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MTHEL 131 (32)
Chapter 14

Chapter 14 Reading Notes

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University of Waterloo
Mathematics Electives
David Kohler

Chapter 14: Life and health insurance in financial planning Personal Financial Planning: Elements: - identification of the overall financial goals and objectives - development and implementation of an integrated plan to accomplish the objectives, taking into consideration the individual’s circumstances The key is starting out with the objectives, instead of seeing how a particular financial instrument would fit into their financial plan Planning today is more difficult because of 1) greater economic uncertainty (ex. fluctuations in rates and inflation) 2) constantly changing rules (ex. tax law changes) 3) proliferation of new financial instruments Financial tools include things such as life insurance, property and liability insurance, mutual funds, stocks, bonds, annuities, savings accounts, wills, trusts, real estate. Financial planning process Gather information - quantitative and qualitative - assets, liabilities, income, expenditures - interest, lifestyle, risk tolerance - usually accomplished with a fact-finding questionnaire Establish objectives - must be well conceived and formulated - advisor must probe into sensitive and confidential business while communicating effectively and professionally Analyze information - quantitative and qualitative information must be examined in light of the client’s objectives - insurance needs would be determined, policies would be reviewed - deficiencies in the financial arrangement would be revealed Develop the plan - should represent coordinated effort to solve problems and help the client achieve his objectives in light of financial constraints and limitations Implement the plan - advisor tells client how plan can be implemented, and how financial constraints can affect achievement of objectives - outline is constructed, with dates and types of actions and products to be purchased - proposal may be modified during discussion - lawyers and tax specialists are required to smooth the process Monitor and revise the plan - results should be monitored to compare with expectations - changes may be needed Risk management plan - Defined as identifying, measuring, treating exposures to potential losses - Can arise from damage/destruction of property, liability, loss of income, expenses, etc. - There are 3 classes of losses:  property, liability, personal Involves 6 steps: 1. Gather information: Direct property loss exposures: damage, disappearance of property Indirect property loss exposures: reduction in income due to loss of use of property, or value of property decreasing due to damage to surrounding property Liability loss exposure: damaging someone else’s property and being sued Personal loss exposure: death, incapacity, illness, injury, unemployment 2. Establish risk management objectives Should be consistent with those in the overall personal financial plan May be simply to avoid financial ruin as a result of the 3 loss exposures 3. Analyze information Involves estimation of the chance that a particular loss will occur, and the impact that it would have on the financial affairs of the individual, family, or business Poor health may cause two types of losses: - loss of earnings - extra expenses Determining the probability of a morbidity condition is hard because: - morbidity cannot be defined exactly - it varies in severity and frequency - conditions are not reported to public authorities 4. Develop the risk management plan Tools include: - risk avoidance - risk reduction (reducing chance or magnitude of risk) - risk transfer (transferring consequence of loss to some other party) - risk retention (bearing the risk personally) 5. Implement the risk management plan May entail purchasing an insurance policy, or risk reduction through healthy eating or exercise 6. Monitor and revise risk management plan Uses of life/health insurance in personal risk management It guarantees that for a modest premium, an individual’s dependents or business will not have to suffer financially due to death or illness Savings and investment program plan Emergency fund: - needed to meet unexpected expenses - can be done through a savings account, government securities, life insurance policy cash values Education fund: - investment fund is set up with the hope that it wont be used in the meantime, but when children reach college age, so the tuition won’t be a financial drain General investment fund: - fixed-value (bonds, savings, etc) and variable (home ownership, stocks, etc) investments exist Retirement fund Minimize taxes - life insurance and annuities gain tax advantages Establish a program for heirs - a sound financial plan does not leave this to chance or la
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