07 FINALS PART B - Life Insurance Planning & Managing Property & Liability Risk

01/06/2022
Rich Dad Poor Dad

1
Chapter 12:
Life Insurance Planning
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in part, except for use as permitted in a license distributed with a certain product or service or on a 2
password-protected website for classroom use.
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• There are two primary risks related

to longevity and finances:
–Risk of dying too soon
–Risk of living too long
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• Two financial problems arise because

you do not know when you will die.
• The first problem is the risk of living
too long.
• This raises the possibility that you will
outlive your savings during retirement. Life
insurance is the wrong way to address
the living-too-long problem. For that
problem you should invest through tax-
sheltered retirement savings plan
• The second problem is the risk of

dying too soon.
• This is the possibility that you might die
before adequately providing for the
financial well being of loved ones left
behind, such as spouse and children.
• LIFE INSURANCE helps replace lost
income if premature death occurs. term
life insurance does this best but only 8
in 10 people have purchased a life
insurance policy. 12
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Ask yourself, “If I die tomorrow will

these people have the financial
support to take care of
themselves?”
Even though it may be uncomfortable
to deal with the idea of dying, you are
smart to protect against the unexpected
and take action to deal with it.
Remember, YOU ARE A “FINANCIAL
GROWN-UP” when you make financial
decisions to protect someone you love 13
Remember,
YOU ARE A “FINANCIAL
GROWN-UP” when you
make financial decisions to
protect someone you love.
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The primary reason for buying

life insurance is to allow your
family to continue with their lives
free from the financial burdens
that your death would bring.
Your purchase of life insurance
is to benefit your loved ones, not
yourself.
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LIFE INSURANCE
• An insurance contract
helps replace lost income if
premature death occurs as
it promises to pay a benefit
to a beneficiary upon the
death of the insured
person. 16
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Learning Objective #1
Understand why you might

need life insurance and
calculate the appropriate
amount of coverage.
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How Much Life Insurance Do

You Need?
• The primary reason for buying

life insurance is to allow the family
members of the deceased to
continue with their lives free from
the financial burdens that death
can bring.
What Needs Must Be Met?
Final expenses: One-time expenses

occurring just prior to or after a death.
Income-replacement needs
Readjustment-period needs
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Debt-repayment needs
College expense needs
Other special needs

Existing insurance and assets reduce
the level of need.
Government benefits can reduce the

level of need.
Social Security survivor’s benefits
Social Security blackout period
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• Life insurance can close any

remaining gap in needs.
• Beneficiary: The person named in the

policy to receive the funds.
What Amount Do You Need?
• The Multiple-of-Earnings Approach:

easy but flawed.
• The Needs-Based Approach: a

better method
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Concept Check 12.1
• Distinguish between the dying-too-son

problem and the living-too-long problem
and the best ways to address each.
• List five types of needs that can be

addressed through life insurance.
Concept Check 12.1

• Explain why the multiple-of-earnings
approach is less accurate than a needs-
based approach to life insurance
planning.
• Identify two periods in a typical person’s
life cycle when the need for life
insurance is low and one when it is high.
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Distinguish among the types of life

insurance.
There Are Only Two Basic

Types of Life Insurance
1) Term Life Insurance (or Pure
Protection)
– Face amount
– Time period
2) Cash-Value Life Insurance
– Cash-Value: Represents the value of the
investment element in the life insurance
policy.
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Most people confused by the

wide variety of life insurance
plans available. But in reality,
there are two types of life
insurance.
 Term Life Insurance
Cash-Value Life Insurance
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Term Life Insurance is often described

as “pure protection” because it pays
benefits only if the insured person dies
within the time period (the “term”)
covered by the policy.
The policy must be renewed if coverage
is desired for another time period. In this
way, term life insurance acts much as
like car or homeowner’s insurance.
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All other life insurance policies are

variations of Cash-Value Life
Insurance.
These policies pay benefits at
death (like term policies) but also
include a savings/investment
element that can provide benefits
to the policy holder prior to the
death of the insured person.
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This cash value factor represents the

value of the investment aspect of the
life insurance policy. The cash value
build up in a policy can either be at a
fixed rate or variable rate. Because of
the investment aspect of cash-value
policies, many people automatically
believe cash value life insurance is the
better option, but this is a false
impression.
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Cash-value life insurance

costs much more than
the term insurance,
often 5 to 8 times more,
and there are much better
options for investing than
through life insurance. 33
Term life insurance are most often

written for time periods (or terms)
of 1, 5, 10, or even 20 years. If the
insured person survives the
specified time period, the
beneficiary receives no monetary
benefits. Term insurance can be
purchased in contracts with a
minimum face amount of 100,000.
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oExplain the major provisions

of life insurance policies.
Understanding Your Life

Insurance Policy
• The life insurance policy is the written
contract between the insurer and the
policyholder.
• Named parties in the policy:
– Insured
– Owner (or Policyholder)
– Beneficiary
– Contingent Beneficiary
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LIFE INSURANCE POLICY

A contract between an
insured (insurance policy
holder) and an insurer or
assurer, where the
insurer promises to pay a
designated beneficiary a
sum of money (the
“benefits”) upon the death
of the insured person.
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OWNER/POLICY HOLDER
Retains all rights and
privileges granted by the
policy, including the right
to amend the policy and
the right to designate who
receives the proceeds.
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OWNER/POLICY HOLDER
The owner controls the policy,
is obligated to pay the
premium and has the right to
receive the cash value if the
policy is terminated prior to
the death of the insured. The
insured and the owner can be
the same person. 39
INSURED
Individual whose Life
is insured.
The insured is the
person whose life is
covered by the policy.
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BENEFICIARY
The beneficiary is the
person who will
receive the proceeds
of the policy at the
death of the insured.
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CONTINGENT BENEFICIARY
The contingent beneficiary
is the person who will
receive the proceeds of
the policy at the death of
the insured should the
beneficiary be deceased 42
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INCONTESTABILITY CLAUSE
• Life insurance policies generally
included an incontestability
clause that places a time limit-
usually two years after the
issuance of the policy - on the
right of the insurance company to
deny a claim.
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INCONTESTABILITY CLAUSE
Provides that a life insurance

policy shall be incontestable
after two years from the date
of issuance, regards of any
mistake, fraud, concealment
or misrepresentation.
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How All Insurance Policies

Are Organized
1) Declarations
2) Insuring Agreements
3) Exclusions
4) Conditions
5) Endorsements (or riders in life
insurance)
DECLARATIONS
Declarations lay out the

descriptive aspects of
the policy including the
who, what, where,
when of the coverage.
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INSURING AGREEMENTS
Insuring agreements are
the basic brief and general
statements of the promises
made by the insurance
company in return for the
payment of premium.
in part, except for use as permitted in a license distributed with a certain product or service or on a
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EXCLUSIONS
• Exclusions narrow the
insuring agreements by
excluding certain
coverages. An example
would be an exclusion for
intentionally set fires to a
home. 48
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CONDITIONS
• Conditions place
obligations on the insured
and insurer to do certain
things such as make
prompt claims, rules for
cancellation of the policy
and prohibited behaviors.49
ENDORSEMENTS
• Endorsements are
amendments to the
policy.
• These are called riders
in life insurance.
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Policy Terms and Provisions

Unique to Life Insurance
• Life Insurance Application: The

policyholder’s offer to purchase a
policy. The application becomes part
of the policy.

• Lives Covered
– First-to-Die Policies: Cover more
than one person but pay only when
the first insured dies.
– Survivorship Joint Life Policy: Pays
when the last person covered dies.
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• The Incontestability Clause
• The Suicide Clause
• Cash Dividends
– Insurance Dividends
– Participating Policies
– Nonparticipating Policies

• Death Benefit: Amount that will be paid
to beneficiary when the insured dies.
• Grace Period
– Lapsed policy
• Reinstatement
• Multiple Indemnity
– Multiple Indemnity Clause
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Policy Features Unique to

Cash-Value Life Insurance
• The Policy Illustration
– Guaranteed Minimum Rate of
Return
– Current Rate
• Non-forfeiture Values
– Cash-Surrender Value
Policy Features Unique to

Cash-Value Life Insurance
• Policy loans
– Automatic Premium Loan
– Living Benefit Clause
• Waiver of premium
• Guaranteed Insurability (or
Guaranteed Purchase Option)
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Life Insurance
Settlement Options
1) Lump sum
2) Interest income
3) Income of a specific amount
4) Income for a specific period
5) Income for life
Concept Check 12.3

• Distinguish among the owner, the
insured, the beneficiary, and the
contingent beneficiary of a life insurance
policy.
• Briefly describe each of the five

components of all insurance policies.
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Concept Check 12.3

• Identify the five settlement options for the
payment of the proceeds of a life
insurance policy to its beneficiary.
• Besides taking the cash value as a lump

sum, what are four more ways a cash-
value policyholder may take the proceeds
of the policy at cancellation?
Concept Check 12.3

• Distinguish between an automatic
premium loan and a waiver of premium
option in a life insurance policy.
• Explain how guaranteed renewability for
term life insurance and guaranteed
insurability for cash-value insurance
protect insured people who develop
serious health conditions.
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61
Managing Property
and Liability Risk
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Introduction
• Property Insurance
– Protects you from financial losses
resulting from damage to or destruction
of your property or possessions.
• Liability Insurance
– Protects you from financial losses
suffered when you are held liable for
others’ losses.
Apply the risk-management process

to address the risks to your property
and income.
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Risk and Risk Management
• What is the nature of risk?

– Risk is the uncertainty about the
outcome of a situation or event.
– Risk is not the same as “odds”.
RISK
It arises out of the possibility
that the outcome will differ
from what is expected. In the
area of financial losses, risk
consists of uncertainty about
both whether the financial loss
will occur and how large it
might be 66
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TWO TYPES OF RISK
• Speculative risk involves situations

where there is the potential for gain
as well as loss.
• Pure risk involves situations when

there is only the possibility of loss.
SPECULATIVE RISK
• INVESTMENTS SUCH AS THOSE

MADE IN THE STOCK MARKET
INVOLVE SPECULATIVE RISK
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PURE RISK
• FIRES, AUTOMOBILE
ACCIDENTS, ILLNESS, AND
THEFT ARE EXAMPLES OF
EVENTS INVOLVING PURE
RISK. INSURANCE ONLY
ADDRESS PURE RISK.
RISK MANAGEMENT
• The process of identifying
and evaluating situations
involving pure risk to
determine and implement
the appropriate means for its
management.
70
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PERILS
• Any events that can
cause a financial loss.
Fire, wind, theft, vehicle
collision, illness, and
death are examples of
perils 71
The Risk-Management Process
• Step 1: Identify your risk exposures.

– Peril: Any event that can cause a
financial loss.
• Step 2: Estimate risk and potential
losses.
– Loss frequency
– Loss severity
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Figure 10-1: The Relationship

Between Severity and
Frequency of Loss
• Step 3: Choose how to handle risk.

– Risk Avoidance
– Risk Retention
– Loss Control
– Risk Transfer
– Risk Reduction
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FIVE WAYS TO HANDLE RISK

I. RISK AVOIDANCE
II. RISK RETENTION
III. LOSS CONTROL
IV. RISK TRANSFER
V. RISK REDUCTION
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RISK AVOIDANCE
 the simplest way

to handle risk is to
avoid it.
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RISK RETENTION
 you either retain

or accept it.
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LOSS CONTROL
Designed to reduce loss frequency
and loss severity. For example,
installing heavy duty locks and doors
may reduce the frequency of theft
losses. Installing fire alarms and smoke
detectors cannot prevent fires but
should reduce the severity of losses
from them
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RISK TRANSFER
Another way to
handle risk is to
transfer it to an
insurance company.
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RISK REDUCTION
The final way to handle risk is to
reduce it to acceptable levels.
Insurance is used by policyholders
when they arrange for all or a
portion of their risk to be covered
by an insurance company, thereby
reducing their personal level of
risk. 80
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• Step 4: Implement the risk-management

program.
– Large-Loss Principle: Insure the
losses that you cannot afford, and pay
the small losses out of your own
pocket.
• Step 5: Evaluate and adjust the
program.
The Large-Loss Principle

• Insure the risks that you cannot afford and
retain the risks that you can reasonably
afford.
• Insure for the highest possible loss.
• Choose a higher deductible to make the

coverage more affordable.
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Explain how insurance

works to reduce risk.
INSURANCE
Insurance is a mechanism
for transferring and reducing
pure risk through which a
large number of individuals
share in the financial losses
suffered by members of the
group as a whole. 84
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Understanding How Insurance

Works
• Insurance reduces risk.

• Premium is the fee paid for insurance
protection.
• Insurance Policy is the insurance
contract between the insured (person
buying the insuranace) and the insurer
(the insurance company).

Works
• Hazards make losses more likely to
occur.
– Hazard: Any condition that increases
the probability that a peril will occur.
• Only certain losses are insurable.
– Fortuitous losses
– Financial loss
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Works
• The Principle of Indemnity Limits

Insurance Payouts
– Principle of indemnity
– Policy limits

Works
• Factors that reduce the cost of insurance:
– Deductibles
– Coinsurance
– Hazard reduction
– Loss reduction
• Selecting higher deductibles and
coinsurance percentages is in
keeping with the large-loss principle.
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Works
• Insurance is applied for, not “bought”,
and insurance companies decide through
underwriting which applicants to accept.
– Preferred applicants pay lower rates
– Standard applicant pay standard rates
– Substandard applicant pay higher rates
– Unacceptable applicants are denied
coverage

Works
• The essence of insurance

– Sharing of losses through the
workings of the law of large
numbers.
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Works
•Insurance is typically sold through

insurance agents.
–Independent insurance agents
–Exclusive insurance agents
•Direct sellers market their policies

through salaried employees.
10 -
Concept Check 10.2

• Define insurance.
• Distinguish among the three types of

hazards.
• Why is the principle of indemnity so

important to insurance sellers?
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Concept Check 10.2
• Identify four key points to review when

reading an insurance policy.
• Summarize how to use deductibles,
coinsurance, hazard reduction, and loss
reduction to lower the cost of insurance.
• Differentiate among independent agents,
exclusive agents, and direct sellers.
47

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01/06/2022

Rich Dad Poor Dad

• There are two primary risks related

–Risk of dying too soon

–Risk of living too long

• Two financial problems arise because

• The second problem is the risk of

Ask yourself, “If I die tomorrow will

The primary reason for buying

Understand why you might

How Much Life Insurance Do

• The primary reason for buying

What Needs Must Be Met?

Final expenses: One-time expenses

What Needs Must Be Met?

College expense needs

Other special needs

What Needs Must Be Met?

Government benefits can reduce the

What Needs Must Be Met?

• Life insurance can close any

• Beneficiary: The person named in the

What Amount Do You Need?

• The Multiple-of-Earnings Approach:

• The Needs-Based Approach: a

Concept Check 12.1

• Distinguish between the dying-too-son

• List five types of needs that can be

Concept Check 12.1

Distinguish among the types of life

There Are Only Two Basic

Most people confused by the

Term Life Insurance is often described

All other life insurance policies are

This cash value factor represents the

Cash-value life insurance

Term life insurance are most often

oExplain the major provisions

Understanding Your Life

LIFE INSURANCE POLICY

Provides that a life insurance

How All Insurance Policies

Declarations lay out the

Policy Terms and Provisions

• Life Insurance Application: The

Policy Terms and Provisions

Policy Terms and Provisions

Policy Terms and Provisions

Policy Features Unique to

Policy Features Unique to

Concept Check 12.3

• Briefly describe each of the five

Concept Check 12.3

• Besides taking the cash value as a lump

Concept Check 12.3

Apply the risk-management process

Risk and Risk Management

• What is the nature of risk?

– Risk is not the same as “odds”.

TWO TYPES OF RISK

• Speculative risk involves situations

• Pure risk involves situations when

• INVESTMENTS SUCH AS THOSE

07 FINALS PART B - Life Insurance Planning & Managing Property & Liability Risk

07 FINALS PART B - Life Insurance Planning & Managing Property & Liability Risk