner spouse (a.k.a. stay-at-home
  mom or dad)
• Have enough to pay off the debts, and
• Replace the services that the non-wage earner
  provided
• Men usually remarry quickly, women do not

1. Married Men
2. Single Women
3. Married Women
4. Single Men

13
Some Examples
Who needs life insurance?

• A young married couple with no children
• A young married couple with two children
• Single adult or an unmarried couple
• Single adult who is a partner in a business
• A married couple with children
• Both parents are high-wage earners
• A middle-aged couple
• Children gone and house paid off
• Same middle-aged couple taking care of one or
  more of their aged parents

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Estimating Your LifeInsurance Requirements
Da Book sez

• The Easy Method
• Typically, you will need 70 of your salary for
  seven years while family adjusts
• The DINK (dual income, no kids) Method
• The Nonworking Spouse Method
• Multiply the number of years until the youngest
  child reaches 18 by 10,000
• The Family Need Method
• More thorough because it also considers employer
  provided insurance, Social Security benefits, and
  income and assets

15
Estimating Your LifeInsurance Requirements
The Wealthy Barber sez

• Get out your Financial Statements
• Use your Net Worth Statement to total your debts
• Start with at least this much life insurance
• The surviving spouse family will be debt-free
• Create a second Cash Flow Statement without the
  persons income and without the person alive
• This will tell you how much income the surviving
  family will need
• Determine the principal needed to generate that
  income
• Well learn this later when we get to investments
• Add the first amount (debt) and second amount
  (principal) to get how much life insurance you
  need
• By the way, the rule of thumb is 7 to 10 times
  your annual salary depending upon the level of
  debt

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Types of Life Insurance Policies

• Term life insurance The Only Type of Life
  Insurance!
• Protection for a specified period of time
• If you do not pay premiums, coverage stops
• A renewability option means that at the end of
  the term you can renew the policy without having
  a physical
• Conversion option allows you to change your
  policy from term to whole life without a physical
• If you are uninformed enough to actually buy a
  whole life policy

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Types of Life Insurance Policies
(continued)

• Whole life insurance (a.k.a. straight life,
  ordinary life, cash-value life, adjustable,
  variable, universal, etc. etc. etc. They keep
  changing the name! Why?)
• You pay a premium as long as you live
• Amount of premium depends on your age when you
  start the policy
• Provides death benefits and accumulates a cash
  value
• You can borrow against the cash value or draw it
  out at retirement
• Look carefully at the rate of return your money
  earns It is almost always abysmal!

18
Types of Life Insurance Policies
(continued)

• Whole life insurance (continued)
• Every 5 to 10 years or so, the insurance industry
  changes the name of whole life insurance
• Why? Because eventually consumers get hip to how
  they are being screwed
• To confuse the issue, they just change the name
• (Heaven forbid they stop selling the cursed
  things!)
• The newest spin is permanent life insurance
• Wouldnt you really rather have permanent whole
  life insurance instead of just temporary term
  life insurance?
• Hint Do you have permanent car insurance?
• How about permanent home insurance?

19
Whole Life Policy Options

• Limited payment policy
• Pay premiums for a stipulated period, usually 20
  or 30 years, or until you reach a specified age
  (65)
• Your policy then becomes paid up and you remain
  insured for life
• Such a deal! You overpaid for 30 years so that
  now you can have life insurance even though you
  dont need it any more!
• Single payment policy
• Allows someone to pay for the entire policy in
  one single payment
• Popular form of compensation for some high-end
  executives

20
Whole Life Policy Options
(continued)

• Variable life policy
• A minimum death benefit guaranteed, but the death
  benefit can rise above it depending on yield of
  the dollars invested in a separate fund
• Meant to give policyholders better returns (They
  lied)
• Universal life
• Lets you pay premiums in almost any amount
• Combines term insurance and investment elements
• Variable universal life
• Combines the odious (uh, I mean, best) parts of
  both variable whole life and universal whole life

21
Term versus Whole Life

• Review
• Term life insurance
• Life insurance without a savings component
• Whole life insurance
• Life insurance with a savings component

So what is the big deal, Paiano? If the
insurance company is offering to provide you with
life insurance and a savings plan, why not let
them?
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Term versus Whole Life
(continued)

• 500,000 Term Life Insurance Policy
• 32-year-old male, preferred
• 20-year term life policy
• 250 per year
• 500,000 Whole Life Insurance Policy
• 32-year-old male, preferred
• 250 per month!

Starting to see the difference yet?
23
Term versus Whole Life
(continued)

• If a company came up to you and said,
• To save at our institution, you must buy life
  insurance. You must pay for it even if you dont
  need it. Well take everything you deposit in
  the first few years for ourselves. In future
  years, well charge you to deposit money into
  your savings account. You can borrow the money
  at any time, but well charge you interest. If
  you happen to die while this loan is outstanding,
  well decrease the amount we were to pay your
  beneficiaries by the outstanding amount of the
  loan. If you dont borrow from this account and
  you die, well pay the beneficiary the face
  amount of the policy well keep your savings
  for ourselves. Oh, and finally, we dont offer
  the greatest rates of return. Usually between 1
  and 2.
• Paraphrased from The Wealthy Barber

See any difference yet?
24
Term versus Whole Life
(continued)

• Insurance companies are regulated by the states
• For the last 50 years, virtually every Insurance
  Commissioners Office in every state has publicly
  stated that term life insurance is a better deal
  for consumers than whole life insurance
• Virtually every consumers group recommends term
  life insurance over whole life insurance

How bout now?
25
Term versus Whole Life
(continued)

• Buy Term and Invest the Difference
• But Mr. Insurance Salesperson will tell you
• But with our whole life policy, you get Forced
  Savings. Most people dont have the discipline
  to Buy Term and Invest the Difference. Even
  with the best of intentions, they will not do
  it.
• Nonsense!
• If you have the discipline to make the payments
  to the life insurance company, surely you have
  the discipline to make the payments to your own
  savings or investment plan!
• Use an automatic contribution from your checking
  account

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Term versus Whole Life
(continued)

• So do you see why we call term life insurance,
• The Only Type of Life Insurance?
• It does not matter which type you buy, you are
  still paying for protection for your dependents
  in the event of your death
• With term life, you are only paying for that
  protection
• With whole life, you are paying far more for that
  protection plus you are being tapped for an awful
  savings plan that you may not even get to use
• Lastly, if you do invest the difference, by the
  time you are nearing retirement, you will not
  need life insurance any more You will be
  self-insured!

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Types of Policies Issued Surprised?
2012 American Council of Life Insurers Fact Book
www.acli.org
28
Amount of Insurance Issued
2012 American Council of Life Insurers Fact Book
www.acli.org
29
Huh? I Do Not Understand

• The number of whole life policies is far greater
  than the number of term life policies
• Mostly because life insurance salespersons get
  far greater commissions from whole life
• But the amount of insurance in force for term
  life is far greater than whole life
• Because term life is far less expensive than
  whole life, you can buy the amount you actually
  need

So after the insurance agent convinces the poor
slob that she needs whole life, the agent sells
her far less insurance than she needs because the
poor slob can not afford to pay the huge premiums
for the amount of insurance her family really
needs! Personally, I believe this behavior
should be criminal because if the poor slob
actually dies, her family suffers. Whole Life
Illustration
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Other Types of Life Insurance Policies

• Group life insurance
• Always term insurance
• Often provided by an employer or professional
  association Usually a very good deal (not
  always)
• Sometimes free (SWC employees get 50,000)
• No physical is required
• Credit life insurance
• Debt is paid off if you die
• Mortgage, car, furniture, credit cards
• By the way, it protects the lenders What?!
• Very expensive protection Do not buy it
• Accidental Death or Double Indemnity
• Is he dead? Oh, how sad How did he die? Good!

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Life Insurance Contract Provisions

• Name your beneficiary and contingent
  beneficiaries
• Update it when necessary (example divorce)
• Suicide clause during first two years
• Misstatement of age provision
• Accelerated benefits, viatical settlements
• Waiver of premium disability benefit
• Loan provision
• Premiums paid from cash value
• (Whole life policies for uninformed people)
• Return of Principal for Term Life policies
• Sometimes a good deal, usually not

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Choosing Your Insurance Agent

• Life insurance is sold, not bought
• Get a good referral
• Is the person willing to take the time to answer
  your questions and find a policy that is right
  for you?
• Are they available when needed?
• Do they ask about your financial plan?
• Do you feel pressured?
• Most importantly, are they still trying to sell
  you whole life when you have already told them
  three times that you want term life insurance?

33
Obtaining and Examining a Policy

• The first step is to apply
• The second step is to provide medical history
• Usually no physical for a group policy
• Read every word of the contract
• After you buy it you have ten days to change your
  mind
• (Whole life policies for uninformed people)
• Give your beneficiaries and your lawyer a
  photocopy

34
Choosing Settlement Options

• Options are the choices for how you want the
  money paid out
• Lump-sum payment is most common
• Almost always the best choice
• Limited installment plan
• In equal installments for a specific number of
  years after your death
• Life income option
• Payments to the beneficiary for life
• Proceeds left with the company
• Pays interest to the beneficiary

35
Payment of Insurance Benefits

• No matter what the life insurance company says,
  Take The Lump Sum and Invest It!
• Leave a letter of instruction if you are the
  insured
• By the end of this class, you will have a
  rudimentary knowledge of investments that will
  give you a rate of return that is at least 2 to 5
  times better than anything the life insurance
  company will offer you
• The life insurance companies love to prey upon
  the surviving spouse
• Well give you an income for the rest of your
  life

• Well screw you for the rest of your life

36
Should You Switch Policies?

• Switch a term life policy if the benefits exceed
  costs of getting another physical, paying
  policy set up costs
• Are you still insurable? Dont cancel the old
  policy until the new policy is in force

Normally, the only reason people switch whole
life policies is because a life insurance
salesperson convinced them to switch. Why did
they want them to switch? Because if they were
uninformed enough to buy a whole life policy in
the first place, theyre probably uninformed
enough to switch to another policy. And the
salesperson gets a ton of new commissions!
Several years ago a few insurance companies got
into hot water for pushing elderly folks to
switch policies.
37
Financial Planning with Annuities

• An annuity is a financial contract written by an
  insurance company that provides you with a
  regular income, often for the rest of your life
• Further discussion of annuities will take place
  when we get to investments and retirement planning

While annuities are insurance products, they
really belong with investments and retirement
planning. We will revisit them in the next
chapter. The book includes a section on
annuities in this chapter because the insurance
companies often try to get the beneficiaries to
purchase an annuity with their life insurance
benefits instead of taking the lump sum.
(Usually a bad idea!)
38
The Bottom Line
Need Life Insurance?
Buy Term and Invest the Difference!