Fundamentals of life insurance

Explain the meaning of premature death

Establish the impact of premature death on different
families
Explain the needs approach of estimating amount of
life insurance
Describe characteristics of term life insurance
Explain the basics of ordinary life insurance
Explain some variations in whole life insurance
 Financial impact of premature death

The impact of premature death varies wih the typeof

family
Single people
Single-parent
Two-income earners with children
Traditional families
Blended families
Sandwiched Families
 Determination of the amount of life insurance

The amount of life insurance required is dependent

on the following factors
Size of family
Income levels
Existing financial assets
Financial goals.
The method that can be used are :
1. Human life value approach
2. needs approach
3. Capital retention approach
 Human life approach

It is the present value of the family’s share of the

deceased breadwinner’s future earnings.
1. Estimate the individual’s annual earning over his
productive lie
2. Deduct expenses such as taxes, premiums and self
maintenance cost etc
3. Determine remaining years to retirement
4. Determine the present value of the family’s share
of earnings.
 Needs approach

 Subtract the value of existing life insurance and financial

asset is subtracted from the total amount required to meet
family needs if the deceased was alive.
 Some of the needs are:
 1.Estate clearance fund
 2.Adjustment period income
 3.Dependency period income
 4.Life income to spouse(Blackout and social security
supplement incom)
 5.Special needs(mortgage, education and emergency funds)
 6.Retirement needs.
 Capital Retention Approach

This approach preserves the capital required to

provide income for the family
Steps
1. Prepare a personal balance sheet(must include
death benefits from life insurance)
2. Determine the amount of income producing
capital
3. Determine the amount of additional capital
required if any
 Example

 Koklotsu is 35 years old and is married with two children ages 3 and
5. His annual income is GHC60,000 but wants his family to receive
GHC40,000 when he is dead. Koklotsu has the following in asets:A
house valued at GHC225,000; automobile valued at GHC 20,000;
personal and household poperty of GHC 40,000. He ivested in
sucurities worth GHC60,000; Checking account balance of
GHC5,ooo; individual and group life insurance worth GHC200,000
and a 401 planvalue GHC70,000. He wants to pay off mortage, credit
card and auto loan of GHC100,000, GHC5,000 and GHC10,000
respectively and in addition establish educational
endowment(GHC100,000) and emergency fund(GHC50,000).
 The liquid assets and life insurance benefit can be invested at 5% per
annum and final expenses stood at GHC15,000. Determine the
amount of life insurance needed using the capital retention approach.
 Solution

Assets
GHC
House 225,000
automobile 20,000
Property 40,000
Security and investments 60,000
Checking account 5,000
Individual and group life insurance 200,000

401(k) Plan 70,000

Total 620,000
Liabilities
Mortgage 100,000
auto loan 10,000

credit card 5,000

total 115,000
 Income producing capital

Tota assets GHC620,000

Less:

Mortgage GHC100,000

Autoloan and credit card GHC15,000

Final expenses 15,000

Emergency fund 50,000

Educational fund 100,000

Non-income producing capital 285,000

Tota deductions 565,000

Available capital GHC 55,000

 Additional capital needed

Income objective GHC40,000

Less:

Income from capitalavailble(GHC55,000*5%) 2750

Survivor benefit 13,000

Income shortage GHC24,250

New capital required (24,250/0.5) GHC485,000

 TYPES OF LIFE INSURANCE

Term life insurance covers the insured life for a specified

period. Term insurance policies are
1. Renewable: Premium is increased at renewal based on
attained age; can lead to adverse selection against insurer
because healthy clients will leave but poor health clients will
renew
2. convertible: attained age method and original age method
of conversing. Original age require payment of difference in
premium with interest
3.have no cash values: no savings or cash value elements.
Term insurance can be Yearly renewal; Term to age 65;
Decreasing term; Reentry term; Return of premium term
 Uses and Limitations of Term insurance

Uses
When the income for life insurance is limited
If the need for protection is temporal
It is used to guarantee future insurability
Limitations
Premiums increase with age at increasing rate; not
suitable for individuals requiring large amounts of
insurance
Can not be used when the desire is to save money for
a specific use
 Whole life insurance

Protection is provided for the entire life of the policy

holder; Whole life insurance comes in the following
forms:
Ordinary life insurance: Provides life time protection
to age 100. In the event that the insured is alive at age
100, he or she receives the face amount of the
insurance
Features:
Level premium leading to overcharging in the early
years and undercharging in later years.
Accumulation of cash surrender values
 USES and LIMITATIONS of Ordinary life
insurance
USES
For life protection
Can be used for saving through the surrender of policy or
borrowing
Limitations
Under insurance
LIMITED-PAYMENT PLIFE INSURANCE
Premiums are paid for a certain period. Eg 20years. Paid up
policies at 65 0r 70; single premium whole life
ENDOWMENT INSURANCE
It pays face amount if insured dies within or lives till the end of
the endowment period
 Variations of whole life insurance

1. Variable life insurance pays fixed premium but the

face value or cash values vary depending on the
investment performance of the accounts in which the
reserve is held.
2. Universal life insurance
 Variations of whole life insurance

1. Variable life insurance pays fixed premium but the

face value or cash values vary depending on the
investment performance of the accounts in which the
reserve is held.
2. Universal life insurance