PERSONAL FINANCE (BWFF3073)

5. Managing Risk and Insurance Needs

Lecturer:
Dr. Md Mahmudul Alam
Associate Professor in Finance
School of Economics, Finance & Banking (SEFB)
Universiti Utara Malaysia (UUM)
Room No: 361 SBM Building
Extension: 6917
H/P: 0182467050
Email: mahmudul@uum.edu.my

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 Chapter 12
Life Insurance

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 Life Insurance: An Introduction
Define life insurance and describe its purpose and
principle.

• Life insurance
– A person purchases a policy by paying a premium
and the insurance company promises to pay a sum of
money at the time of the policyholder’s death to the
designated beneficiary. If an endowment, then the
amount is paid to policyholder while living.

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 Purpose of Life Insurance
• Protect someone who depends on you from financial loss
related to your death.
• Proceeds may also be used to:
– Pay off a home mortgage or other debts at the time of
death
– Provide lump-sum payments to children when they reach
a specified age (endowment)
– Provide an education or income for children
– Cover medical expenses and funeral costs
– Accumulate savings or establish income for survivors
– Make estate and death tax payments

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 Principle of Life Insurance
and Life Expectancy
• THE PRINCIPLE OF LIFE INSURANCE
– Mortality tables show the number of deaths among
various age groups and gender during any year.

• LIFE EXPECTANCY
– Individuals are living longer due to improved
medical care, healthier lifestyles, and education
obtained. Women outlive men.

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 Determining Your
Life Insurance Needs
Determine your life insurance needs.

• DO YOU NEED LIFE INSURANCE?

– Do you have people you need to protect financially
(spouse, children, parents)?
– Influenced by your stage in the life cycle and the
type of household you live in.
• Households with small children have greatest
need for life insurance.

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 Determining Your
Life Insurance Objectives
– How much money do you want to leave to your dependents
if you were to die today?
– Will you require more or less insurance protection to meet
their needs as time goes on?
– When would you like to be able to retire?
– What amount of income do you believe you and your spouse
would need in retirement?
– How much are you able to pay for your insurance program?
– Are the demands on your family budget for other living
expenses likely to be greater or lower as time goes on?

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 Estimating Your
Life Insurance Requirements (1 of 2)

• The Multiple of Income Method

- Needs range between 5 and 10 times your annual
income.
• The Easy Method
- Typical family needs 70% of your salary for seven
years before they adjust to life without your
income.
• The DINK (dual income, no kids) Method
- Funeral expenses plus half of debts.

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 Estimating Your
Life Insurance Requirements (2 of 2)

• 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
liquid assets.
• Online Calculators and Applications (Apps)

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 Types of Life Insurance Companies (1
of 2)
Distinguish between the types of life insurance
companies and analyze various types of life
insurance policies.
• Stock life insurance companies are owned by
shareholders.
– 71% are of this type
– Sell nonparticipating policies
– If you want to pay the same premium each year,
choose a nonparticipating policy with its
guaranteed premiums.

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 Types of Life Insurance Companies (2
of 2)
• Mutual life insurance companies
– 29% are of this type
– Owned by policyholders
– Sell participating policies
– Higher premium than nonparticipating policies but
part of the premium is refunded to the policyholder
annually; refund is called the policy dividend.

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 Types of Life Insurance Policies
• Temporary Insurance (term, renewable term,
convertible term, or decreasing term insurance)
• Permanent Insurance (called whole life, straight
life, ordinary life, or cash value life insurance)

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 Term Life Insurance (1 of 2)
• Term life insurance (temporary life insurance)
– Protection for a specified period of time
– If you stop paying premiums, coverage stops.
– Renewability Option: renew the policy at the end of
the term without a medical reevaluation.
– Multiyear Level Term: popular because you pay the
same premium for life of policy.

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 Term Life Insurance (2 of 2)
– Conversion Option: can exchange term policy for
whole life policy without a medical examination.
– Decreasing Term Insurance: premium stays the
same, but the coverage decreases as you age or debt
is repaid (if paired with mortgage).
– Return of Premium: policy refunds every penny of
the premiums paid if one outlives the policy term.

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 Whole Life Insurance (1 of 5)
• Whole Life Insurance (permanent life insurance)
– Also called straight life or cash-value life or ordinary
life.
– You pay specified premium as long as you live.
– Premium depends on your age when you start the policy.
– Provides death benefits and a savings account
(accumulates a cash value).
– Makes sense if you intend to keep the policy for the long
term or must be forced to save.
– First consider other savings and investment options
before investing in whole life insurance.

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 Whole Life Insurance (2 of 5)
• Limited Payment Policy
– Pay premiums for a stipulated period, usually 20 or 30
years, or until you reach a specified age (such as 60 or
65).
– Your policy then becomes “paid up” and you remain
insured for life; face amount paid at death.
• Modified Life Insurance Policy
– Attractive to people who want whole life policies, but
find the premiums too high to handle on their current
budget.

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 Whole Life Insurance (3 of 5)
- Typically allow lower premiums for five to ten years and
then the premiums will increase significantly for the
remainder of the life of the insured.
• Variable Life Policy
– Minimum death benefit guaranteed but cash value is not
guaranteed.
– The death benefit can be greater than the minimum
depending on earnings of the dollars invested in a
separate stock, money market, or bond fund.

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 Whole Life Insurance (4 of 5)
• Adjustable Life Insurance Policy
– Whole life insurance policy, but you can change your
coverage by changing the premium payments or the
period of coverage.
• Universal Life
– Gives you more direct control.
– Can pay premiums at any time in almost any amount.
Amount of insurance can be changed more easily than a
traditional policy.

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 Whole Life Insurance (5 of 5)
– The increase in the cash value of the policy reflects the
interest earned on short-term investments.
– Combines term insurance and investment elements.

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 Other Types of Life Insurance Policies
(1 of 2)
• Group Life Insurance
– Insures large number of persons under a single
policy without medical examinations.
– Term insurance
– Often provided by an employer
• Endowment Life Insurance
– Provides coverage from the beginning of the
contract to maturity and guarantees payment of a
specified sum to the insured, even if still living at the
end of the endowment period.

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 Other Types of Life Insurance Policies
(2 of 2)
• Credit Life Insurance
– Used to repay personal debt such as car loan if
borrower dies
– Expensive protection; considered a “ripoff”
• Industrial Life Insurance
– Known as home service or debit insurance
– Premiums collected at insured’s home
– Least popular

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 Important Provisions in a
Life Insurance Contract
Select important provisions in life insurance
contracts.
• Payments to Life Insurance Policies
– Policy Reinstatement
• Reinstatement of a lapsed policy if it has not been
turned in for cash; time limit 1 to 2 years
– The Grace Period
• Allows 28 to 31 day late payment without penalty
– Automatic Premium Loan
• Cash value is used to pay premium if not paid within
grace period
– Guaranteed Insurability Option

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 Clauses in Life Insurance Policies
• Nonforfeiture Clause
- Keep accrued benefits if you drop the policy.

• Incontestability Clause
- After the policy has been in force for awhile (2
years), the company cannot dispute its validity for
any reason, including fraud.

• Suicide Clause
- During first two years

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 Payments from Life Insurance Policies
• Naming Your Beneficiary
- Contingent Beneficiary
• Misstatement of Age Provision
- Pays based on actual age
• Policy Loan Provision to borrow against cash value
– Up to the cash value of the policy
• Joint Life Options
- First-to-die pays benefit upon death of first spouse.
- Second-to-die, also called survivorship life, insures two
lives.

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 Riders to Life Insurance Policies
• A rider to a policy modifies the coverage by adding or
excluding conditions or altering benefits.
– Waiver of Premium Disability Benefit
– Accidental Death Benefit — double indemnity
– Cost-of-Living Protection
– Accelerated Benefits
• Also called living benefits; pay to those who are
terminally ill before they die.

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 Buying Life Insurance
Create a plan to buy life insurance.
• FROM WHOM TO BUY?
– SOURCES
• Examine both private and public sources.

– RATING INSURANCE COMPANIES

• Check reputations of local agencies.
• Talk to friends or colleagues.
• Look up the company’s rating in A. M. Best or
other rating agencies.

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 Choosing Your Insurance Agent
• Can friends or parents make recommendations?
• Does the agent have professional designations such as
Chartered Life Underwriter (CLU)?
• Is the agent willing to find a policy that is right for you
or does he push a certain type of policy?
• Do they ask about your financial plan?
• Do you feel pressured?
• Is agent available when needed and happy to answer
questions?

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 Comparing Policy Costs (1 of 2)
• Five factors affect the price of a policy:
- The company’s cost of doing business
- Return on the company’s investments
- Mortality rate the company expects among policyholders
- Policy features
- Competition among companies with comparable policies
• Underwriting uses many attributes of individuals such as age,
gender, health, occupations, and even hobbies to determine
the appropriate premiums to charge for insurance.

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 Comparing Policy Costs (2 of 2)
• Use interest-adjusted index to compare policies.
- Takes into account the time value of money.
- Helps you make cost comparisons among insurance
companies.
- The lower the index, the lower the policy cost.

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 Obtaining and Examining a Policy
1. Application
2. Provide medical history.
3. Usually no physical for a group policy.
4. Read every word of the contract.
5. After you buy it, you have a 10 day “free-look” period
to change your mind.
6. Give your beneficiaries and lawyer a photocopy.

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 After the Purchase (1 of 2)
• After you buy new life insurance, you have a 10-day “free-
look” period during which you can change your mind.
• When you receive your new policy, read it carefully.
• If you are not satisfied for any reason, you may return the
new policy within 10 days after you receive it.
• Mail it to the company’s home office or give it back to the
agent who sold it to you.

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 After the Purchase (2 of 2)
• Be sure to get a dated receipt from the post office or the
agent.
• The company must return your premium within 30 days
from the date you returned the policy. If the insurance
company keeps your money longer, legally it is
responsible for a 10 percent penalty—payable to you.

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 Life Insurance Proceeds
Evaluate the payout options for life insurance.
• Death (or Survivor) Benefits
– To cover the immediate expenses resulting from the
death of the insured.
– To protect dependents against a loss of income
resulting from premature death of primary wage
earner.

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 Common Settlement Options
• Lump-sum Payment
- Pays face amount in one installment.
• Proceeds Left with the Company
– Pays interest to the beneficiary.

• Limited Installment Payment

– Pays equal installments for a specific number of
years after your death.
• Life Income Option
– Payments to the beneficiary for life (annuity).

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 Income from Life Insurance Policies

• Insured of a whole life policy may borrow against cash

value or surrender policy and receive cash value.
• People who purchase variable life insurance policies
may supplement retirement income by withdrawing
some of the investment portion as an annuity.

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 Switching Policies
• Are you still insurable?
– Before you switch, make sure you are still insurable
(check medical and other requirements).
• The older you are, the higher the premium will be.
• Can you get all the provisions in the new policy that
existed in the old policy?

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