Transcript Life Insurance - Florida State University

Life Insurance Basics
Agenda
• Who needs life insurance?
• How do you calculate the amount needed?
• What types of life insurance are available?
Life insurance is used to provide a death benefit:
a stipulated sum (the face amount of the policy) is
paid to a beneficiary upon the demise of the
policyholder (who has paid the premiums).
Remember: a beneficiary who receives life
insurance payments due to the death of the insured
pays no income tax on the amount received.
Who Needs Life Insurance?
• When does one need life insurance?
– Do you have people you need to protect financially?
• Consider different types of families
– Do you have a partner who works?
– How long are your obligations?
• Other considerations:
– How much money do you want to leave your
dependents should you die today?
– How much will you be able to pay for your insurance
program?
Amount of Insurance Needed
• There are some basic “rules of thumb”
– “the death benefit on your policy should equal five to
ten times the amount of your annual salary”
• There are several more accurate ways to
determine the amount of insurance needed:
– Human Life Value Approach
– Needs Approach
– Capital Retention Approach
The Options…
• Once you determine one has a need for
insurance, and the amount of coverage is
determined, there are a variety of ways to
meet the need…
• Policies differ on a number of dimensions,
as the next slides show.
Because policies are taken out without the
insurance company knowing when payment
of the policy will be required, companies may
issue:
• participating policies, in which the company
shares the costs of coverage with policyholders;
if premiums exceed costs, a policy dividend is
issued
• nonparticipating policies, in which the company
does not share profit (or loss) with the
policyholders; the premiums for these
companies tend to be lower
There are 2 types of insurance companies:
– stock companies are owned by the company
stockholders and usually sell nonparticipating
policies (example: MetLife Insurance Co.)
– mutual companies are run by the company
policyholders and usually sell only participating
policies (example: Massachusetts Mutual Life
Insurance Co.)
Industry Strength
• Life insurer capital, as measured by
policyholders surplus, rose from $310.4 billion in
2011 to $328.6 billion in 2012.
• The industry’s net gain from operations before
federal income taxes rose significantly from
$28.0 billion in 2011 to $60.5 billion in 2012.
• Net income rose from $14.4 billion to $40.9
billion during the same period, the highest level
in at least dozen years.
LIFE INSURANCE OWNERSHIP
• Sixty-two percent of all people in the United States were
covered by some type of life insurance in 2013,
according to LIMRA’s 2013 Insurance Barometer Study.
• One third of consumers believe they do not have enough
life insurance.
• Life insurance ownership jumps dramatically as young
consumers advance in their careers, with over half of
consumers aged 25 to 34 owning policies, compared
with 18 percent of those under 25.
• 30 percent of employed consumers own disability
insurance.
• 14 percent of consumers own long-term care insurance.
Life insurance is typically used to secure
business loans, for partnership buy-sell
agreements, and as security for families.
There are 2 types of life insurance sold: term
and permanent.
• Term policies provide coverage for a period of
years, typically 1 or 5 (but this is changing)
• policies provide insurance only
• premium costs increase with age
• coverage is not offered after age 65 to 70
There are 2 types of term policies:
• Yearly renewable term has premiums that are
initially low; however, the premiums increase
substantially as the insured gets older. These
policies have diminished in popularity due to the
introduction of level premium term life insurance.
• Level premium term has premiums which remain
unchanged over a specified period of time.
Coverage is purchased for a period of 5, 10, 15, 20,
25, or even 30 years. After the initial level period
expires, the annual premium will increase for the
next level (but there is usually a guaranteed
maximum increase).
Yearly renewable term insurance premiums
increase rapidly with age, whereas level term
insurance premiums only change over a period of
years (e.g., every 10 or 20 years). Over the 20 years,
level term premium costs are about one third those
of yearly renewable term.
The newest product in term life insurance is called
the “return of premium” (ROP) policy.
A level term policy is purchased, usually for 20 or 30
years, and if the policyholder makes it through the 2
or 3 decades, the insurer pays back the premium
payments (tax free). So the premium cost is zero.
However, the premiums are 30% to 40% higher than
with regular level term policies (the 30 year policies
have the least increase in cost).
And the insured has to “stay the course” for the time
period involved.
Permanent insurance policies provide coverage “for
a person’s whole life”, hence also the name “whole
life”; policies provide both insurance coverage and
investment return.
The policy premium does not change substantially
over time, even though payments can be made for
many decades.
Also, the policy accumulates cash value that can be
borrowed (usually at a set interest rate). So at the
death of the insured, both the policy face amount and
the cash value are paid to the beneficiary.
There are 3 types of “whole life” coverage:
• ordinary life—premium payments continue for the
policyholder’s whole life; there is usually a modest
guaranteed investment return for the cash value
• limited payment life—premium payments continue
to a certain age or for a stated number of years;
premiums are higher but cash value accumulates
faster because of the reduced years
• variable life—offers a minimum death benefit,
fixed premiums, and investments in stocks, bonds,
mutual funds, or money market funds; the value of
the policy at death is primarily based on the return
on the investments
Universal life insurance provides flexible insurance
coverage and investment return, and both can be
changed over time as the policyholder wishes.
The investment return is usually greater than with
ordinary and limited payment life policies; the
policyholder may make tax-free withdrawals (up to
the amount contributed) or the annual return can be
used to pay for coverage, making it self-funding; there
is a maintenance fee, but annual statements are
provided to explain costs.
This is the preferred type of “whole life” policy
because of it’s flexibility.
Comparison of premium costs for a $500,000
life insurance policy (nonsmoker):
• 20 year term policy
-30-year-old male
-30-year-old female
$600
$400
20 year cash value
is zero; total cost is
$12,000/$8,000
• 20 year ROP term policy
-30 year-old-male
$800
-30-year-old female
$550
20 year ROP is
$16,000/$11,000; total
cost is zero
• Whole life policy
-30-year-old male
-30-year-old female
$1,600
$1,300
20 year cash value
is about $25,000; total
cost is $7,000/$5,500
$2,400
$2,000
20 year cash value
is about $40,000; total
cost is $8,000/$6,000
• Universal life policy
-30-year-old male
-30-year-old female
Life insurance coverage may vary from individual to
individual, but the usual progression is:
• begin with term
• add universal life (can be used to pay for college
expenses)
• the coverage amount should be sufficient to allow
the family to adapt after death (typically 5 to 7
years’ equivalent of income)
Life insurance coverage can be supplemented
by the use of riders:
• guaranteed insurability—guarantees periodic
increases in coverage
• accidental death—pays double or triple the face
amount (“double indemnity”)
• disability—pays premiums of a disabled
policyholder
There are several payment options; it is left to
the policyholder to decide which one to use:
• lump sum—the total value of the policy is paid to
the beneficiary
• fixed period—payments are made over a set
period of years
• fixed income—payments are made in equal
installments
• interest income—only interest is paid to a
(usually) minor beneficiary until a certain age
• life income (annuity)—payments are made for the
life of the policyholder
Life insurance can be converted into an annuity.
An annuity pays a certain amount each month to the
policyholder (“annuitant”) until the policyholder
dies; thus it provides a “life benefit”.
For example, a policyholder may purchase a single
premium immediate annuity (payments begin
immediately) or single premium deferred annuity
(payments begin in years) for the cash value of the
policy.