2. Insurance Planning. 11. Insurance Needs Flashcards
Module Introduction
At 85, Ruth Brown’s world revolved around her son, Benjamin. The untimely death of Benjamin in a car crash left her numb with grief. Grieving over her son, she wondered how she would ever cover the liabilities of mortgage, car payment, and outstanding bills. Financial relief came in the form of Ben’s life insurance policy.
Throughout history humans have sought both physical and monetary security. The quest to achieve security, and reduce uncertainty, continues today. Our income-dependent and wealth-acquiring lifestyles render us, along with our families, more vulnerable to environmental and societal changes over which we have no control. However, with insurance, we can safeguard individuals, families and organizations against the financial impact of such misfortunes.
The Insurance Needs module will explain various insurance needs.
The online portion of this module takes the average student approximately two and a half hours to complete.
Upon completion of this module, you should be able to:
* List the risk management process,
* Explain the types of health insurance policies, and
* Discuss the various aspects of property coverage.
Module Overview
Insurance coverage can be classified as life insurance, health insurance, or property insurance. Traditional health insurers such as Blue Cross/Blue Shield and Health Maintenance Organizations (HMOs) are the most common type of health insurance providers. For commercial activities, the Commercial Package Policy designed by the Insurance Services Office (ISO) provides broad coverage. Private homeowners are covered by the ISO’s Homeowner’s Policy.
To ensure that you have an understanding of insurance needs, the following lessons will be covered in this module:
* Insurance Planning Process
* Insurance Coverage
* Property Coverage
Section 1 – Insurance Planning Process
Not having enough life or health insurance coverage is perhaps the biggest mistake individuals make with life and health insurance planning. This mistake cannot be corrected after the event of incapacitation or death. The financial consequences of loss of health and premature death constitute key personal loss exposures, faced by all individuals. The risk management process facilitates necessary insurance planning.
To ensure that you have an understanding of the insurance planning process, the following topic will be covered in this lesson:
* Risk Management Process
After completing this lesson, you should be able to:
* Define types of assets,
* Discuss the various components of the risk management process, and
* Explain the various types of income.
Exam Tip with Audio:
Describe the Approaches to Calculate Life Insurance Needs
The question to be asked is will anyone suffer financially from the stopped income? If no one needs the money to support them, then there is not a financial loss.
The Human Life Value formula is based on the person’s income-earning ability. Human life value is the present value of income lost as a result of the person’s death. The question is, how much money is needed for investment now, in order to provide replacement income for a set number of years?
This approach is still the most popular method of measuring the economic value of human life in situations like wrongful death lawsuits.
This method is not an accurate way to estimate how much life insurance is needed because it does not take into consideration other resources. In some cases, part of the income may be replaced from other sources such as life insurance, group life, and social security survivor benefits. When interest rates are higher, it appears that less capital is needed to be invested. This approach also does not take into account whether there is anyone who needs to have the income replaced.
The Needs Analysis Approach looks at how that income was being used, instead of simply replacing lost income.
There are three steps to this analysis.
* Identify the needs that would arise or continue following the death of the individual – death expenses, mortgage payoff, readjustment period, income for dependents.
* Total the resources that would be available such as life insurance, employer-provided benefits, Social Security survivor benefits, savings, retirement plans.
* Measure the difference between the needs and the resources available. The resulting shortfall is the insurance need.
Note: For thorough examples of both the Human Life Value and Needs Approaches please see our Calculator Keystrokes reference page.
Exam Tip: Listen in to distinguish between the Human Life Value and Needs Analysis Approaches.
* Audio:
* Life insurance needs analysis questions - can be rather long calculations. More likely tested from a conceptual standpoint, but study the keystrokes for both approaches.
* Human Life Value approach - focused on replacing the decedent’s income; quick calculation, few variables. What percentage of income would be needed?
* Needs Analysis Approach is quite detailed. Rather than just replacing income, it’s looking at the expenses and financial goals of the family - resulting in an amount of insurance that can deliver the income to pay for all the line item things that were laid out.
Practitioner Advice:
Describe the role of Assets in Calculating Insurance Needs
Assets normally are considered either liquid or illiquid. Liquid assets are those assets available to be liquidated with reasonable price certainty. These would be available to meet income or other monetary needs on an individual’s death, loss of health or incapacity. They include stocks, bonds, money market and savings accounts, mutual funds and amounts available in pension, profit sharing or individual retirement accounts.
Illiquid assets are those assets not available to meet income or other monetary needs because they are not easily liquidated. They include the family’s house, automobiles, and personal possessions such as clothing, jewelry and household goods. These assets are usually passed intact to heirs or kept for personal use.
Practitioner Advice: Using a more conservative approach, you would not count Retirement Plan funds as usable assets, but rather leave them in place for the surviving spouse. This is less of a consideration if the surviving spouse is close to retirement age.
Traditional pensions, funded solely by the employer’s money, may not be accessible until retirement.
Practitioner Advice:
Describe the role of Liabilities in Calculating Insurance Needs
Identifying an individual’s liabilities is an important part of the information gathering process. A review of an individual’s liabilities shows which ones are to be paid at death and which ones should be transferred to heirs. Most liabilities are paid at death. However, some may be assumable by others (such as, some mortgage loans), or they may be in more than one person’s name.
If the home mortgage loan is to be paid, its outstanding balance is included. If it is not to be paid off at death or at incapacity, it is excluded. However, mortgage loan payments would be included as an ongoing income need.
Practitioner Advice: In addition to existing liabilities at the time of incapacity or death, planning must include those liabilities that are created by the incapacity or death. For example, costs not covered by medical insurance and/or final expenses such as funeral, probate and estate liabilities need to be considered. Individuals who do not seek professional advice with this process often tend to miss some of these variables when identifying their needs.
Select the liabilities that are typically paid at death.
I. Credit card balances
II. Tax obligations
III. Personal loans
IV. Auto loans
* II only
* III and IV
* I, II, III, and IV
* I and III
I, II, III, and IV
* Each of these liabilities is typically paid at death.
The death or incapacity of a parent or spouse causes a disruption in savings. Select the most common areas of financial concerns surrounding savings shortfalls.
I. College education
II. Emergencies
III. Retirement
IV. A home
* I and III
* II and IV
* I and II
* II and III
I and III
* The most common areas of financial concern when a parent is incapacitated or dies prematurely are funding for college education and retirement.
The current living standard may translate into a survivor income need of at least __ ____??____ __% of the pre-death family income need.
* 45
* 50
* 60
* 75
60
* The current living standard may translate into a survivor income need of at least 60% of the pre-death family income.
* The amount would typically be less than the current total family income, as the deceased spouse’s self-maintenance expenses would end.
Practitioner Advice:
Describe Cash Objectives in Calculating Insurance Needs
Cash objectives require a single-sum cash amount to fulfill. They are the easiest to estimate. These objectives arise from the need or desire to pay outstanding liabilities such as auto and personal loans, credit card balances, payment of an outstanding mortgage loan balance and incurred income tax liabilities. Cash needs also might arise from a desire to establish or augment an educational fund. Final and medical expenses also fall into this category.
Practitioner Advice: It is important for clients to understand that cash need figures are being allocated for those specific needs. Thus, any resources earmarked to cover those specific funding needs will not be available for future income needs. Often clients will attempt to include these cash amounts when determining available resources for on-going income needs. For example, $250,000 of life insurance proceeds designated to fund a surviving child’s education should not be viewed as available funds to replace daily income needs.
Practitioner Advice:
Describe the Capital Liquidation Approach
The capital liquidation approach assumes that both principal (capital) and interest are liquidated over the relevant time period to provide the desired income. This approach requires a smaller capital sum to provide a given income level than the retention approach.
When the need for income is for the entire life of the survivor(s), the capital liquidation method can be approached in one of two ways:
The future desired lifetime income could be funded through the purchase of a life annuity.
The capital liquidation method could provide for the complete liquidation of principal and interest between the present and the maximum age to which the income recipient is likely to live.
The critical decision variable in the second approach is the maximum age. If the life expectancy age is set too low, the income recipient may outlive the income. The higher the age, the higher the principal sum required to fund the income.
The life annuity will generate a higher income than the other liquidation approach (assuming a long life expectancy), all other things being the same. Moreover, with the life annuity, the income recipient cannot outlive the income.
Practitioner Advice: The life annuity concept demonstrates why annuities should be considered as part of every person’s retirement plan. Bank accounts, CDs, and mutual funds that are being tapped for income do not provide a guaranteed life income. As a hedge against superannuation (outliving one’s money), an annuity can be a safe complement to a retirement portfolio.
Practitioner Advice:
Describe the Capital Retention Approach
The capital retention approach assumes that the desired income is provided from investment earnings on the principal, and no part of the desired income is from the capital. In other words, the capital is retained undiminished, even after death. This approach permits a capital sum to be passed on to the family’s next generation (or to whomever is designated). It is considered more conservative, because in an emergency, the principal itself can be accessed.
The decision to follow the capital retention or one of the capital liquidation methods is not an all-or-nothing proposition. As each option does not have to pay out all capital or retain all capital, there is a continuum between the two extremes.
Practitioner Advice: The retention approach is both more conservative and more flexible. Having the principal available (rather than being distributed) means keeping more resources on hand for increasing inflation, unexpected medical costs or declining rates of return on investments.
Section 1 – Insurance Planning Process Summary
Many individuals and families are faced with serious perils such as personal losses from incapacity and death. With insurance coverage individuals can ensure that their dependents will be provided for should the need arise. Planning of insurance involves implementing the risk management process, a framework for analysis of the financial consequences of loss of health and of premature death.
In this lesson, we have covered the following:
* The risk management process is used to determine whether any insurance is needed and, if so, the amount. The three steps in the risk management process reviewed in this module are gathering information, establishing objectives and analyzing information.
- Step One: Establish Objectives as well as specific sub-objectives. This process includes determining income levels and future needs.
- Step Two: Identify Loss Exposure involves compiling relevant quantitative and qualitative data to facilitate identification of financial loss exposures. It would include information regarding assets, income, savings programs, liabilities and final expenses.
- Step Three: Measure Loss Exposure involves measuring and analyzing the relevant data and loss exposures (incurred) and their financial effects.
From the following items, select all liquid assets:
* Jewelry
* Stocks
* Automobiles
* Household goods
* Individual Retirement Accounts
Stocks
Individual Retirement Accounts
* Liquid assets are those assets available to be liquidated with reasonable price certainty.
* These would be available to meet income or other monetary needs on an individual’s death, loss of health, or incapacity.
* Illiquid assets are those assets not available to meet income or other monetary needs because they are not easily liquidated. These assets are usually passed intact to heirs.
Which types of insurance are very important for single individuals to obtain?
* Health Insurance
* Disability Insurance
* Life Insurance
* Long-Term Care Insurance
Health Insurance
Disability Insurance
Long-Term Care Insurance
* The greatest personal risk for single individuals is their loss of health and incapacity.
* Life insurance is not needed unless someone is financially dependent upon them.
Rudolph is a business tycoon with a large net worth. On his death, which one of the following final expenses would be the major final expense?
* Probate costs
* Executor fees
* Estimated final illness expenses
* Funeral expenses
* Death-related taxes
Death-related taxes
* Death-related taxes can constitute a major final expense for those whose net worth is large.
* These taxes can equal 50 percent or more of an estate.
* All the other final expenses given above aren’t as high as death-related taxes, especially for an individual whose net worth is high.
* For example, probate costs vary significantly by jurisdiction and as a function of the estate size. Such costs in the United States commonly range from 2 to 5 percent of the gross estate.
* A well-designed and implemented financial plan should provide for health insurance or other means for meeting estimated final illness expenses.
Section 2 – Insurance Coverage - Exam Tip with Audio
Margaret was worried about the expenses incurred during her medical treatment over the last 3 months while undergoing chemotherapy for cancer at a local hospital. She wondered how she was ever going to pay the hospital bills. She thought, “Oh, if only I had listened to Martha and purchased a health insurance policy.”
Insurance is a financial agreement in which individuals exposed to a specified contingency each contribute to a financial pool. Using this pool, the covered events suffered by participating individuals are paid. Individuals purchase the right to collect from the pool if the insured eventuality occurs. Insurance then is the contingent claim contract on the pool’s assets.
To ensure that you have an understanding of insurance coverage process, the following topic will be covered in this lesson:
* Health Insurance
After completing this lesson, you should be able to:
* Discuss the types of health insurance policies,
* Discuss long-term care coverage, and
* Explain the various benefit arrangements.
Exam Tip: The basic features of insurance coverage are discussed in this exam tip audio.
Audio:
* This section touches on the major categories of insurance that typically make up a client’s insurance portfolio
* Can be tested on exam - given as a narrative or case study.
* Question could be what are the vulnerabilities
* Keen on knowing what these major categories are
* What would you recommend at this time?
Each of the following are reasons to purchase long-term care insurance (LTCi) EXCEPT:
* To offset the risk of depleting personal savings.
* The higher risk for individuals age 65+ having an LTC need.
* Constantly inflating LTC costs for all levels of care.
* To generate gains to offset purchasing power risk.
To generate gains to offset purchasing power risk.
* Long-Term Care Insurance benefits may be protected from purchasing power risk with an inflation protection rider, however, the policy cannot be used as an investment vehicle to generate gains.
Practitioner Advice:
Describe the Benefit Coverage of LTCi
The benefit provisions in LTC policies set forth what will be payable by the insurer if an insured event occurs. These relate to the types and levels of care for which benefits will be provided, any prerequisites for benefit eligibility, and the actual level of benefits payable. No policy covers all LTC expenses.
The policies offered by many companies provide:
* A choice of elimination (waiting) periods (0 to 365 days) before benefits.
* A schedule of maximum daily benefits and length of benefit periods. The schedule of the benefit periods offered might range from two to five years. Very few insurers offer a lifetime benefit period, which is an expensive option.
* A maximum lifetime approach to defined benefit payments. Thus, if the benefit amount is $250 per day and the benefit period four years, the maximum lifetime payout would be $250 times 365 days times 4 years, for a total of $365,000. This $365,000 pool of money can be used for covered services in whatever way desired, subject to the daily maximum.
* Some companies pay a set amount monthly, as with disability income insurance. Thus, the policy may agree to pay $5,000 per month or a per day amount such as $265 regardless of actual charges.
* Community-based care can be less expensive than nursing home care (if they need less than 24-hour care). The maximum daily benefit is often 50 percent of the maximum daily benefit for nursing home care. The length of the benefit period is often the same for both coverages, but some policies require a different waiting period.
Practitioner Advice: Policies can now be designed with 100% of the daily benefit for community-based care. This is more appealing to clients, and easier for them to understand and remember (e.g. $200 a day, no matter where the care is given).
