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MTHEL 131 (13)
Midterm

Midterm Exam Review (Lectures)

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Department
Mathematics Electives
Course
MTHEL 131
Professor
David Kohler
Semester
Fall

Description
Midterm Exam Review Lesson 1 Primary financial concerns of Canadians - living too long (insufficient savings) - dying too soon (leaving family in bad financial situation) - becoming disabled (not being able to work) Life insurance contract - Insurer - Policy owner - Insured - Face amount (payout) - Premium (monthly payment) Most valuable assets of insurance company - money - human resources - ability to predict death - ability to compete with other firms - reputation, ability to keep a promise Insurance: arrangement where any financial loss encountered will be covered by the policy - not intended to improve financial condition, just reimburse losses - has social benefit: → keeps remaining family off welfare → keeps family contributing to the economy Benefits of life insurance - goes straight to beneficiary (tax-free) - → bypasses estate, unlike will - is protected from creditors (beneficiary can’t be sued to settle debt) - is complete confidential (unlike will) - you can borrow 90% of your policy at a good rate - policies are unparalleled in safety (claims always get paid) Disadvantages of life insurance - not available to individuals in poor health - can be difficult to understand - cost of premiums reduces current family funds that can be used for consumption or investment Lesson 2 Features of the contract: - It is valid for the whole of life - The premiums are level - Premiums vary based on age of entry - In the case of public calamity, premiums could be increased, payout could be done in installments Features of the industry: 1. The industry offers a wide range of financial products on insurance: Living benefits: → life → disability → health → critical illness → long term care Investment: → annuities Etc. 2. The industry plays a big role in meeting the financing needs of all levels of government - the taxes that government collects aren’t enough - governments create bonds - insurance companies purchase those bonds (invest) 20% of insurance industry assets are invested in government bonds 40% of assets are corporate bonds and stock 20% of assets are mutual funds Probably not 15% of assets invested in mortgages important 5% of assets are invested in other things 3. The insurance industry is a financially strong and secure industry 4. The insurance industry is internationally successful - 50% of Canadian revenue is from outside the country 5. It is a highly competitive domestically industry - 87% of insurance policies purchased in Canada were created by Canadian firms 6. The industry contributes to small businesses - as a source of financing (provides mortgages) - provides important products that attract, retain, employees (benefits, pension plans) - agents affiliated with insurance companies provide consulting services (help small businesses by demonstrating how they can benefit from insurance) 7. The industry is a major employer (132,000 employees) Types of life insurance * Average Canadian who has life insurance has $165,000 of coverage Life Insurance Individual – average coverage is $115,000 – 2 types: → term → permanent - pays under any circumstance (other than fraud) Group – average coverage is $49,000 – 3 types (offered by): → employer → creditor (offered through banks when selling mortgages) → association (alumni, union, etc.) - Group insurance does not pay out often - Does not pay out if you perform criminal act at time of death (ex. drunk driving) - Does not cover pre-existing conditions (ex. illness that began before start of policy) - Costs almost the same as individual life insurance → why would you get that when you can get more coverage with individual? * Banks aren’t allowed to sell individual life insurance in their branches, or use their database of clients as insurance customers. Some insurers have their own actuaries, while some are too small, so they just use the services of actuarial firms. Financial independence Your most valuable asset: - ability to earn an income (human capital) → can only be robbed by death or disability If you are financially independent, you are: - self-sufficient - debt-free - able to make decisions about how to spend your money - able to financially support others People fail to achieve financial independence (only 5% do) because: 1) they fail to plan 2) they fail to get financial advisors 3) a time frame is not set 4) procrastination 5) investment and insurance is expensive 6) failure to protect life/ability to work 7) failure to diversity assets/investments 8) failure to manage health risk (health insurance) 9) failure to prioritize (financial planning pyramid) To achieve financial independence: - 10% of income should go to long-term programs of investment and insurance  12-14% for our generation - You can invest and get whatever you put aside, or buy life insurance and get hundreds of thousands. S. M. A. R. T. goals S- specific M- measurable A- attainable R- realistic T- time framed without a timeframe, it’s just a dream, not a goal Lifestyle is balanced by 2 people’s incomes. If one loses their job, dies, or suffers a disability, most families would not be able to sustain the same lifestyle. Life insurance and disability insurance help relieve that burden. - Insurance is not an investment, but a return - It is about protecting against risk of unexpected death - We buy it to provide financial protection to beneficiary Lecture 3 EX. Needed to determine how much savings are needed upon retirement: - life expectancy (when death will occur) - money needed a retirement - current income/expenses - current savings/investment - how to save? (method) - expected income upon retirement Steps for a financial planner: 1. identify amount of money that needs to be made up 2. identify goals to keep score of the situation 3. keep track of net worth (capital vs debt) Complete financial planning process: 1. develop relationship, understand the situation and objective 2. collect financial data 3. analyze financial data 4. formulate plan 5. implement plan 6. monitor/make necessary changes Important questions: 1) How much insurance is best? Most people don’t have enough saved up for even 2 months 2) Which type of insurance is best? To calculate how much life insurance is needed, consider: Expenses 1) immediate expenses: - funeral - mortgage - debts - emergency fund (3-6 months of new target income) - education fund (depending on number of kids) 2) ongoing expenses - Income replacement capital - additional ongoing income required should be 60-80% of what it was before - multiply by number of years it is required for (use table) * Add up capital required Capital available 1) capital available: - insurance compensation - survivor’s income *Add up capital available COVERAGE NECESSARY= CAPITAL AVAILABLE – CAPITAL REQUIRED EXAMPLE Paul makes 70,000 Lily makes 50,000 $120,000/ year = $12,000 / month Lily thinks she can survive on $80,000/year.  She only needs to make up $30,000/year  $2500 / month This money will be necessary for 15 years (until child turns 18) 15 years x ( $2500 x 12) x 145.57 = $360,000  145.57 is the factor from the given actuarial table  she needs $360,000 to continue the same lifestyle as before SO: immediate expenses ($305k) + ongoing expenses ($360k) = $665k Lecture 4 When insurance companies price premiums, they consider: - mortality rates - investment returns - expenses of the company - buffers (capital necessary to counter risk) A company takes premiums collected and puts them into a reserve. That’s where money used to pay out claims comes from. Q: Given ages of all the insureds, and the sizes of their policies, how much should be in the reserve right now? A: you don’t need total sum of potential claims in reserve because: - People aren’t going to die at the same time - Interest will be accumulated Sometimes, there is more money in the reserve than necessary, because of: - Overcharging on premiums - More interest earned than expected - Less people dying than expected - Expenses lower than expected Money belongs to policy-owners, so ways of giving the surplus back: 1. Reduced premiums (P.R.O. – premium reduction option) 2. Cash (sending them a cheque) 3. Accumulation option (on deposit) – dividends would be deposited every year policy-owner can withdraw the money at any time 4. Additional coverage (P.U.A. – paid up additions) – you don’t have to pay for
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