introduction to life insurance
• Insurance is a method of spreading the result of finance loss among a lot of people so that no single individual will have to bear the entire burden when such a loss occurs.
• One way to spread losses is through assessment-"passing the hat" when losses occur.
• However, in terms of ensuring against the financial losses of death, there are no drawbacks to this method:
1. As the group gets smaller, each individual assessment gets larger.
2. Younger members can be expected to be assessed more often than older members.
3. A catastrophe that kills many individuals can result in an assessment large enough to create a financial hardship for the survivors.
A better method of insuring lives is through the creation of a fund that is actually determined to be large enough to pay the losses that can be expected to occur. Later in the session will talk about the mortality factor in determining the prepayment (premium) amount. In later sessions, we will discuss the other factors that go into computing premiums.
II. Principal of INSURANCE
- How It Works
No one knows exactly when any given individual will die. But within a large group of individuals, the total number of individuals that will die each year can be predicted with a high degree of accuracy. If anyone puts in enough money at the beginning of the year to fund benefits for those deaths that will occur during the year, the large, unknown cost for each individual can be replaced with a smaller, known cost. This is the essence of insurance.
- Role of the Insurance Company
Life insurance companies operate the "fund" and provide the following services to make it all work:
1. Sell Insurance to people who need and want it
2. Collect the "contributions" needed to provide insurance
3. Handle all the details of running the operation
4. Pay out the money upon the death of an individual covered by insurance
III. ELEMENTS OF A CONTRACT
A contract is a legal agreement between two or more parties, promising a certain performance, in exchange for a valuable consideration.
- Relationships to Life Insurance
Insurance is contact between an insurance company and a person called the policy owner promising that the insurance company will pay a certain amount as long as the policy owner pays the premium.
- The Unilateral Aspect of Insurance
The insurance company is legally bound to fulfill its part of the agreement as long as the policy owner pays the premium. However, the policy owner is not obligated to continue paying premium. This makes insurance a "unilateral" contract: Only one party to the contract is obligated to fulfill its part of the agreement. (Under a bilateral contract, both parties must perform.)
- Characteristics of a Legal Contract
1. Competent Parties
One must be considered legally competent to enter into an enforceable contract. Individuals whose judgement may be untested or impaired are legally incompetent: minors, for example, or someone who is insane.
2. Legal Purpose
A contract maybe enforced only if its purpose is legal. Example: The contract specifying payment for the sale of a cocaine cannot be legally enforced.
3. Offer and Acceptance
For contract to exist, there must be an agreement. Offer and acceptance is the vehicle through which agreements is effective: One party makes an offer which the other party accepts. We often think of insurance "offering" for products to the public. However, in contractual terms, it is usually the applicant that the makes the offer to become an insured by filling out the application and writing a check for the first premium. The insurance company then accepts the offer by issuing a policy as applied for. At that point, all the elements for the existence of a contract are in place. But offers must be accepted unconditionally -- the offering party is not obligated by any new conditions the other party might make and respond to an offer. For example, if a policy is not issued as applied for, the insurance company has not made a "conditional acceptance", but rather, a counter-offer. Under these circumstances, it is upto the applicant to accept or reject the insurance company offer.
Consideration is defined as something of value given in exchange for the other party's performance under the contract. In an insurance contract, the policy owners consideration is the premium and the application, and the insurance company's consideration is the promise to pay benefits as described in the policy. Consideration is a legal requirement of all contracts. Without consideration, no contract exist. For example, insurance policies do not go into effect until a premium is paid.
IV. IMportant contractual concepts
- Basic Terms
Additional concepts that you need to know are explain in the text.
A waiver is the giving up of a known right or privilege. Express waivers are written and are always intentional. But waivers may also be implied, that is, unwritten. Implied waivers may be intentional or unintentional. Even if unintentional and unwritten, an implied waiver is effective. Though implied waivers, agents may unintentionally give up rights that may cost an insurer thousands of dollars.
Is being prevented from asserting a right because of past behavior. For example, once a right has been waived, an individual is estopped from asserting that right.
- Parol Evidence Rule
Oral agreements need to be included in the written contract if they are able to be enforceable.
- Personal Contract
Life insurance is personal as it is a person, not a thing being insured.
- Aleatory Contract
Equal value is not given by both parties to the contract. The insurance company may have to pay out much more than has been collected in premiums.
- Contract of Adhesion
The insurer draws up and issues the contract. It is not, in the ordinary sense, a negotiated document.
- Contract of Utmost Good Faith
The insurer must rely to an extent upon the truthfulness and integrity of the applicant, while the policy owner must rely on the insurer's promise to pay.
- Executory Contract
Performance under the agreement is not carried out immediately (proceeds will not be paid until the insured dies).
- Conditional Contract
The obligation of the insurer to meet its responsibilities is dependent upon the policy owner meeting his or her responsibilities, such as paying the premiums and furnishing proof of claims.
- The Life Insurance Contract
The following summarizes the agreement made between the insurer and the policy owner in a life insurance policy.
- The policy is a legally binding contract
- Under which the policy owners premiums are exchanged for the insurer's promiseto pay benefits
- To a party specified by the policy owner (the beneficiary)
- In event of the insured's death.
V. The Mortality Rate
- Definition - The mortality Rate is the statistical probability of death among a large group of people.
- The Law Of Large Numbers - The law of large numbers states that the more examples used to develop any statistics, the more reliable the statistics will be.
- Relationship To Life Insurance - Through the analysis of record over hundreds of years, life insurance companies are able to determine with high accuracy how many persons in any age group will die each year.
- Effect of Aging - Statistics show that the number of deaths per year are much higher for a group of individuals age 75 than for a group of individuals age 25. Therefore, insurance costs less for younger individuals.
The need for life insurance
I. Obligation At Death
Life insurance eases the financial hardship Created by death. How much life insurance does someone need? We can answer this question by analyzing the areas in which money will be needed following an individual’s death. This is called “The Needs Approach “of determining the amount of life insurance someone should own. There are two types of needs: Need for immediate cash, needs for continuing income.
A. Needs For Immediate Cash
1. Final Expense - These expenses are incurred when someone dies.
a. Hospital, Dr Bills , Etc, From your last Illnesses.
b. Funeral Expenses
c. Death Taxes, Expenses, Etc.
2. Debt Repayment - Besides the cost of dying, certain debts may come due at an individuals death. Or, If they don't actually come due, It still may be desirable to have them paid off so they don't become a drag on the surviving family income.
a. Credit Card Balances.
b. Car Loans, Other Installment Loans.
3. Home Assurance - A fund to pay off the mortgage or, to provide ongoing rent payment might be considered a need for future income. But having a place to live is so basic to a surviving families financial security that most experts recommend a accessing this need, as one for immediate cash.
4. Education Fund - Like Home Assurance, a college education fund might be considered a future need for money if the children are still young. By creating an education fund immediately allows interest early on the funds to help also future increases in the cost of attending college.
5. Emergency Fund - This fund creates a cushion for unforeseen financial needs.
B. Needs For Continuing Income
Even with cash needs taken care of, the surviving spouse and children will need ongoing income to maintain their standard of living. Without the living expenses of the deceased spouse, they will not need the entire amount of income, they enjoyed previously. But people in the middle, and high income brackets will almost certainly need more income, the social security benefits will provide.
II. Building an Estate
Life insurance is the best way of building an estate to meet the financial needs created at death. Other methods of accumulating money are useful for creating a retirement fund, or a vacation fund, or things of that nature. But they fall short of providing the security a family needs to offset the danger of prematue death.
- Problems With Savings Plans
1. Time Factor
2. Spend Factor
- Problems with Investment Plans
1. Time Factor
2. Fluctuation Factor
- Advantage of Life Insurance
Life Insurance solves the problems associated with building an estate.