You pay someone to face your financial consequence if something happens. Why would someone face your financial consequence?

Transcription

1 11. Life, Health, and Disability Insurance Nature: You pay someone to face your financial consequence if something happens. Why would someone face your financial consequence? Risk pooling 2 conditions for insurance to work well: Adverse selection: people who join are the pool are the people who are most likely to suffer the loss Ex. medical exam Pre-existing condition. Moral hazard: Life and health insurance and property, casualty, and liability insurance Life Insurance Terms: Insured: the person whose death will trigger the payment of death benefit. Beneficiary: the person(s) who will receive the death benefit. Death Benefit or Face Value: the dollar amount that will be paid to the beneficiary if the insured dies. Premium: the amount that must be paid to the insurance company. It is the price or the cost of the insurance policy. Owner: the person who pay the policy. The owner can be the insured, his/her employer, the beneficiary, and other third parties.

2 Policy Term: the period during which the policy is in force. Rate: the cost of each unit of insurance. A unit can be $1000. A rate of $10 per unit means that the premium for $10,000 of insurance is equal to $100 ($10*10units). Insurability: the qualification for buying the life insurance policy usually in the form of a medical examination. The objective here is to minimize the adverse selection problem. Guaranteed Insurability: this is a provision that allows the insured to increase the face value at certain specified future dates without proof of insurability. 3 importance questions: (1) Who need life insurance? Do you need life insurance? (2) How much life insurance do you need? Earnings or Income Multiple Approach- 5 to 15 annual gross income. This can be similar to the PVIFA idea Ex. Mr. & Mrs. Johnson family,where Mr. Johnson is breadwinner with an annual income of $80,000 a year. They have 2 children, aged 2 and 4. The children will not be supporting them for another 20 years. Mrs. Johnson would like to stay home to raise the kids and plan to enter the workforce after that. How much do they need if she thinks she can make an real return of 5% Needs or Budget Approach: Funeral expenses Debt elimination Living expenses

3 Educational expenses Retirement needs Sources of income: CPP, savings, Whatever your insurance agent suggest, ask the rationale. PVIFA can be an useful guide. (3) What kinds of life insurance are sold? What kind should you buy? Term Life vs. Non-Term life Term life- pure insurance policy without a savings/investment component. Advantage: least expensive, no commission Disadvantage: premium rises with age In response, insurance companies now offer up 30-year level term life Group term life offer to a group of individuals without physical exams. Disadvantage- the policy will lapse if you are layoff. Credit or mortgage life insurance- pay off your specific debt upon your death. Disadvantage: no flexibility. It can be used to pay off the mtg, even you may have other more expensive debt such credit card debt. With or without, regular term life, you will pay off your credit first. Non-Term life pure insurance policy and a savings/investments component.

4 Example: whole life, endowment policy, universal life. The policy pays a higher premium than that of a comparable term insurance in early years of the policy because part of the premium goes into a savings account. The money in the savings account can be used to reduce future premiums or be returned to the policyholder when the policy is cancelled. The amount in the savings account that will be returned to policyholder at the time of cancellation is known as cash value or cash surrender value. Whole Life Insurance- provides a death benefit when the insured dies, turns 100 or some maximum stated age. The FV of the policy will be eventually paid, provided that premiums have been paid. The premiums are known and quite often fixed, unlike term life In the early years of the whole life policy, the insurance deducts amounts for commission, sales and administrative expenses, profits cost of death protection, What is left goes into a savings account and is called cash value. This build-up in cash value continues. As the policyholder ages, cost of death protection may go so high that the premium will not be enough to cover the cost. The savings or cash value is used tp pay the cost in later years. The policyholder can borrow against the cash value. Or it can be accessed by terminating the policy. Nonfortfeiture right gives the policyholder the right to the cash value in exchange for the giving up the death benefit. Premium structure: (1) Continuous level premium- constant premium until 100 or dies (2) single premium- one very large initial premium (3) limited premium- hybrid of the above two. large premium for periods of time, then the policy is considered paid up Variations of the above- Ex. Freedom 55- pay higher premium until 55 to build up an endowment (endowment Insurance) for retirement or educational purpose

5 Disadvantages: (1) less death protection for the same level of premium as term life (2) return on cash value is not as attractive as alternative investment Universal Life-Variable premium between a max and a min, death benefit can change, the cash value will accommodate the changes. Premium= 3 components- death protection, administrative expenses, and cash value. Higher premium usually mean more cash value. Skip a premium, cash value will be used to fund death protection and administrative expenses. For both whole life and universal life, cash value can grow tax-free. Index funds can accomplish the same purpose. Disadvantages: (1) For people who lack discipline, they may allow the premium to lapse and the cash value to run out. (2) higher expenses and low returns- a lot lower than what they show you on the promotional materials Term vs Cash Value Term- cheapest for death coverage Cash Value- (1) tax-deferred investment return. Like RRSP, all investment income is taxed like regular income. (2) cash value is not part of your estate. The cash value goes directly to the beneficiary upon your death Other features and riders

6 Participating- In a participating whole life insurance policy, which is the only type of participating policy, the policy will receive policy dividends if the long-term assumptions made by the life insurance company with respect to the cost of insurance, company expenses, and investment returns have changed in favour of the policy owner. Wavier of premium- premiums will not have to be paid if the insured becomes disabled before certain age (usually 65). i.e 2 policies in one= life insurance and disability insurance that pays the premium Guaranteed Insurability- ability to buy additional coverage without medical exam Restatement Time limit- max length of time a lapsed policy can be restated without proof of insurability Suicide Time Limit- insurance policy will not pay for policy within a certain time limit (usually 2 years) from the date of purchase (adverse selection problem) Loan provision- ability to borrow money up to the cash value.. The terms of the loan are usually spelled out Settlement Options- lump-sum, periodic payments Convertibility- ability to convert from a term life to whole life Accidental death benefit- usually double or triple the normal benefits Grace period- short period of time (usually 30 days) after payment due date in which the policy is still in force. Critical Illness Insurance-relatively new product. The policy pays a lump-sum upon the diagnose of a critical medical condition. The list of critical medical conditions covered varies from policy to policy. This makes price comparison difficult. Who need it?

7 Kids? Unlikely to get heart disease, cancer. How much? Either income or expense approach will do Disability Insurance-like health insurance with emphasis on income replacement rather than reimbursement of medical expenses Public sources- CPP- disability benefits may depends on years in the Plan and salaries, and therefore may be inadequate. Workers Compensation- covers work-related disability. Definition of disability- lack of uniform definition. It reflect some inability to work. Waiting period or elimination period- the start of disability to the time benefits begin Benefit duration- Wavier of premium- Exclusions- things not covered, EX. acts of war, pregnancy etc. Buying Insurance- term life can be easily bought via internet Cash value policies tend to be more difficult because of a variety of features that make comparison difficult. Insurance agents tend to be commission-based. Cash value policies pay commissions of 25-50% of the first year s premium. Ask about it!

8 12 Property, Home, and Automobile Insurance PROPERTY INSURANCE- car, house Property Liability Types of Policies: (1) Comprehensive- covers the home structure, its contents, and the third part liability Building and other structures-land usually is not insured Contents- furniture, appliances, clothes etc. Third party liability- your liability to other people for injuries suffered on your property Frequent parties and swimming pool can be factors to keep in mind. (2) Basic/named Perils -fire Def. of peril- an event or happening, whether natural or man-made, that cause a financial loss (1) Tenant s Insurance- cover contents and perhaps liability Do you need it as a student or first years in your career? Maybe not if you don t have a lot of parties and the value of your possessions is low and non-smoker.? Supplemental coverage or features:

9 Personal property floaters- extended coverage for all personal property, regardless of it s located, for the policyholder and household residents. Children away at school are often excluded. Earthquake coverage- excluded from most policies. Adverse selection makes this very expensive. Sewer backup Replacement cost Replacement Value vs. Market Value: Replacement value excludes the value of the land and foundation Additional living expenses- cost of living while repair is underway 80-percent rule: insurance companies will not pay in full for partial damage unless the insured has bought enough insurance to cover at least 80 of the replacement value. Ex. Replacement value= $100,000 Coverage = $70,000, less than 80% Fire damage = $30,000 Payment from insurance company = $26,252 Note: You may have bought enough coverage in excess of 80%. With inflation over time, your coverage will fall below 80%. What to do? Inflation Protection Provision Personal Liability- premium is a not simple linear function of coverage. Doubling the liability coverage does not lead to twice the premium.

10 Umbrella Policy- provide extra coverage beyond basic third part liability for both cars and home. It usually ranges from $5m to $10m. Keeping your cost down: (1) Higher deductibles- after insurance should be used to cover losses that will significantly affect your lifestyle (2) Security system (3) Multiple policy discounts (4) Pay policy annually instead of by installment

11 Automobile Insurance Types of covergaes: (1) Third party liability- cover what you are liable and therefore pay other individuals rather yourself Bodily injury- injury and death of other people Property damage-damages you cause to other properties Min=$200,000 (2) Collision- pay repair bills for your car up to the book value or depreciated value. (3) Medical expense coverage or accident benefits (4) Uninsured Motorist s protection coverage (other driver at fault)-protect you and your family by covering bodily injury caused by drivers without insurance or with inadequate insurance. Hit-and run (5) Comprehensive- damage to your car resulting from non-accidents such as theft, vandalism, fire etc up to the book value. No fault insurance- You insurance pays you regardless of fault. Collision is no fault. Medical payments, comprehensive, and uninsured motorist are usually no fault. Factors affecting car insurance Type of car Use of your car Driver s personal characteristics- age and sex

12 Driver s record Where you live ID Theft insurance 13. Estate Planning Objectives: (1) Distribution of your property according to your wishes (2) Caring for dependents under 18 (3) Minimizing taxes and other costs 6 ways estate get passed to beneficiaries: (1) gifts while you are alive (tax implications) (2) living trusts (3) non-probatable assets (not through the will) (4) directly through a bequest in a will (5) indirectly through a testamentary trust created in a will (6) according the provincial law if you die intestate Estate planning Process Step 1: Determine your Net worth and keep record Step 2: Choose your heirs and decide what they get and when they get Who will look after your dependents? Step 3: Determine the cash needs of the estate

13 Legal fees etc. Step 4-Select and implement your estate planning Will is part of it. It may also include gift, joint ownership etc Cost of do nothing; (item 6 above) -in general, the spouse and children share your estate. Without spouse and children, your parents and then your brothers/sisters Will-legal document to carry out your wishes. It won t become effective until you die. You can revoke or change it. 3 types of wills: Holographic will-a will hand-written and signed by you Formal (English form) will- a will typed, signed, and witnessed by 2 unrelated individuals( not beneficiaries) Notarial will- used in Quebec and completed in the presence of a notary (lawyer) Testator-the individual who makes the will Beneficiary- the recipient of your assets. Executor-responsible for carrying out the provisions of the will Guardian-care for children under 18 Probate-legal process to confirm the will. Storage- safety deposit box? Ways to avoid probates: (1) Joint tenancy- assets can be passed on at cost without taxes

14 (2) Make your spouse the beneficiary for RRSP and life insurance (3) Gifts during your lifetime-taxes right away and lose control (4) Living (inter vivos)trust- a settler transfer a property into a trust Trust- a legal entity in which assets are held for the benefits of others Advantages- privacy, professional management of assets, avoid probate, Living (inter vivos) trust- a trust created during you lifetime. Taxes- assets transferred into a living trust are deemed to be disposed of at fair market value at the time of transfer. Income generated is taxed as a separate entity at the highest marginal tax rate or trust income be allocated to the beneficiaries and taxed in their hands. Cottage, for example, can be transferred into a living trust by a settler. The settler retains control of the property. When the settler passes away, the property belongs to the beneficiary since there is no sale. Testamentary trusts-created by your will and it does not exist until probate Tax advantages: (1) use the full tax schedule rather than the highest tax rate. (2) non-calendar taxation year Living wills-instructions to doctors for medical treatments Power of attorney: A limited power of attorney- A general power of attorney- A general power of attorney- Durable power of attorney for health care