2. Insurance Planning. 13. Insurance Policy Selection Flashcards
Module Introduction
In today’s society, income-dependent and wealth-acquiring lifestyles render individuals, families, and businesses vulnerable to uncontrollable environmental and societal changes. A formalized solution is required to offset the negative impact of unemployment, loss of health, death, old age, lawsuits, and the destruction of property.
Insurance, in some form or another, has been a universal solution to these needs for security. Today, the market is flooded with a wide variety of insurance policies. Individuals and businesses face the challenging task of selecting the appropriate insurance that meets their needs.
The Insurance Policy Selection module will present you with the methods used in assessing the need for insurance and selecting the best type of policy.
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:
* State the advantages of insurance, other than financial protection,
* Enumerate the steps in insurance policy selection,
* List the rules that guide insurance purchase selection,
* Define financial perils and transactions,
* Describe risk management information systems,
* Identify the process of financial risk analysis, and
* Explain the various factors that affect financial risk management.
Module Overview
Though the main function of insurance is compensation of financial loss, many added benefits make it valuable to an individual. These factors, and several others, must be considered while planning for insurance. Guidelines on purchase selection and policy pricing help an individual make an informed decision.
Businesses use risk management techniques that involve statistical analysis to plan for and deal with potential losses. Risk management information systems maintain detailed history and accurate records, called loss data, which is used in such analysis.
To ensure that you have an understanding of insurance policy selection, the following lessons will be covered in this module:
* Purpose of Coverage
* Financial Risk Management Overview
Section 1 – Purpose of Coverage & Practitioner Advice:
Insurance plays an important role in financial planning, even when no loss is experienced. Some forms of life insurance provide for cash accumulation during the life of the insured, offering added benefits. Referring to life insurance as an investment has been scrutinized since the mid 1990’s due to the misleading sales practices of some agents, but there are valid investment-like features that are available to the insured. As an investment, it encourages thrift, minimizes worry and provides assurance of continual income. This makes it essential to make informed decisions regarding insurance policy selection and ensure that policies are priced correctly.
The essence of insurance is the sharing of losses. In the process, an uncertain large loss is substituted by a certain small loss. The small loss is called the premium. So, insurance coverage safeguards us against misfortunes by having contributions of many, in the form of premiums, pay for the losses of the unfortunate few.
To ensure that you have an understanding of the purpose of insurance coverage, the following topics will be covered in this lesson:
* Importance of Insurance
* Policy Selection
* Policy Purchase Selection
* Policy Pricing
After completing this lesson, you should be able to:
* Describe how an individual can benefit from an insurance policy,
* Differentiate between saving through insurance and ordinary savings vehicles,
* Describe how annuities are a source of assured income,
* List the steps in selecting a suitable insurance policy,
* Define the purchase selection rules of insurance, and
* List the guidelines for proper policy pricing.
Practitioner Advice: Many class-action lawsuits occurred during the mid- to late-1990’s due to consumers feeling they were mislead by insurance agents who oversold the investment features of certain life insurance policies. Investment terms such as deposit and contribution were used to describe premium payments into policies that did in fact provide for cash accumulation and offered investment account returns. However, when the underlying investments or interest rates did not perform as originally estimated, consumers complained that they were misled. Agents and insurers argued that the consumers forgot they were also paying for the cost of protection, which logically reduces the net returns on such policies.
Regardless of who was to blame, it is evident that agents must be very clear when explaining the primary and additional benefits of any policy being sold. Also, consumers must be aware that some policies provide investment features, and they should not discount such benefits solely based upon past lawsuits. The bottom line is that a need-based assessment is the primary form of discovery in determining what amount and which type of policy should be purchased, with the client’s budget constraints as a major factor.
Practitioner Advice:
Describe how Insurance Minimizes Worry
It has been frequently asserted that life and health insurance can be regarded not so much as producers of wealth, but as mechanisms for distributing funds from the fortunate to the unfortunate.
In reality, life and health insurance can be important forces in the production of wealth, in that they can relieve the policyowner of worry and increase his or her efficiency. To the extent that concern about the financial consequences of loss of life or health causes an individual uncertainty and worry, life and health insurance could help reduce this concern.
Practitioner Advice: The primary reason clients buy disability income and life insurance is to create a sense of security for themselves and their family. It’s important for adults to fulfill their need to provide for their dependents and to know they have prepared for life’s challenges as well as possible.
The government expects taxes to be paid in cash within a reasonable time period. How many months from the date of death are taxes normally due?
* One month
* Six months
* Nine months
* Twelve months
Nine months
* The government expects taxes to be paid in cash and within a reasonable time period, normally nine months from the date of death.
* This payment often requires selling estate assets. However, the heirs may prefer to retain these assets, either because of a depressed price due to a down market or because of a desire to avoid loss of ownership.
Identify the characteristics of a good insurance policy.
I. Meets the client’s individual needs.
II. Provides required amount of coverage.
* I only
* II only
* Both I and II
* Neither I nor II
Both I and II
* A good insurance policy is defined as one that meets the consumer’s needs without providing more insurance than is required.
Practitioner Advice:
Describe determining the Consumer’s Financial Goals
Determining the consumer’s financial goals is the starting point when choosing the proper amount of life or disability insurance. How much money is needed to solve financial problems if death or disability were to occur immediately? Choosing the proper amount of insurance, like choosing the proper policy, begins with knowledge of the need for insurance.
The need for insurance is related to the severity and the probability of a potential loss. In property insurance, the need for protection usually is based on either the acquisition cost or the replacement value of a physical asset. This need can be readily calculated.
In cases of business income insurance or liability claims, estimates of potential losses are needed. Trends suggest that people tend to buy too much insurance for low severity, high-frequency losses, and purchase inadequate coverage for high severity, low frequency exposures. An example of such a mistake would be to purchase a service contract on a new car extending the warranty several years, while simultaneously driving with the minimum amount of liability coverage. The most one could lose in terms of a car repair bill is far less than the most one could lose in a liability suit.
Practitioner Advice: It is important to review all of the client’s insurance coverages to see if their money is being well spent. For example, could the deductibles on the Homeowners and Auto policies be increased so that the premium savings could be used to buy Life Insurance?
Practitioner Advice:
Describe Policy Pricing
Useful hints for consumers will help them to pay the right price, but few absolute rules exist.
Practitioner Advice: When selecting the right policy at the right price one must consider the financial strength of the insurer to back up its promise to pay in the event of a loss. What good is a policy that costs less when the insurer is very slow or disagreeable in paying claims? When choosing policies, be sure to narrow the field to only those insurers you have determined to be worthy of your business. “You get what you pay for” is a popular saying for a good reason.
The right price is the one providing the consumer with the greatest amount of insurance after giving consideration to the other criteria just described. That is, the right price for insurance is not necessarily the lowest price. The lowest price may come from a company that has other drawbacks, such as:
A company whose financial strength is questionable
A company that too frequently resists or denies its insureds’ legitimate claims
An insurer whose agents are not trained adequately, and
A company whose policies do not offer coverage as valuable as that offered by other companies.
For these and other reasons, the consumer should first consider all the other criteria and then search for the right price.
One rule in finding the right price is to engage in comparison-shopping. Researchers have found considerable price variation for comparable insurance policies offered by similar insurers. The need for shopping is true in both life and property insurance. A consumer should consider shopping from both mutual and stock insurers, and from both independent agents and direct writers.
Changing insurers to save a small amount of money, especially if a consumer’s current insurer gives discounts for insureds of long standing, may not be an efficient strategy.
Practitioner Advice: Life insurance regulations require all policy illustrations (detailed numeric and narrative representations of what the policy will do over time) to be presented in a similar format to make comparisons easier. Also, policy illustrations must use standard indexes to provide a numeric per unit cost for comparison. All else being equal, the policy with the lower index number is the most cost-effective choice.
Section 1 – Purpose of Coverage Summary
The importance of insurance cannot be minimized in today’s economically developed world. However, the insurance consumer is generally not well informed while making the purchase. Acquiring the needed information takes time and effort. Costs of making uninformed purchases include wasting time and money on the wrong policy, buying from the wrong company, and paying the wrong price. Therefore, an individual must assess his needs and assets to make informed insurance-related decisions.
Apart from providing financial protection, life insurance has the following advantages:
* Makes savings possible by ensuring that the targeted savings amount is received even in the face of unforeseen disability or death
* Furnishes profitable investment through interest added to policy cash values and protection against misuse of death of proceeds
* Encourages thrift through semi-compulsory savings plan
* Assures income in the form of annuities that pay regular amounts until the death of a person
* Helps preserve an estate by providing the heirs with funds to pay estate taxes
A good insurance policy - meet’s a person’s need without providing more insurance than required. The two steps in choosing a good insurance policy are:
* Choosing the proper amount of insurance based on needs, and
* Determining the amount of available assets to meet these needs.
The following rules help in choosing the proper amount of insurance:
* Insure first exposures to loss those that are most likely to cause the greatest amount of damage.
* Never over expose to lose more than you can afford to lose.
* Never risk great loss in exchange for a small gain.
What rules can be applied in choosing the proper amount of insurance? (Select all that apply.)
* Insure first exposures to loss
* Never over expose
* Never risk great loss
* Follow your heart
Insure first exposures to loss
Never over expose
Never risk great loss
* The three rules that may be applied when choosing the proper amount of insurance are: (1) Insure first exposures to loss; those that are most likely to cause the greatest amount of damage, (2) never over expose to loss more than you can afford to lose, (3) never risk great loss in exchange for a small gain.
Which of the following are features NOT applicable to life annuity?
* It is a contract made with an insurance company.
* It guarantees a specified minimum income every year for as long as the individual lives.
* It pays out only the interest on the capital sum.
* Payment ceases on death, unless a refund feature had been selected.
It pays out only the interest on the capital sum.
* The life insurance company is able to liquidate both the capital sum and the interest in making these payments.
A savings program can yield only a small amount at the start, whereas an insurance policy guarantees the full face value or other benefit from the beginning.
* False
* True
True
* An insurance policy guarantees the full face value or other benefit from the beginning, even if early death or incapacity befalls the person.
* On the other hand, a successful savings program depends totally upon the survival of the person and his or her ability to continue saving.
The most important choice a consumer must make when purchasing insurance is:
* The lowest price.
* The most coverage available.
* Coverage from a company of unquestioned solvency.
* Coverage from a company with the widest array of policy alternatives.
Coverage from a company of unquestioned solvency.
* The right price for insurance is not necessarily the lowest price.
* The guidelines are that the company must be financially strong, not frequently deny legitimate claims, have adequately trained agents and offer coverage as valuable as that offered by other companies.
Debbie was planning to purchase insurance. She decided to purchase a policy that gave the most coverage and with the widest array of policy alternatives, even though she did not really need all of it. We can be sure that she purchased a good insurance policy.
* False
* True
False
* A good insurance policy meets the consumer’s needs without providing more insurance than is required.
* The extra amount of cash resources spent on this policy is no longer available to be used for other financial needs.
Section 2 – Risk Management
Risk management is the logical development and execution of a plan to deal with potential losses. The focus of a risk management program is to manage an organization’s exposure to accidental losses and to protect its assets.
Modern risk management does not make the traditional distinction between pure and static risks. Likewise, the line drawn between insurance and other risk transfer techniques is becoming less distinct as insurance companies and other financial services companies begin to offer innovative combination products. One of the breakthrough concepts of modern risk management is the convergence of insurance and financial arrangements.
In addition to the pure risks all organizations encounter, many businesses, especially financial companies such as banks, face a whole set of contingencies called financial risks. Static risk contemplates only the possibility of loss, as opposed to dynamic risk which also anticipates the potential for gain. Many companies consider managing financial risk to be a separate problem from managing other loss exposures. Hence, these companies do not manage their financial risks in the same ways as their pure risks. Other companies take a broader view. They see that cost of capital issues and cash flow management issues are common threads connecting financial and pure risk management. This lesson introduces the vocabulary and basic elements of financial risk management.
To ensure that you have an understanding of financial risk management, the following topics will be covered in this lesson:
* Financial Risk Management Vocabulary
* Risk Management Information Systems
* Deductibles and Policy Limits
After completing this lesson, you should be able to:
* List financial perils and transactions and state their definitions,
* State the function of risk management information systems,
* Enumerate the steps in risk analysis,
* Explain why risk managers must consider deductibles and policy limits,
* Describe the extremes of overinsurance and underinsurance, and
* Specify how tax implications and psychological, social, and ethical factors affect risk management.
