PowerPoint Slides 14 - American University

Report
FIN 200:
Personal Finance
Topic 14-Life Insurance
Lawrence Schrenk, Instructor
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Learning Objectives
1.
2.
Explain the features of life insurance
policies. ▪
Explain and calculate the effect of inflation
on financial decision-making.▪
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Life Insurance
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Do you need life insurance?
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Death Expenses
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Ongoing Financial Obligations
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Funeral Expenses
Others Dependent on your Income
Others Dependent on your Service
Investment/Savings Vehicle
Bequest
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How much do you need?
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Goal: Maintain Current Standard of Living
Income Method
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Budget Method
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Rule of Thumb: 7-8 Times Annual Income
Life Insurance Needs Estimator
Be Conservative; More is Better
Adjust for Inflation
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Terminology
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Primary Beneficiary
Contingent Beneficiary
Face Amount/Death Benefit
Cash/Surrender Value
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Types of Life Insurance
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Term (Fixed Period) Life Insurance
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Permanent Life Insurance
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Annual Renewable
Fixed-Rate (Lock-In Premium)
Decreasing Term
Whole Life
Universal Life
Variable Life
Free (Employer Provided) Life Insurance
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Term Life Insurance
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Cost Factors
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Coverage Time
Coverage Amount
Age
Gender
Medical History
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Permanent Life Insurance
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Insurance + Savings Vehicle
Whole Life
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Universal Life
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Zero Risk Policy
Low (but Guaranteed) Return
More Flexible
Variable returns
Possible Increase in Premium
Variable Life
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Various Investment Possibilities
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Comparison
Whole
Universal
Variable
Mortality Costs
Fixed
Variable
Fixed or Variable
Expenses
Fixed
Variable
Fixed or Variable
Cash Value
Fixed
Variable
Variable
Investment Risk
None
Yes
Yes
Vary Premium
No
Yes
Usually
Change Death Benefit
No
Yes
Usually
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Sources
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Agent
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Can be necessary for permanent life insurance
Find a good agent
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E.g, Certified Life Underwriter (CLU)
Multiple Policy Agent
Financial Planner
Internet
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Insure.com
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Life Insurance as Investment
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Rate of Return
Flexibility of Disbursement
‘Forced Savings’
Life Insurance Dividends
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Other Issues
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Other Forms of Life Insurance
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Mortgage Insurance
Credit Life Insurance
Travel Accident Insurance
Financial Stability of Issuer
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Ratings Agencies Rate Insurers
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Insure.com Ratings
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Ratings Example
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Project Note
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Ethical Dilemma
Steve had a whole life insurance policy that provides
$10,000 in life insurance protection and
accumulates a cash value of twice his current
annual income by age 65. Two years later, after
Steve's marriage, he bought a second policy. His
agent told him each policy would have a cash value
double his annual income. At 65 he was appalled to
see that the cash value on the older policy was
$17,000 and on the newer policy was only $15,000.
a. Was the agent being unethical in now showing Steve the
potential impact of inflation on the policies' cash value?
b. How much does an insurance agent need to reveal to
potential clients?
c. What ‘informational’ responsibilities does the buyer have?
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Inflation
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Example
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Your dream car costs $50,000 and you plan
to buy it in 10 years.
You save $273.30/month at 8%, so that you
have $50,000.00 at the end of ten year.
What happens to your dream? ▪
You don’t get it. If inflation were 5%, in 10
years the car would cost $82,350.47.
You are $32,000.00 short! ▪
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Another Example
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You want to be a millionaire by age 50.
You save $546.23/month at 9%, so that you
have $1,000,000 at the end of 30 years. ▪
You are technically a millionaire since you do
have $1,000,000 in your investment account.
But, in today’s dollars, that million is only worth
$301,795.87 if the inflation rate is 4%.
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‘In Today’s Dollars’–$1,000,000 in 30 years will
allow you to buy the same goods that $301,795.87
buys today.▪
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Real versus Nominal
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Inflation–Rise in the General Level of Prices
Nominal Values
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‘Money of the Day’
Not Adjusted for Inflation
The Dollar Value You Actually Pay
Real Values
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Adjusted for Inflation
‘Current’ Dollars/Today’s Dollars
Constant Consumption Value
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Historical Inflation
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Simple Example
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A can of soda costs $1.00 today and $1.05 next
year.
What is the inflation rate?
$1.50  $1.05
 5%
$1.00
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At this rate of inflation, what will a can of soda cost in
5 years?
$1.00 1.05   $1.28
5
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Simple Example with Calculator
At 5% inflation, what will a $1.00 can of soda cost in
5 years?
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1.
2.
3.
4.
Input 5, Press N (This is annual so N = 5)
Input 5, Press I/Y
Input 1, press +/-, press PV
Press CPT, FV to get $1.28
Do you recognize this pattern? ▪
The following two questions are identical:
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At 5% inflation, what will a $1.00 can of soda cost in 5
years? $1.28
At a 5% interest rate, what will be the future value of $1.00
5 years? $1.28 ▪
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Another Example (Revisited)
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You save $546.23 per month at 9%, so that you
have $1,000,000 at the end of 30 years. Inflation is
4% ▪
How much is that amount worth in today’s dollars?
1.
2.
3.
4.
5.
Change P/Y to 12
Input 360, Press N (30 x 12 = 360 monthly payments)
Input 4, Press I/Y (use inflation not the interest rate)
Input 1,000,000, press +/-, press FV
Press CPT, PV to get $301,795.87
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Real versus Nominal Rates
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Nominal Interest Rate
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Real Rate of Interest
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This is what we have been using
It does not adjust for inflation.
The nominal rate adjusted for inflation.
Relationship (Approximation)
Real Rate = Nominal Rate – Inflation
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Another Example (Revisited, Again)
How much do you need to save monthly at 9%
to have $1,000,000 (in today’s dollars) in 30
years, if inflation is 4%?
Use the real rate for your calculation
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1.
2.
3.
4.
5.
Real Rate of Interest = 9% - 4% = 5%.
Change P/Y to 12
Input 360, Press N (30 x 12 = 360 monthly payments)
Input 5, Press I/Y (use the real interest rate)
Input 1,000,000, press +/-, press FV
Press CPT, PMT to get $1,201.55 (NOT $546.23)
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Getting your Dream Car!
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How much do you need to save monthly at 8%
to have $50,000 (in today’s dollars) in 10
years, if inflation is 5%?
Use the real rate for your calculation
1.
2.
3.
4.
5.
Real Rate of Interest = 8% - 5% = 3%.
Change P/Y to 12
Input 120, Press N (10 x 12 = 120 monthly
payments)
Input 3, Press I/Y (use the real interest rate)
Input 50,000, press +/-, press FV
Press CPT, PMT to get $357.80 (NOT $273.30)
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