Topic 15: Insurance Terms Peril: cause of loss such as fire
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Transcript Topic 15: Insurance Terms Peril: cause of loss such as fire
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Topic 15: Insurance Terms
Peril: cause of loss such as fire
Hazard: increases likelihood of loss
Physical: ice on sidewalk
Moral: dishonesty
Morale: indifference to loss such as
speeding
Law of large numbers
More units exposed to loss, greater
predictability of loss
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Topic 15: Insurance Terms
Adverse selection: higher risk individuals will
seek insurance
Self-insurance: business creates fund to pay
own losses
Risk avoidance: don’t drive
Risk diversification: hold harmless, shift risk to
someone else
Risk reduction: lower chance of loss
Take driver’s training
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Topic 15: Insurance Terms
Risk transfer: buy insurance
Principle of indemnity: can’t profit from loss
Subrogation: right to pursuit legal action to
collect from third party
Insurance interest: insured stands to lose
Life insurance: required only when policy issued
Property liability: must have at start of policy
and when loss occurs
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Topic 15: Insurance Contracts
Contract can’t be assigned
Aleatory: one person may get better deal than other
party
Adhesion: non negotiable
Good faith: both parties must be honest
Beneficiary can be changed unless irrevocable
designation
Need consent of beneficiary if want to change
Conditions precedent, subsequent
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Topic 16: Risk Exposures
Personal
Death, disability, health
Property
Reduction in value
Or cost of replacement
Liability:
Business related
Loss of income
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Topic 17: Property Insurance
80% rule: required insurance
(Amount Insured/Amount Should Have Insured
x Loss) – Deductible = Insurance Payment
Deductible subtracted last
Amount Should Have Insured = Replacement Cost
x 80%
Home
$400,000 replacement cost
$300,000 insurance
$1,000 deductible
Fire causes $20,000 damage
Insurance reimbursement?
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Topic 17: Property Insurance
Homeowners Insurance
HO 01: fire and named perils
HO 02: broad form covers additional perils
Personal property covered up to 50% of dwelling
insurance
HO 03: open perils (all risk) on dwelling; broad form
on personal property
Most common policy
Excludes pets, property of boarders, separately
scheduled property
Excludes flood, sewer backup, wet basement
Rising water versus falling water: Oakcrest
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Topic 17: Property Insurance
Homeowners Insurance
HO 04: renters insurance
Broad form coverage for personal property
HO 05: open perils for dwelling and open perils
for personal property
HO 06: condo insurance
Dwelling covers interior walls
Broad form on personal property
HO 08: older homes
Replacement cost > FMV
Insures them at a lower value
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Topic 17: Property Insurance
Coverage A: dwelling and attachments
Coverage B: structures separated from dwelling
Garages, pools, fences
Generally 10% of Coverage A amount
Coverage C: personal property located anywhere
Generally 50% of Coverage A amount
Limits on high value items: jewelry, guns, etc.
Can be increased by endorsement
Exclusions: business property, boarders property
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Topic 17: Property Insurance
Coverage D:
Additional living expenses while home repaired
Credit cards: up to $500, no deductible
Coverage E:
Comprehensive personal liability for unintentional
bodily injury and property damage up to $100,000
Covers damages off premises by insured, pets
Not for insured
Coverage F:
$1,000 per person per occurrence medical payments
Covers damages off premises by insured, pets
Not for insured
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Topic 17: Property Insurance
Exclusions
Earthquake
Flood, rising water. (Falling water covered)
War, nuclear accidents
Intentional loss
Endorsements
Scheduled personal property
Earthquake
Flood
Personal property replacement cost
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Topic 17: Property Insurance
Miscellaneous
No coverage if conceal material info
Insured can cancel at any time
Insurer must give advance notice of cancellation,
nonrenewal
Only one year to sue insurer
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Topic 17: Personal Auto Policy
Part A: liability: bodily injury and personal
property caused by insured’s negligence
Also attorney fees to defend insurance
Split limits: per person/per accident/property
damage
$15,000/$30,000/$50,000
Required? Get minimum?
Covered individuals
Named insured
Spouse and family members
Others using car with permission
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Topic 17: Personal Auto Policy
Covered vehicles
All vehicles listed in policy declaration
New vehicles
14 days to notify
Trailers
Loaner cars
Rental cars???
Exclusions
Intentional injury/damage
Employees
Motorcycles require separate coverage
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Topic 17: Personal Auto Policy
Part B Medical Payments: $1,000 per person
Covers, no matter fault,
Insured
Insured family members
Even when pedestrians hit by car
Others in car: flying turkeys
Part D: Physical Damage to Your Auto
Collision
Other than collision (comprehensive)
Hitting deer: not collision, covered under
comprehensive
Deductibles
$250 - $1,000
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Topic 17: Personal Auto Policy
Uninsured motorist
Coverage applies when accident fault of individual
with
No insurance
Less insurance than required by law
Hit and and run drivers
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Topic 17: Umbrella Liability
Insurance
Required underlying policies
Auto, home, boat, motorcycle
Must have required amounts of coverage
Provides additional liability coverage
Large amount; generally inexpensive
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Topic 17: Commercial
Insurance
Property
Homeowners coverage generally provides minimal
coverage for business property in home
Endorsement
Open perils or specified perils
Actual cash value or replacement cost
May have co-insurance (80%) requirement but not
mandatory
Bars, restaurants, amusement parks not eligible for
this policy
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Topic 17: Commercial
Insurance
Business income coverage
Replaces income and covers expenses due to closure
by covered peril: fire, wind, etc.
Crime insurance
Police must be notified
Liability
Occurrence basis
Covers claims from events during policy period
Doesn’t matter when claim filed
Claims made
Covers only claims made during policy period
Will need tail coverage for claims after policy lapse
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Topic 17: Commercial
Liability
Types
Same coverage as Personal Auto Policy
Garage Coverage: for businesses storing; selling;
servicing; parking vehicles
Umbrella
Self insure generally first $25,000
Occurrence basis
Professional liability
Physicians, attorneys, etc.
Fail to perform as promised
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Topic 17: Commercial
Surety bonds
Insures party will fulfill obligations
Insured is liable to issuing company if payment has to
be made on bond
Directors and Officers
Covers wrongful acts
Workers Comp
Provides benefits required under state law
Payment for liability claims from employee injuries
Injured on the job
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Topic 18: Health Insurance
Hospital, surgical and physicians
insurance
Hospital: room and board up to $X per
day
Surgeon: all or usual and customary
Physicians: only in hospital
Not the type of “health insurance” you
want
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Topic 18: Health Insurance
Major medical insurance policy
Covers most medical expenses
Both in and outside of hospital
High payment limit: $1 million/unlimited
Deductible
Usually $500 to $1,000 per year
Often per person/per family ($500/$1,000)
Coinsurance:
For example, after deductible met, insured must pay
20% of next $5,000 of medical expenses per
person???
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Topic 18: Health Insurance
Major medical insurance policy
Not covered
Chemical addictions
Cosmetic surgery
Glasses
Travel outside U.S. / Canada
Injuries covered by workers comp
Self-inflicted injuries
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Topic 18: Health Insurance
Medical insurance premiums
Self-employed
Deducted in calculating AGI
Employees
Must itemize
Medical expenses must be > 7.5% AGI
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Topic 18: Health Insurance
Medicare
Part A: Hospital
Over 65
Eligible for Social Security
Automatically covered
No cost
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Topic 18: Health Insurance
Medicare
Part B: Doctors’ services
Over 65
Eligible for Social Security
Must pay premium
Premium increases with AGI
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Topic 18: Health Insurance
Medicare
Deductibles
Part A: Hospital
$1,068 for first 60 days
After 60 days, patient pays most of the cost
No deductible for first 20 days at skilled
nursing facility
After 20 days, patient pays most of the cost
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Topic 18: Health Insurance
Medicare
Deductibles
Part B: Doctors services
$135 per year
20% co-pay
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Topic 18: Health Insurance
Medicare
Part D: Prescription drugs
Anyone in Part A or B is eligible
Annual premium $420 per year
Covers large portion of initial costs and
extraordinary costs but not costs in the
middle (donut)
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Topic 18: Health Insurance
Medigap: Medicare Supplemental
Must offer:
Part A: up to one year hospitalization
beyond Medicare coverage
Part B: pays 20% co-payment
Can offer other benefits
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Topic 18: Health Insurance
Medicaid: provide medical care
for those who can’t afford to pay
Administered by each state
Must meet income/asset tests
Five year look back rule on transfer
of assets
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Topic 19: Disability Insurance
Definition of disability
Own occupation: can’t do what you normally do
Relief pitcher: disabled even if could coach
ETE: can’t work at any job for which education,
training and experience would qualify you
Tiger Woods making cheeseburgers
Partial disability: can’t work full time
Generally 50% of total disability benefit
Residual disability benefit: if earnings decrease by
2/3, collect 2/3 of total disability benefit
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Topic 19: Disability Insurance
Benefit period
To age 65
Period of years
Elimination period
One to six months
Benefits
Tax-free if insured paid for policy
Employer paid for policy: benefits taxable
Up to 75% of income
COLA riders available
Guaranteed renewable: pay premiums, policy stays in force
Guaranteed insurability: can increase coverage without
showing insurability
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Topic 20: Long-Term Care
Insurance
Medicare only covers 20 days of
skilled nursing care
Not nursing home so Grandma can
play bingo (custodial care)
Can generally buy coverage up
until age 84
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Topic 20: Long-Term Care
Insurance
Benefits payable if can’t do more than one of following:
Dress, eat, bathe, toilet, walk
Benefits are usually $X per day
May be an elimination period
Benefits paid from one year to lifetime
Inflation rider available
May have waiver of premium if receiving benefits
Must be guaranteed renewable for favorable tax
treatment
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Topic 20: Long-Term Care
Insurance
Life insurance
Accelerated death benefit provision and viatical
settlements allow access to funds for long-term care
if terminally ill
Insurance premiums
Self-employed
Deducted in calculating AGI
Not self-employed
Must itemize:
Medical expenses must be > 7.5% AGI
Amount deductible limited based on age
$3,180 for ages 61 - 70
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Topic 21: Life Insurance
Concepts
Mortality: death rates
Morbidity: rates of disability
Expenses: greatest in early years
Commissions
Insurable interest
Required at time of policy inception
Not at the time benefits are paid
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Topic 21: Life Insurance
Term insurance: temporary
Renewable: to age 70
Convertible: to whole life
Whole life: permanent/forced savings
Variable: separate account invested based on policy holder’s
allocation
Whole life funds go into general account of company
Can increase death benefits/cash value based on investment
performance
Universal: can change
Premiums: can skip payments
Death benefit
Cash value separated from death benefit
Variable universal: combine features
Survivorship: second to die policy
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Topic 21: Life Insurance
Contract provisions
All language contained in contract
Backdating: can be done up to six months
Owner may not be insured
One month grace period for premium payments
Misstate age: adjust death benefit
Loans: amount borrowed subtracted from death
benefits
Assignment: generally policies may be assigned
Common disaster: primary beneficiary must outlive
insured by 60 – 90 days
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Topic 21: Life Insurance
Contract provisions
Incontestable: insurer has two years to
challenge validity of policy
Exclusions: suicide (one to two years)
and war
Settlement options
Lump sum
Annuity
Single or joint life; term certain
Interest only
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Topic 21: Life Insurance
Dividends
Cash
Accumulate
Reduce premiums
Buy additional coverage
Interest credits
Portfolio method: based on insurer’s
earnings of overall portfolio
New money method: based on insurer’s
earnings on money invested that year
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Topic 21: Life Insurance
Riders
Accelerated death benefits: pay benefits if expected
to die within year; in nursing home permanently
Long-term care: benefits rider can be added to life
insurance policy
Waiver of premiums: if disabled
Guaranteed insurability: can buy more coverage
without showing insurability
Double indemnity: twice policy amount if death
accidental
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Topic 21: Life Insurance
Nonforfeiture options
After policy has cash surrender value,
Can get cash within six months
Can get a paid-up policy with a reduced
face amount
Can get a term policy with the same face
amount
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Topic 21: Life Insurance
Illustrations
Projection of financial results
Incorporate present value or just nominal values?
Optimistic assumptions?
Clearly label what is guaranteed?
NAIC model does not apply to variable
life/annuities
Policy replacement
Regulated by many states
High commissions
May make sense due to reduced mortality charges
and in higher interest rate periods
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Topic 21: Life Insurance
Accelerated death benefits
Allow terminally ill insured to obtain funds prior to
death tax-free
Pay for custodial care
Preferable to viatical due to discounts on viatical
Viatical settlements
Terminally ill insured transfers policy for lump sum
payment
Benefits tax-free to insured if:
expected to die within two years
can’t perform two activities of daily living
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Topic 22: Income Taxation of Life
Insurance
Dividends: whole life policies
Not taxable unless total dividends > premiums
paid on policy
Loans: whole life policies
Not taxable
Withdrawal of cash value
Not taxable unless withdrawals > basis
If taxable, ordinary income
Surrender
Not taxable unless proceeds > basis
If taxable, ordinary income
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Topic 22: Income Taxation of Life
Insurance
Death benefit: not taxable
MECs: premiums higher than necessary for
insurance.
Often single premium policy
Then take cash value prior to death
Test during first seven years of policy
If policy is MEC,
Death benefit is still not taxable
Withdrawals and loans taxed as
ordinary income with penalty if under
59 ½
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Topic 22: Income Taxation of Life
Insurance
Transfer for value
Sell policy to someone other than related
party (business, co-owner, family
member)
Seller not taxed if viatical settlement
Expected to die within two years
Buyer will be taxed on death benefits if
greater than basis (ordinary income)
Including premiums paid and purchase price
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Topic 22: Income Taxation of Life
Insurance
Section 1035 exchange
Trade an existing policy for a new policy
Good idea???
Mortality/interest rate assumptions
Trade an insurance policy for an annuity
Makes IRS happy
Can not trade an annuity for an
insurance policy
Would make the IRS sad
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Topic 23: Business Uses of
Insurance
Buy-Sell Agreements
Provides for the sale of business interest
on death of owner
Allows heirs to cash out of business
Keeps heirs from becoming co-owners
Keeps ownership with existing owners
Value generally based on formula
Valid for estate tax valuation
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Topic 23: Business Uses of
Insurance
Buy-Sell Agreements
Cross purchase
Owners buy policies on each other
Number of policies?
Older owner
Premiums not deductible
Entity
Company buys policy on each owner
Premiums not deductible
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Topic 23: Business Uses of
Insurance
Key Person Life Insurance
Insures life of valued employee:
Pujols
Janitor
Business is beneficiary
Premiums not deductible
Benefits tax-free
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Topic 23: Business Uses of
Insurance
Split Dollar Life Insurance
Employer and employee share cost of premiums
Employer pays cash value portion
Employee pays pure life insurance cost
If employer pays entire premium, coverage above $50,000
taxable
Endorsement method
Employer owns policy
Receives reimbursement for premiums paid
Employee gets balance
Employer paid premiums income to employee
Collateral assignment method
Employee owns policy
Again must reimburse business for premiums paid
Premiums treated as loans: employee must pay interest
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Topic 24:Insurance Needs Analysis
Life insurance
Human life approach: six to ten times
annual income
Present value of insured’s future income
Does not consider assets, liabilities
Financial needs: determine cash needs,
income needs, special needs and then
subtract net worth
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Topic 25:Insurance Policy and
Company Selection
Life insurance
Temporary needs: term
Permanent needs: whole life
Participating: pays dividends when
premiums were “too large”
Cost analysis
Net cost method per $1,000 of coverage =
(total premiums – cash value) / number of
years policy held
Ignores time value of money
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Topic 25:Insurance Policy and
Company Selection
Life insurance
Cost analysis
Surrender cost index =
(future value of premiums – dividends – cash
value)/fv factor for $1 for n years at i rate)
/$1,000 units of coverage
Net payment cost index =
Same as surrender cost index but cash value is not
subtracted
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Topic 25:Insurance Policy and
Company Selection
Life insurance
Cost analysis
Net payment cost index = same as surrender
cost index except does not subtract cash
value
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Topic 25:Insurance Policy and
Company Selection
Life insurance
Company selection: financial ratings
Companies rated based on financial strength
A.M. Best, S&P, Moody’s
Best: insurance companies only
“A+” rating has different meanings
Variable products provide security of
subaccounts
Company selection: underwriting
Some companies only want certain types of risk
State Farm: Florida, b & b
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Topic 25:Insurance Policy and
Company Selection
Property and casualty insurance
Policy selection
Insure catastrophic losses
Select deductibles based on
Risk tolerance
Risk capacity
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Topic 26: Annuities
Types
Immediate: payments begin now
Deferred: payments begin later
Single premium: one payment
Purchase annuity with 401(k) proceeds
Periodic premium
Single vs. joint and survivor
Period certain: benefits continue for a
minimum number of years
Even if die before period ends
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Topic 26: Annuities
Types
Fixed: periodic payment known
Turn defined contribution plan into defined
benefit plan
Variable: periodic payments based on
investment performance
Considered securities: must hold Series 6
and insurance license to sell
Oversold/undersold????
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Topic 26: Annuities
Structured settlements
Receive periodic payments instead of
lump sum
For auto accident, medical malpractice, etc.
Payments are tax-free if compensatory
including pain/suffering/wrongful death/loss
of goodwill
Effectively makes interest tax-free
Punitive, non-physical damages are taxable
Companies buying structured settlements
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Topic 26: Annuities
Taxation of annuities
Noncontributory-qualified plan
All payments ordinary income
Contributory-qualified plan
Basis / total expected payments = percent of each
payment not taxed
Remainder of payment ordinary income
Subject to 10% penalty if not age 59 1/2
After recover entire basis, all taxable
If die before deferred annuity payments begin
Refund of premiums paid generally not taxable
since payment equals basis
No step-up in basis for annuities
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Topic 26: Annuities
Taxation of annuities
Commercial annuity
Ordinary income and return of capital based on expected
payments
Corporate annuities
Must recognize income immediately on increase in value of
annuity; no deferral
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Topic 27: Group Term Life
Insurance
Must be nondiscriminatory
Amount of coverage usually multiple
of salary
Cost of coverage above $50,000 is
taxable
No evidence of insurability required
Even if leave company and convert to
individual cash value policy
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Topic 27: Group Permanent
Insurance
Premiums
Deductible by employer
Taxable to employee
GULPs: employees pay for universal life coverage
Advantage
Group underwriting
Can continue as individual policy after leaving
employment
No evidence of insurability required
Must convert to permanent insurance
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Topic 27: Group Permanent
Insurance
Carve Out Insurance
Cover top dogs only
Employer’s cost deductible
Top dogs taxed on premiums paid
Pay bonus to top dogs so they can pay taxes
on premiums so they won’t be sad
Employer paid death benefit
Taxable
Not funded by life insurance policy
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Topic 28: Group Disability
Insurance
Can discriminate
Long-term plans
Similar to individual policy features
Benefits taxable if employer pays premiums
Employer can deduct premiums
Integrated with other sources of disability income such
as Social Security so don’t get rich watching Oprah
Disability definition: can’t do job qualified for based on
training, education, experience
If just top dogs covered, own occupation definition
more likely
Short-term disability
Sick for a week: continue to pay salary
Sick for up to six months: short-term disability policy pays
benefits
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Topic 29: Group Medical Insurance
Types of policies
HMOs:
Lower deductibles, co-payments
Restricts selection of medical care providers
PPOs:
Lower deductibles, co-payments if select
“preferred provider”
Point of service
In network providers have lower
deductibles, co-payments if selected
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Topic 29: Group Medical Insurance
Tax advantages
Employer deducts premiums
Employee not taxed on premiums or
benefits received
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Topic 29: Group Medical Insurance
COBRA
For businesses with more than 20 employees, insured
can continue coverage if lost coverage due to
Termination of employment (including retirement)
Continue coverage for 18 months
Dependent no longer covered due to
death/divorce/Medicare eligibility/dependency
status
Continue coverage for 36 months
Employee must pay cost of coverage
Government paying in 2009 65% of cost for first
nine months
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Topic 29: Group Medical Insurance
HIPAA
Individuals losing group coverage must
be offered coverage without pre-existing
conditions
HSAs
Require high deductible health insurance
Deductible of $2,300; out of pocket $11,600
If individual contributes
Can deduct from AGI up to $5,950 for family
policy
Once eligible for Medicare, can’t contribute
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Topic 29: Group Medical Insurance
HSAs
Earnings not taxed if used for medical
expenses
Even if after covered by Medicare
No required distributions
Advantage for those who want to retire early
Can roll over funds from IRA into HSA one
time up to annual contribution limit