ch. 7 planning ahead

CH. 7 PLANNING CH. 7 PLANNING AHEADAHEAD

•7-1 Life Insurance: Who needs it?7-1 Life Insurance: Who needs it?•7-2 Spreading the Risk: How 7-2 Spreading the Risk: How Insurance worksInsurance works•7-3 Value for the Future7-3 Value for the Future

Ch 7-1 Life Insurance: Who Ch 7-1 Life Insurance: Who needs It?needs It?

• What is life insurance?What is life insurance?• Who needs life insurance?Who needs life insurance?• How much life insurance does a How much life insurance does a

family need to buy?family need to buy?• What kinds of life insurances are What kinds of life insurances are

available?available?• What are the costs of these different What are the costs of these different

insurances?insurances?

What is Life Insurance?What is Life Insurance?Life insurance is a contract to pay a specified

amount of money to a designated person upon the death of the policy-owner.

• Insurance is based on two ideas: risk sharing Insurance is based on two ideas: risk sharing and statistical probabilityand statistical probability

• Every person faces the possibility of financial Every person faces the possibility of financial disaster caused by an unpredictable event disaster caused by an unpredictable event such as an accident, fire, flood, illness, or such as an accident, fire, flood, illness, or death of principal wage earner.death of principal wage earner.

• Insurance companies manage the pooled Insurance companies manage the pooled money (premiums) and in the event of a loss money (premiums) and in the event of a loss the beneficiaries receive money from the the beneficiaries receive money from the pooled money.pooled money.

Who needs life Who needs life insurance?insurance?

• If an income provider in a family dies, If an income provider in a family dies, then that event puts a financial burden then that event puts a financial burden on the family. Having a life insurance on the family. Having a life insurance policy large enough to replace all or policy large enough to replace all or most of the income that is needed for most of the income that is needed for the dependents to survive financially the dependents to survive financially after the death of a family provider. after the death of a family provider. Life insurance is purchased to protect Life insurance is purchased to protect the dependent members of a family.the dependent members of a family.

How much life insurance How much life insurance does a family need to buy?does a family need to buy?

• An ideal goal is to have the insurance provide An ideal goal is to have the insurance provide enough income for the family to continue its enough income for the family to continue its current standard of living. You should attempt current standard of living. You should attempt to replace your family’s usual to replace your family’s usual net incomenet income, that , that is , the amount that remains after income and is , the amount that remains after income and FICA taxes have been deducted.FICA taxes have been deducted.

• 75% of the previous gross income would 75% of the previous gross income would probably accomplish this. However the probably accomplish this. However the premiums may be to high.premiums may be to high.

• At least 60% of gross income would probably At least 60% of gross income would probably avoid a serious lowering of your family’s avoid a serious lowering of your family’s standard of living.standard of living.

What kinds of Life What kinds of Life Insurance is available?Insurance is available?

• Term InsuranceTerm Insurance• Cash-Value InsuranceCash-Value Insurance

Term InsuranceTerm Insurance• Group life – Purchased through an Group life – Purchased through an

employer; lower ratesemployer; lower rates• Renewable convertible term – One-, Renewable convertible term – One-,

five-, or ten-year terms; renewable and five-, or ten-year terms; renewable and convertibleconvertible

• Decreasing term – Like renewable Decreasing term – Like renewable convertible term but less expensive convertible term but less expensive and with a gradually decreasing death and with a gradually decreasing death benefitbenefit

Cash-Value InsuranceCash-Value Insurance• Whole Life – Combines savings with insurance; Whole Life – Combines savings with insurance;

can be cashed in for its accumulated cash valuecan be cashed in for its accumulated cash value• Limited Payment – Higher premiums for a fixed Limited Payment – Higher premiums for a fixed

number of years, such as 20; builds up cash number of years, such as 20; builds up cash value more quickly than whole lifevalue more quickly than whole life

• Endowment – Emphasis on high cash value Endowment – Emphasis on high cash value buildup; very high premiumsbuildup; very high premiums

• Universal Life – Combines savings with Universal Life – Combines savings with insurance; can be cashed in for its accumulated insurance; can be cashed in for its accumulated cash valuecash value

What are the costs of What are the costs of these different these different

insurances?insurances?• To find the best price for both term insurance To find the best price for both term insurance and cash-value life insurance, you should shop and cash-value life insurance, you should shop around and compare the prices that different around and compare the prices that different insurance companies offer.insurance companies offer.

• The proceeds paid to a beneficiary from some The proceeds paid to a beneficiary from some kinds of life insurance policies are generally kinds of life insurance policies are generally free from federal income taxes but may be free from federal income taxes but may be subject to other taxes, such as an estate tax. subject to other taxes, such as an estate tax. Tax laws changes from time to time, so you Tax laws changes from time to time, so you should obtain up-to-date information from a should obtain up-to-date information from a tax adviser.tax adviser.

Try Your SkillsTry Your Skills

Current Current EarningEarningss

AgeAgeIncome Income ReplaceReplacementment

Amount Amount of of InsuranInsurancece

1.1. $65,000$65,000 3535 75%75%

2.2. 65,00065,000 4545 60%60%

3.3. 40,00040,000 5555 75%75%

Try Your SkillsTry Your SkillsCurrent Current EarningEarningss



1.1. $65,000$65,000 3535 75%75%7.5 * 7.5 * (65,000(65,000)= )= 487,500487,500

2.2. 65,00065,000 4545 60%60%

3.3. 40,00040,000 5555 75%75%




1.1. $65,000$65,000 3535 75%75%7.5 * 7.5 * (65,000(65,000)= )= 487,500487,500

2.2. 65,00065,000 4545 60%60%6 * 6 * (65,000(65,000) = ) = 390,000390,000

3.3. 40,00040,000 5555 75%75%




1.1. $65,000$65,000 3535 75%75%7.5 * 7.5 * (65,000(65,000)= )= 487,500487,500

2.2. 65,00065,000 4545 60%60%6 * 6 * (65,000(65,000) = ) = 390,000390,000

3.3. 40,00040,000 5555 75%75%7 * 7 * (40,000(40,000) = ) = 280,000280,000

Try Your Skills (2)Try Your Skills (2)Amount of Amount of InsuranceInsurance

AgeAge TypeType PremiumPremium

4.4. $100,000$100,000 2525 TermTerm

5.5. 100,000100,000 2525 Whole lifeWhole life

6.6. 200,000200,000 3535 TermTerm


8.8. 300,000300,000 4545 TermTerm




4.4. $100,000$100,000 2525 TermTerm $207$207


6.6. 200,000200,000 3535 TermTerm


8.8. 300,000300,000 4545 TermTerm




4.4. $100,000$100,000 2525 TermTerm $207$207

5.5. 100,000100,000 2525 Whole lifeWhole life 918918

6.6. 200,000200,000 3535 TermTerm


8.8. 300,000300,000 4545 TermTerm




4.4. $100,000$100,000 2525 TermTerm $207$207


6.6. 200,000200,000 3535 TermTerm 2(254) = 2(254) = 508508


8.8. 300,000300,000 4545 TermTerm




4.4. $100,000$100,000 2525 TermTerm $207$207


6.6. 200,000200,000 3535 TermTerm 2(254) = 2(254) = 508508

7.7. 200,000200,000 3535 Whole lifeWhole life 2(1374) = 2(1374) = 27482748

8.8. 300,000300,000 4545 TermTerm




4.4. $100,000$100,000 2525 TermTerm $207$207


6.6. 200,000200,000 3535 TermTerm 2(254) = 2(254) = 508508


8.8. 300,000300,000 4545 TermTerm 3(562) = 3(562) = 16861686


AssignmentAssignmentP. P. 328328 1-22 1-22

Chapter 7-2Chapter 7-2

SPREADING THE RISK: SPREADING THE RISK: HOW INSURANCE WORKSHOW INSURANCE WORKS

OBJECTIVESOBJECTIVES• Understand how life-expectation Understand how life-expectation

tables are used to estimate the tables are used to estimate the probability that an individual will die probability that an individual will die within one year.within one year.

• Learn how an insurance company Learn how an insurance company determines its premium schedule to determines its premium schedule to make a reasonable profit.make a reasonable profit.

Probability of an EventProbability of an Event

P(E) = m/nP(E) = m/n

Where P(E) = the probability of an event EWhere P(E) = the probability of an event Em = the number of times the event m = the number of times the event

occursoccursn = the number of all possible n = the number of all possible

outcomesoutcomes

ExampleExampleUsing the chart on page 331 of your Using the chart on page 331 of your

textbook, find the probability of a 16-year textbook, find the probability of a 16-year old person will be alive 1 year from today.old person will be alive 1 year from today.

# of 16-year old people alive 1 year later# of 16-year old people alive 1 year laterTotal number of 16- year old peopleTotal number of 16- year old people

99,92199,921100,000 = .99921100,000 = .99921

P(E‘) = Probability of a 16-year old will die in 1 year Total number of 16-year old people

P(E‘) = 79 = .00079 100,000

The sum of the probabilities of an event and its complement is 1P(E) + P(E‘) = 1

ch. 7 planning ahead

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