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Class 11 Insurance and Risk Management


Life insurance is valued policy, not a contract of indemnity. ... Determining the Amount of Life Insurance to Own Needs Approach. Estate clearance fund ... – PowerPoint PPT presentation

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Title: Class 11 Insurance and Risk Management

Class 11Insurance and RiskManagement
  • George D. Krempley
  • Bus. Fin. 640
  • Autumn Quarter 2006

Premature Death
  • Death of a family head with outstanding
    unfulfilled financial obligations
  • Examples
  • Dependants to support
  • Children to educate
  • Unpaid mortgage

Life Expectancy
  • Climbed to record high of 77.2 years in 2001
  • Sharp reduction in chance of premature death
    since 1900 due to
  • Significant medical breakthroughs
  • Health improvements arising from better economic
    conditions and higher incomes
  • Public health and sanitation improvements

EXHIBIT 16.1 Improvements in Life Expectancy
over the Past Century
Costs of Premature Death
  • Family shares of deceaseds wage earnings lost
  • Additional expenses
  • Funeral expense
  • Uninsured medical bills
  • Estate settlement costs
  • Federal estate taxes

Costs of Premature Death (cont.)
  • Insufficient income causes some families to
    experience a reduced standard of living
  • Non-economic losses
  • Emotional grief
  • Loss of parental role model
  • Loss of guidance and counseling for children

What is the insured event?
  • Life insurance is valued policy, not a contract
    of indemnity.
  • The insured event is the uncertainty of the time
    of death
  • Because of this uncertainty, the family head may
    die with outstanding financial obligations

Economic Justification of Life Insurance
  • Economic justification arises if
  • The Insured earns an income
  • Others are dependent on that income for at least
    part of their financial support
  • Premature death creates the loss of wage earning
    ability upon which others are dependent

Premature Death Financial Impact Depends on
Family Make-up
  • Single People
  • Single-Parent Families
  • Two-Income Earners
  • Traditional Families
  • Blended Families
  • Sandwiched Families

Methods for Determining the Amount of Life
Insurance to Own
  • Human life value approach
  • Needs approach
  • Capital retention approach

Determining the Amount of Life Insurance to
OwnNeeds Approach
  • Estate clearance fund
  • Income during readjustment period
  • Income during dependency period
  • Life income to surviving spouse
  • During blackout period
  • After blackout period
  • Special needs
  • Mortgage redemption fund
  • Educational fund
  • Emergency fund
  • Retirement Needs

EXHIBIT 16.2 How Much Life Insurance Do You Need?
Product Overview
  • Term - Pure life insurance
  • Cash value policies
  • Pure life insurance Savings accumulation
  • Examples
  • whole life
  • universal life
  • variable life

Product Overview
  • Can obtain savings accumulation by surrendering
    the policy
  • Why bundle death protection savings
  • Tax advantaged method of saving

EXHIBIT 16.3 Relationship Between the Net Amount
at Risk and Legal Reserve
  • Death benefit amount beneficiaries receive
  • Cash value amount of savings accumulation
  • Death protection amount of pure death
    protection death benefit - cash value
  • Face amount stated amount of coverage

Term Insurance
  • ¼ of policies
  • Almost ½ of death protection purchased
  • Guaranteed renewable
  • Premium increases over time

Whole Life Insurance
  • Policy period ends when insured reaches 100
  • Equivalent to endowment policy to 100
  • Premiums
  • single premium
  • limited pay
  • continuous premium

Whole Life Insurance
  • Premiums generally do not increase over time
  • Probability of dying increases over time
  • Higher upfront premiums than with term
  • Policyholder prepays part of the cost of future
    death protection
  • entitled to prepayments if policy is surrendered
  • this is the cash value (savings accumulation)

Whole Life Insurance
  • If insured dies,
  • beneficiaries receive face amount
  • death protection cash value
  • Structured so
  • cash value ? over time
  • death protection ? over time

Whole Life Insurance
Tax Treatment of Life Insurance
  • Death benefits are not taxed
  • Income tax is not paid on increases in cash value
    while the policy is in force
  • Upon surrender, income tax is paid on
  • Cash surrender value - sum of all premiums
  • sum of all policyholder dividends

Implications of Tax Treatment
  • Implicit returns on savings accumulation
  • Escape taxation if insured dies
  • Tax deferred if the policy is surrendered
  • Partially taxed if policy is surrendered
  • Amount which is taxed is less than implicit
    return because part of premiums is cost of death

State Laws Require Rates To Be
  • Adequate
  • Not excessive
  • Not unfairly discriminatory

Business Rate-Making Objectives
  • Simplicity
  • Stability
  • Responsiveness
  • Encourage loss prevention

EXHIBIT 27.1 Commissioners 1980 Standard
Ordinary Mortality Table, Male Lives
EXHIBIT 27.1 (continued) Commissioners 1980
Standard Ordinary Mortality Table, Male Lives
EXHIBIT 27.2 Present Value of 1 at 5 Percent
Compound Interest
EXHIBIT 27.3 Figuring the NSP for a Five-Year
Term Insurance Policy
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