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Life Insurance

Explain the purpose and basic characteristics of life insurance. . 1 in 5 households have no life insurance. . Can be used for term or permanent life insurance. . – PowerPoint PPT presentation

Title: Life Insurance

1
Life Insurance

  • RMI 3500
  • Intro. to Risk Mang. Ins.
  • Robert Klein

Revised 10/14/07

2
Topic Objectives

  • Explain the purpose and basic characteristics of
    life insurance.
  • Review different types of products.
  • Important contract provisions.
  • Determining life insurance needs.

3
Why Buy Life Insurance?

  • Why would a risk averse person purchase insurance
    against a certain event?

4
Why Buy Life Insurance?

  • Why would a risk averse person purchase insurance
    against a certain event?
  • Timing is not known and premature death poses
    risk.
  • Unfulfilled obligations to dependents others.

5
Features of Life Insurance

  • Purpose
  • Meet financial needs of survivors.
  • Savings?
  • Distinguishing Features
  • Valued policy.
  • Payment is made to named beneficiary.
  • Benefit is not taxable.
  • Insurance against a certain event.

6
Risk of Premature Death

  • Cost of premature death
  • Unfulfilled financial obligations
  • Loss of income
  • Funeral expenses
  • Estate settlement expenses

When you say Do we have enough life insurance,
I assume you mean me.

  • Impact of early death depends on type of family.

7
Family Characteristics

  • Number and ages of dependents.
  • Employment status of heads of household wage
    earners.
  • Age and health of wage earners.
  • Income and assets.
  • Special needs.
  • 1 in 5 households have no life insurance.
  • Median amount of life insurance purchased covers
    only 2 years of income.

8
Mortality Rates
9
How much life insurance?

  • In general it depends on many things.
  • How much income is lost?
  • How much debt is there?
  • Income goals
  • Expected inflation
  • Methods
  • Human Life Value
  • Needs Approach
  • Capital Retention Approach

10
Needs Approach

  • Needs
  • Cash Needs
  • Income Needs
  • Other
  • Project needs of survivors over their remaining
    lives.
  • Total Needs Assets
  • Additional Life Insurance Needed

11
Life Insurance Pricing

  • Three Components
  • Mortality charge
  • Interest Adjustment
  • Expense and profit loading
  • Net Premium mortality charge with the interest
    adjustment
  • Net Single Premium
  • Net Level Premium

12
Yearly vs. Level Pricing

  • Yearly Pricing
  • Premium is adjusted each year based on insureds
    age.
  • Rates escalate rapidly with age.
  • Used only for yearly term insurance.
  • Level Pricing
  • Level premium is charged through policy term.
  • Can be used for term or permanent life insurance.
  • Premiums income will be higher in early years and
    lower in later years remainder is invested into
    a legal reserve.
  • Net amount at risk – difference between the face
    value of the policy minus the legal reserve.

13
(No Transcript)
14
Example 1,000 Face Amount, Male 45, P 5/year

15
Types of Life Policies
Term Insurance
Yearly
Multi-Year
Whole Life
Ordinary
Variable
Universal
Variable Universal
16
Major Types of Life Insurance
17
Term Insurance

  • Characteristics
  • Temporary
  • Renewable
  • Convertible
  • Pure insurance protection only
  • Types
  • Yearly renewable
  • X-year renewable
  • Term to age A
  • Decreasing term
  • Re-entry term
  • Advantages and disadvantages?
  • Max protection for lowest cost.
  • Not permanent, no forced savings.

18
Whole Life Insurance

  • Characteristics
  • Lifetime protection
  • Includes a savings and insurance element.
  • Cash Value vs. Surrender Value.
  • Savings element earns a stated investment return.
  • Option to borrow against cash value at stated
    interest rate.

19
Whole Life Insurance

  • Types
  • Ordinary life
  • Limited payment life
  • Participating vs. non-participating policies
  • Advantages and disadvantages?
  • Less protection for given premium.
  • Permanent nature and savings element.

20
Universal Life Insurance

  • Characteristics
  • Death benefit and cash values vary according to
    investment experience and premiums paid.
  • Policyholder determines amount and frequency of
    premium payments, subject to minimums.
  • Unbundling of components
  • savings
  • protection
  • expense charges

Thank you, but Ive already provided for my
childrens education.

21
Universal Life Insurance

  • Advantages Disadvantages?
  • flexibility, higher returns on investment
  • complex, buyer misunderstanding

22
Universal Life Flexibility

  • Change death benefits.
  • Change premium payments.
  • Make partial cash withdrawals.
  • Policy loans allowed at competitive interest
    rates.
  • More competitive with term insurance investment
    of premium savings approach.

23
Variable Life Insurance

  • Variable Life
  • Premiums fixed.
  • Death benefit and cash value vary according to
    investment return on funds held in separate
    account by insurer.
  • Variable Universal Life
  • Policyowner determines how premiums are invested.
  • No guaranteed minimum interest rate or cash value.

24
Life Insurance Purchases in the United States
Percent of Face Value In Force by Type of Policy
(Individual)
25
Major Contract Provisions

  • Exclusions
  • Beneficiary Designations
  • Policy Loans
  • Participation/Dividends
  • Non-Forfeiture/Surrender
  • Settlement Options
  • Guaranteed Purchase Option

We cannot write a life policy for your husband,
Mrs. Blaine, because he is already dead. In
insurance terms, that is considered a prexisting
condition

26
Significant Clauses

  • Incontestable Clause
  • Insurer cant contest policy after 2 years.
  • Grace Period
  • Reinstatement Clause
  • Permits reinstatement of lapsed policy.
  • Evidence of insurability required.
  • Exclusions
  • war, aviation

27
Policy Loans

  • Allows the insured to borrow the cash value of
    his/her policy.
  • Insured must pay interest to cover the loss of
    interest income to insurer.
  • Loan and interest must be repaid or deducted from
    benefits.
  • Policy loans pose disintermediation risk to
    insurers.

28
Non-Forfeiture Options

  • If policy is surrendered, insured has some rights
    to cash value.
  • Options
  • cash
  • reduced paid-up insurance
  • extended term insurance
  • Surrender charges discourage adverse selection,
    disintermediation.

29
Guaranteed Purchase Option

  • Insured can purchase additional amounts of life
    insurance at specified times in the future
    without evidence of insurability.
  • Poses adverse selection risk to insurer.
  • Restrictions on option limit risk to insurer.

30
Speculating on Death

  • Need for terminally ill people to collect all or
    a portion of their life insurance proceeds.
  • Accelerated Death Benefits Rider
  • Terminal Illness Rider
  • Catastrophic Illness Rider
  • Long-Term Care Rider
  • Viatical Settlements
  • Firms buy the life insurance policies of
    terminally ill insureds at a discount.
  • Issues and Abuses

31
Conclusions

  • Life insurance decision determined by income,
    needs, family circumstances goals.
  • Tradeoffs between term life vs. other life
    insurance products.
  • Importance of contract provisions and flexibility.

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The History of Insurance in America

Insurance was a latecomer to the American landscape, largely because there were just too many known risks, and even more unknown ones. When it finally did make it over, it was supported by one of the most famous Americans in history. Let’s take a look at the history of insurance in the U.S.

Benjamin Franklin and American Insurance

Not content with the titles of statesman, scientist, inventor or author, Benjamin Franklin added insurer to his collection. In 1752, the Philadelphia Contributionship for the Insurance of Houses from Loss by Fire became the first mutual fire insurance company in America. Much like London in the 1600s, houses at this time were made almost entirely out of wood. Worse yet, the settlements that grew into cities were built close together. This was originally done for security reasons, but as cities grew, developers built homes very close to each other for the same reasons they do today—to fit as many homes as possible on their development plots.

Home and Life Insurance

The Philadelphia Contributionship for the Insurance of Houses from Loss by Fire set new standards for building houses because it refused to insure houses they considered fire hazards. The criteria they used to evaluate buildings would one day be reworked into both building codes and zoning laws. Seven years later, Franklin was also instrumental in getting the first life insurance company, the Presbyterian Ministers’ Fund, off the ground. (For more, see: How Much Life Insurance Should You Carry?)

The various religious authorities at the time were outraged at the practice of putting a value on human life, but criticism cooled when it was seen that insurance worked to protect widows and orphans. The Industrial Revolution then brought the necessity of both business insurance and disability insurance to the forefront.

Throughout history, the types of insurance offered have been expanded in reaction to new risks. 1864 saw the Travelers Insurance Company sell its first accident policy. 1889 saw the first auto insurance policy. As time progressed, new types of insurance were being offered to keep up with the risks of an increasingly modern life. (For related reading, see: Five Insurance Policies Everyone Should Have.)

Scandal, Fraud and Regulation

With the explosion in insurance products and companies issuing them, the young industry was fraught with fraud and scandal. These ranged from issuing companies without the actual capital to pay claims running instead like fragile Ponzi schemes, to insurers demanding unfairly high premiums or forcing out competitors in an attempt to create a monopoly. Many state laws were passed to try and curb the problems, but in the early 1900s things were still unsettled. (For related reading, see: What Is a Pyramid Scheme?)

In 1935, the Social Security Act came into effect, providing unemployment compensation and retirement benefits. This took away some of the insurance companies’ territory and it sent a clear signal that encouraged the industry to begin regulating itself for fear of more government involvement. World War II brought a wage freeze, and companies, desperate to attract the workers still in the country, started offering group life and health insurance. These big policies went to companies large enough to handle them. This swelled the big guys and starved out the little guys, along with most of the fly-by-night rabble. In 1944, the Supreme Court ruled insurance should be federally regulated, but Congress passed the McCarran-Ferguson Act in 1945, returning control to the state level.

The control remains mainly at the state level to this day, but after many insurance companies have been called to task over basing rates on gender, race and other factors, the insurance industry has become more egalitarian and affordable for the public. It has also become more complex to respond to the needs of the business. The size of insurance companies continues to increase as they merge with one another and other giants in the financial industry. Now insurance policies can be found at institutions offering a range of financial services.

Investing in Insurance

Insurance is always in demand because people and businesses are always looking for ways to minimize risk. The demand and range of coverage available has caused insurance policies to increasingly become investments in and of themselves. Because the level of insurance concentrated in urban centers could lead to huge losses and chaos in the insurance industry if a mega-disaster or succession of regular disasters occurred, the insurance industry has begun to repackage its risk in catastrophe-linked securities that trade on the market and mitigate insurers’ risk. (For related reading, see: The Financial Effects of a Natural Disaster.)

Insurance Today

The internet changed the insurance industry by blowing the field wide open. Now people can go online to find the cheapest rate, even as companies shop internationally for the right coverage. This is one source of motivation for companies to merge with other financial services—the increase in size gives them a global market, and the integration of services gives them a domestic advantage with customers who are more concerned with convenience than price.

The History of Insurance

If risk is like a smoldering coal that may spark a fire at any moment, insurance is our fire extinguisher.

Countries and their citizens need something to spread risk among large numbers of people and to move risk to entities that can handle it. This is how insurance emerged. Read on to learn how insurance evolved and how it can work to protect you from being burned by risk.

King Hammurabi’s Code and the Beginning of Insurance

The main concept of insurance—that of spreading risk among many—has been around as long as human existence. Whether it was hunting giant elk in a group to spread the risk of being the one gored to death or shipping cargo in several different caravans to avoid losing the whole shipment to a marauding tribe, people have always been wary of risk.

The first written insurance policy appeared in ancient times on a Babylonian obelisk monument with the code of King Hammurabi carved into it. The Hammurabi Code was one of the first forms of written laws. These ancient laws were extreme in most respects, but one offered basic insurance in that a debtor didn’t have to pay back his loans if some personal catastrophe made it impossible (disability, death, flooding, etc.).

Guild Protection, First Form of Group Coverage

In the Dark and Middle Ages, most craftsmen were trained through the guild system. Apprentices spent their childhoods working for masters for little or no pay. Once they became masters themselves, they paid dues to the guild and trained their own apprentices. The wealthier guilds had large coffers that acted as a type of insurance fund. If a master’s practice burned down—a common occurrence in the wooden hovels of medieval Europe—the guild would rebuild it using money from its coffers. If a master were robbed, the guild would cover his obligations until money started to flow in again. If a master were suddenly disabled or killed, the guild would support him or his widow and family.

This safety net encouraged more and more people to leave farming and take up trades. As a result, the amount of goods available for trade increased, as did the range of goods and services available. The style of insurance used by guilds is still around today in the form of group coverage. (For related reading, see: Individual vs. Group Health Insurance: What’s the Difference?)

Reducing Risk in Dangerous Waters

The practice of underwriting emerged in the same London coffeehouses that operated as the unofficial stock exchange for the British Empire. In the late 1600s, shipping was just beginning between the New World and the old as colonies were being established and exotic goods were ferried back. A coffeehouse owned by Edward Lloyd, later of Lloyd’s of London, was the primary meeting place for merchants, ship owners and others seeking insurance.

A basic system for funding voyages to the New World was established. In the first stage, merchants and companies would seek funding from venture capitalists. The venture capitalists would help find people who wanted to be colonists, usually those from the more desperate areas of London, and would purchase provisions for the voyage. In exchange, the venture capitalists would be guaranteed some of the returns from the goods the colonists would produce or find in the Americas. It was widely believed you couldn’t take two left turns in America without finding a deposit of gold or other precious metals. When it turned out this wasn’t exactly true, venture capitalists still funded voyages for a share of the new bumper crop: tobacco.

After the voyage was secured by venture capitalists, the merchants and ship owners would go to Lloyd’s and hand over a copy of the ship’s cargo to be read to the investors and underwriters who gathered there. The people interested in taking on the risk for a set premium would sign at the bottom of the manifest beneath the figure indicating what share of the cargo they were taking responsibility for (hence, underwriting). In this way, a single voyage would have multiple underwriters who would try to spread their own risk by taking shares in several different voyages.

By 1654, Blaise Pascal, the Frenchman who gave us the first calculator, and his countryman, Pierre de Fermat, discovered a way to express probabilities and, thereby, understand levels of risk. Pascal’s triangle led to the first actuary tables that were, and still are, used when calculating insurance rates. These formalized the practice of underwriting and made insurance more affordable. (For related reading, see: How is my insurance premium calculated?)

Fire and Plague Protection

In 1666, the great fire of London destroyed around 14,000 buildings. London was still recovering from the plague that ravaged it a year earlier, and many survivors found themselves without homes. As a response to the chaos and outrage that followed the burning of London, groups of underwriters who had dealt exclusively in marine insurance formed insurance companies that offered fire insurance.

Armed with Pascal’s triangle, these companies quickly expanded their range of business. By 1693, the first mortality table was created using Pascal’s triangle and life insurance soon followed. (For related reading, see: Five Insurance Policies Everyone Should Have.)

The Slow Exodus to America

Insurance companies thrived in Europe, especially after the Industrial Revolution. In America, the story was very different. Colonists’ lives were fraught with dangers that no insurance company would touch. As a result of lack of food, wars with indigenous people, and disease, almost three out of every four colonists died in the first 40 years of settlement. It took more than 100 years for insurance to establish itself in America. When it finally did, it brought the maturity in both practice and policies developed during that same period of time in Europe. (For related reading, see: The History of Insurance in America.)

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