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CHAPTER 10 life, health and disability insurance.docx

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FIN 502
Steve Joyce

CHAPTER 10 life health and disability insuranceLIFE INSURANCELife insurance financing the risk of the premature and untimely death of a family memberInsupportable risk loss of income due to the unanticipated death of a family memberInsured the person upon whose death and death benefit or the face value of the insurance policy will be paidBeneficiary the persons who receives the death benefit or face value of the policy upon the death of the insuredDeath benefit or face value the dollar amount that will be paid to the beneficiary if the insured diesPremium dollar amount that must be paid to the insurance company The premium may be payable in one lump sum or periodicallyOwner the person who pays the premiums If you buy life insurance for your son you are the owner and your son is the insuredPolicy term the period during which the insurance is in forceRate cost of each unit of insuranceInsurability qualifications for the insured to be insurable There are certain requirements that the insured may have to meet before an insurance policy can be bought EX Passing a medical examinationGuaranteed insurability provision that allows the insured to buy additional life insurance at certain specific future dates without proof of insurability Income approach estimates the face value of the life insurance by calculating the present value of the insureds expected future income o Present value of the insured expected future income is conceptually the insureds human capital o Use the real rate of interest to calculate present value Real rate of interestnominal rate of interestexpected rate of inflation o Lifetime earnings stream is risky and one may want to use a higher discount rate than the real rate of interest o Basic benchmarkpresent value of the insureds lifetime earnings assuming no growth in real earnings and using real rate of interest as the discount rate o Assumes that the beneficiary pays income tax on the receipts at the same rate as the insured paid on the original incomeFace amount of life insurance policy is not taxable income for the beneficiary because the premiums are not tax deductibleInterest earned on face amount is taxable therefore the principle amount is less than the amount calculated by the basic benchmark method o Rule of thumbrather than insuring 100 replacement of the insureds income families may want to insure only 70 or 80 of the insureds future income Expense approach a life insurance face value amount that the family needs is the amount that will provide enough funds to pay those expected expenses of the beneficiaries that are not covered by government transfer income or other income o If insurer dies life insurance death benefit is invested and used as the expenses occur o Calculates the present value of the beneficiaries future expenses o Basic benchmarkpresent value of the insureds expected income shortfall from now until retirement if there is no shortfall there is no need to buy life insurance under the expense approach o Can use the approximate method to estimate the amount of life insurance Life InsuranceAverage annual incomediscount rate x adjustment factor o Six steps to expense approach
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