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55 Cards in this Set
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Chapter 1: How Client Data Affects the Life Insurance Selection Process
Stage 1: Identify Client's Life Insurance Selection Facts |
1st step determine client facts in relation to Life Insurance Selection process.
Client Profile Goals & objectives Survivor's needs Estate Liquidity Risk Tolerance Existing Insurance Amount of Insurance Needed Review facts annually, client situation may change |
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Client Profile
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Age; income ; health; investment levels are important factors of what insurance available @ what cost
Insurance cheaper at younger age Looking in relatively low premium at younger age beneficial. If cannot afford whole/permanent insurance at young age then term normally more affordable and can be converted to permanent insurance at a later date. Health direct impact on cost...Preferred, standard, or substandard risk, effects premiums or coverage at same premium $. If health has changed for worse since original policy was written, probably better to keep existing policy in place. Conversion privileges important in evaluating term, can we convert to permanent insurance in future? |
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Client Goals and Objectives
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What clients truly need and what clients want to do not always the same.
May need really large amount of insurance to protect family but can only afford small amount of term insurance. |
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Survivors Needs
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Found through fact finding process of planning....
Determine needs for... Education fund, how large? Income for dependents, how much for how long? Pre-retirement and post-retirement income fund for spouse, how much for how long? Adequate postmortem emergency fund. AKA adjustment fund, money used to adjust to life after death of spouse. |
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Estate Liquidity
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Is insurance needed to provide estate liquidity at death.
Estate must pay, debt, probate, admin costs, state tax, federal tax, all typically within 9 months of death. Does estate have sufficient liquid assets to pay? Vs. being forced to sell long held family assets? House or farm? Insurance can provide liquidity with longer life expectancy liquidity now a long term need. Permanent insurance best method to cover liquidity |
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Risk tolerance
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Both market risk and ability to retain risk on personal level
Market risk= variable annuity, invested in equities Personal risk= holding term insurance and likelihood can afford increased premium payments in future Know what client is comfortable with and go from there |
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Existing Insurance
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Some people rely extensively on employer provided insurance, don't own any insurance individually.
what would happen if they lost their job and lost term insurance they've paid into for several years. |
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Amount of insurance needed
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Generally most important question - How much? Not what type?
Answer to How much? Answers - What type? Large amount needed - Term may be only option Permanent may be too expensive - provide less coverage for same cost. |
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Changing Needs
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Some say that after age 65 no need for insurance.
However generally no point in life when no insurance is needed. Have young children in home, insurance need is obvious, children grow up live, couple still living on joint income and loss of one income could severely affect spouse. Inflation always changing cost of living, amount of coverage needed. |
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Chapter 2: Life Insurance Selection Process
Stage 2: Establish Goals |
Establish goals and quantify them in time frame and $ amounts.
Found through fact finding process of planning.... Determine needs for... Education fund, how large? Income for dependents, how much for how long? Pre-retirement and post-retirement income fund for spouse, how much for how long? Adequate postmortem emergency fund. AKA adjustment fund, money used to adjust to life after death of spouse. |
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Stage 3: Identify Resources
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Review clients financial statements
Cash flow = source of funds, salaries, dividends, interest, etc. Also allocation of outgoing funds, outflows. Statement of Financial Position = assets and liabilities, net worth |
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Stage 4: Identify Economic Assumptions
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Inflation and after tax rate of return must be determined/assumed.
Assumed inflation = based on average rate over long time frame. After tax return = based on long-term average and not based on today's economic scenario. Planner should help client make realistic assumptions given expected market conditions over a wide range of markets and assets. GDP, Interest rate changes, inflation, energy costs, financial markets, currencies, fiscal policy. Planner should help make assumptions as realistic as possible. Safe to assume inflation slightly higher and investment returns slightly lower than historic averages. Imperative client helps select some assumptions, client must believe they are reasonable. If planner makes all assumptions client may have harder time accepting reality of needs. |
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Stage 5: Determine Life Insurance Needs
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Replacing earning power of family income earner and assuring liquidity of estate = top function of insurance.
Answer requires you to recognize and evaluate current and future needs / goals, assets / liabilities, economic conditions, social security, etc, many many things taken into account. " Needs" implies minimum amount to provide income. "Wants" should be included in calculations as well. Want family to continue with same lifestyle level. Most common method to determine insurance needed... Six; eight; or ten times salary rules of thumb. Income replacement approach (human life value) Percentage Income method Personalized needs approach Some of the simple approaches don't take changing life factors or dependents into account. |
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Stage 5: Determine Life Insurance Needs
Major Steps Detailed page 20-29 |
Major steps in determining needs includes...
1: Gather info on financial and social situation 2: List liquid and non-liquid assets 3: Determine liabilities & postmortem expenses 4: Compare liquid assets to liabilities & postmortem expenses, difference would be amount of insurance needed 5: Estimate amount of funds needed to provide dependents with income till youngest child reaches 18. 6: Estimate $ for higher education fund 7: Estimate funds for pre-retirement income to spouse after youngest child reaches 18. 8: Estimate funds required for retirement income for spouse. 9: Estimate amount required for emergency fund 10: Compare total needs to total assets to determine insurance need. |
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Detailed
Step 1: Gather info on family |
Determine ages, attitudes, goals, and personal financial resources of family members
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Detailed
Step 2: List Assets |
List Fair market value of assets that can be liquidated at death.
Liquid assets: Net Death benefit of life insurance, don't include both DB and CV. Savings and Cds FMV stocks, bonds, money market funds Assets that may or may not be liquid Lump sum pension benefits Equity in real estate collectibles Do not include as either Liquid or non-liquid assets Checking accounts fund earmarked for expenses - college fund Cars / use assets personal affects - jewelry IRA's |
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Detailed
Step 3 List Liabilities / Postmortem expense |
Repayment of debts owed - credit card balance, student loan, bank loan, car loan, Note: mortgage on current residence not include if survivor plans to stay in house, this is accounted for in income need portion.
Estimate Last illness expense Estimated Funeral expense Estimate Probate Cost - attorney fees, court costs, executor fee, appraisal fees. Estimate estate taxes - Estate passed to non-spousal heirs may be subject to federal estate tax. If below estate tax threshold no tax wold apply. Assets passing to spouse qualifies for unlimited marital deduction. Use of trusts and titling of assets may affect probate and estate expenses Include Adjustment Fund |
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Detailed
Step 4: Difference in estimated liabilities and postmortem expenses |
Expenses exceed liquid assets insurance is needed.
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Detailed
Step 5: Estimate Size of fund required to provide dependents adequate income to age 18 |
Estimate desired monthly income: All amount on after-tax basis.
Gross salaries - taxes - savings - investments / 12 x .75 Must consider economic value of homemaker. Loss of right to file joint taxes loss of estate tax marital deduction loss of gift tax marital deduction Determine sum of... expected monthly after tax earning of surviving spouse Expected social security benefits for survivors any other expected survivor benefits Subtract total expected monthly income of survivors from desired monthly income. If income is enough to cover then no insurance may be required. multiply this number by 12 to determine annual income needs If insurance need exists, calculate total amount needed to provide series of inflation adjusted income payments |
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Detailed
Step 6: Estimate higher education fund |
Estimate amount required to provide higher education.
1: determine total cost in today's dollars 2: Determine number of years until student begins college, estimate inflation, determine future value of income needed to cover cost in future 3: Determine number of years attend college, Present value of annuity due. 4: Determine number of periods until student begins college and after-tax rate of return during periods. Calculate PVAD remember costs vary wildly at college |
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Detailed
Step 7: Estimate size of fund for surviving spouse income from time youngest reaches 18 until retirement benefits are available. Blackout period |
Blackout trigger point = Age 18 of youngest child
1: Estimate spouse's desired annual income - today's dollars 2: Estimate spouse's expected annual after tax earnings, today's dollars 3: Subtract step 2 from step 1 to determine annual payments needed during blackout period. Could be zero 4: Calculate amount needed to provide series of inflation adjusted "blackout period" income payments, assume payments made at beginning of year. Example page 28 |
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Detailed
Step 8: Estimate income needed in retirement years |
Income needed after social security and other retirement benefits.
Estimate life expectancy at time retirement benefits begin, use that term to estimate total retirement income needed. |
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Detailed
Step 9: Emergency Fund |
3 to six months of living expenses
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Detailed
Step 10: Determine amount of insurance needed. |
Add amounts from Step 5 though 9, subtract sum of liquid assets. Positive number indicates insurance need.
Amount of insurance needed added to insurance need for estate liquidity. review plan annually. |
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Selection Process
Pitfalls Term Insurance |
Most problems come from making unwarranted assumptions
Term Insurance: Recommending term insurance just because client is young. Page 38 Know benefits of buying straight into permanent policy vs converting a term policy. Pay more now, but increased benefits in the future. Forced tax deferred savings through level premiums of permanent policy. Combo of time and tax-deferral makes significant difference over life of contract. Ideal solution: Cover long term needs with permanent insurance, cover short term needs with term. |
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Selection Process
Pitfalls Variable vs non-variable |
Pitfall: Assuming variable will outperform non-variable, or ignoring emotional implications of equity products for clients.
Consider short term effects of decline in equity markets in early years of policy. Solution: Pick conservative investments for first few years. Start policy with larger than anticipated contribution to cover future premiums. Possible client management risk of performance in variable product. |
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Selection Process
Pitfalls Investing through the insurance company |
Pitfall: Assuming that client can invest their own money better than insurance company can.
Insurance company would have large team of investment professionals who typically manage conservative pool of investments that historical do well. |
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Selection Process
Pitfalls Diversification concept applied to insurance |
Pitfall: Assuming client should diversify types of insurance they hold.
Diversification doesn't apply to insurance like it does to investments. May want to spread purchase of insurance to multiple insurance companies to reduce insolvency risk. |
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Selection Process Example
Page 42 |
Know Selection process
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Stage 7: Evaluate Existing Type and Product
Ways to compare policies |
After appropriate insurance type / product is determined for client, planner must evaluate existing insurance. Client may or may not have existing insurance that is suitable.
Compare cost-per-thousand basis, against similar policy. Traditional net cost, surrender cost method, net payment cost method, net payment cost method. Equal outlay method, cash accumulation method, Linton Yield Method, Belth yearly method, yearly price of protection method, Baldwin Method. |
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Belth Method
Aka Yearly Price Method Information Needed |
Evaluates life insurance policy costs, yearly price of protection method.
Tells you yearly cost per thousand dollars of insurance. First Gather following information: > Death benefit payable @ end of policy year > Cash value payable on surrender at end of policy year (term insurance = zero) > Cash value end of previous policy year > Annual policy premium payable beginning of policy year > Annual dividend payable end of each policy year, based on current dividend scale > Insured's current age Info obtained from existing policy illustration (In-force ledger), current policy statements, policy itself. Must compare same variables across different policies, compare over several years. |
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Belth Method
Aka Yearly Price Method Calculations |
Yearly price per thousand = ( P + CVP) ( 1 + i) - ( CV + D) / ( DW - CV ) ( .001)
DB = Death Benefit CV = Cash Value at end of Policy Year CVP = Cash value end of previous policy year P = Annual Premium D = Annual Dividend at end of policy year i = tax deferred rate of return that could have been earned had the premium and cash surrender value (P+CVP) been invested in different vehicle with similar risk. Keep in mind tax consequences of other possible investment vehicle. Example of Yearly Price Method Page 47. |
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Belth Method
Aka Yearly Price Method Benchmark Table - Page 47 |
Used to compare policies when using the Yearly Price Method.
Benchmarks derived from certain US population death rates. Benchmark for each 5 year period slightly higher than death rate per 1,000 people at highest age in that bracket. If price of life insurance protection / $1,000 is close to "raw material" cost (amount needed to pay death claims based on population death rates). Then insurance reasonably priced. |
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Belth Method
Aka Yearly Price Method Benchmark - How to Use Guidelines |
If yearly Price Per Thousand of the policy is...
> Less than benchmark figure, yearly price is low and owner should not consider replacing policy > More, but not double, the benchmark figure, yearly price is moderate, probably shouldn't consider replacing policy > more than double benchmark figure, yearly price high, should consider replacing policy if adequate coverage available at lower price |
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Belth Method
Aka Yearly Price Method For Term Policy ex pg 49 |
Similar Calculation
Nonparticipating term life insurance policy - Face Value $100,000 Premium $1,600 Yearly Price Per Thousand = (1,600 + 0) (1.06) - (0) / 100,000 * .001 Yearly Price Per Thousand = $1,696 / 100 YPPT = 16.96 |
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Belth Method
Aka Yearly Price Method Front End load multiple |
Many policies charge higher expenses in early years to cover selling / admin costs.
Multiple Derived by dividing policy's price by the benchmark price. Front end multiple = YPPT / Benchmark PPT If policy substantially front end loaded it's multiple will be substantially higher than table's multiple. Guidelines: If policy's front end load is > less than benchmark, front end load low > more, but not double, benchmark, front end moderate > more than double, front end is high Evaluating this multiple only effective in first few years of policy being active, after couple years front end load is sunk cost. |
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Belth Method
Aka Yearly Price Method Caveats and Conditions |
> Not to be used if policy covers more than one life
> Year chosen for calculation may not be representative of policy as whole, calculate for several years to get full picture. > YPPT could be negative if conservative interest rate used, or when evaluating very competitive permanent policy > Realize not all products are same, customer service, reliability, and other service issues are important when buying insurance > If CV high (i.e little life insurance protection remains) consider return on investment as you would any other similar available investments |
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Linton Method
Linton Yield Calculations |
Created to compare cash value of life insurance with "buy term, invest difference" approach.
Based on subtracting "cost of protection" from each year's policy premium, net of dividends, and treating remainder as savings deposit. Rate of Return = additional savings / Beginning cash surrender value 1) Divide policy into 2 parts cash surrender value - face amount = net amount @ risk or amount of life insurance protection 2) Amount at risk then "priced" based on insured's age, gender, health, etc. ( what would it cost policy owner to buy the net amount at risk on street?) 3) Premium - cost of protection (term cost) - dividends = added savings deposit Addition to savings = rate of return or yield for particular policy year |
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Linton Method
Linton Yield Limitations & Drawbacks |
Drawbacks...
> Dividend assumptions and term cost assumptions could vary according to source, affect amount that would be added to savings. > Could choose too low term rates, resulting in low-yield permanent policy. > High term rates used, permanent policy appears unrealistically beneficial. Method subject to manipulation...use carefully and selectively Can help compare yield of different policies Replacement could involve tax consequences, high initial replacement cost, surrender of valuable existing insurance provisions. Must consider total situation and not outcome of Linton method alone. |
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Stage 8: Appropriate Amount
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Stage 7 determine appropriate type of insurance, now must consider what appropriate amount would be. Amount of insurance determined in Stage 5 during insurance needs. If correct type and adequate amount exists selection process has ended.
If client has appropriate type of insurance but not enough time to move to stage 9. |
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Stage 9: Sufficient Resources
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If determined in Stage 7 client has incorrect type of insurance now time to consider if client has resources to purchase more suitable form of insurance.
Client may be forced to buy less insurance than they really need. |
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Stage 10: Purchase Appropriate Coverage
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If sufficient resources available, next stage to purchase additional coverage.
Adding new coverage to existing plan Replace existing coverage If no need to cancel existing coverage, life insurance planning ends at stage 10. Replacement considered move to stage 11. If insufficient resources available... change client objectives, or least desirable option to buy most appropriate product in smaller amount. |
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Additional Considerations in Life insurance planning
Irrevocable Life Insurance trusts |
Irrevocable Life Insurance Trusts (ILITs)
Multiple Uses - multiple life policies and split dollar arrangements Main idea is to remove an asset from your estate, reducing potential estate tax liability. Biggest negative = loss of control over life insurance policy, transfers permanent. 2 big positives: > Assets is ILITs escape estate taxation & stay out of probate, settling estate more confidential and more money passes to heirs > Trust assets cannot normally be challenged by dissatisfied heirs or creditors. Both benefit high net worth individuals |
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Private Split-dollar arrangements
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Private Split-dollar agreements between private parties (often family members, not employer and employee)
Normal Split-dollar agreement = money to pay premium provided by one entity (employer) who has right to receive amount equal to premiums paid. Remainder CV or DB goes to insured's Bene's. > used by business to retain key employees Private Split-Dollar arrangement between family...typically family member (Parent) pays premiums on another family member (child). Done correctly premiums paid are considered gift, sheltered from annual gift tax exclusion. Most arrangement, eventually cost of insurance exceeds annual gift tax exclusion. Many end arrangement and do rollout. Rollout may reimburse grantor by taking money out of cash value, policy would likely then require high future premium payments. Alternative rollouts - gifting cash value to non-grantor in lump sum or over period of years. or grantor receives interest-bearing note from trust with note payments being paid by additional gifts to trust by the grantor. |
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What does IRS think of Trusts and Split-Dollar Agreements?
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Largely Depends on benefits to grantor and other parties in arrangements.
Split-dollar arrangements can be either... > Equity Based, insured receives DB along with disproportionate share of CV) > non-equity based, insured gets DB, but not CV. Arrangements only taxed on value of insurance protection. 2 basic types of equity split-dollar arrangements 1) economic benefit regime: if policyowner pays premiums for benefit of another, insured. Tax treatment = Economic Benefit of life insurance considered gift to insured from owner (grantor) 2) Loan Regime: Premium payments made by non-owner (grantor) deemed as loans to owner / insured. Owner considered borrower, grantor lender. Loans must be interest bearing at market rates, if charge interest below market rate the interest owed could become taxable. Loan Regime Cannot be used in Public companies: Sarbanes - Oxley prohibits loans from public companies to executives. |
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Chapter 4: Deciding to keep or cancel policy
Stage 11: Cancel inappropriate coverage Reasons not to replace existing coverage |
Reasons to not replace existing policies...
> Pay new acquisition costs > Existing policies increase with age > New policies must pass through contestable period and suicide clause, existing policy may already have passed through > New participating policy dividends likely be much less than existing policy. > New policy cash value < Cash received from old policy > Replacement policy and existing policies are different types, without clients change in needs, new policy might not fulfill objectives Most states recognize replacing policies often not in best interest of client. Lots of disclosures required to replace policy. Reasons to consider... Change in client's circumstances might make sense to modify insurance coverage. Insurance companies come out with new products that may better suit clients needs |
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Nontaxable Policy Exchanges / Replacements
1035 exchange requirements |
Section 1035 IRS code...circumstances that policy can be exchanged for another without taxable event.
Requirements... > Exchange of one life insurance policy for another life policy or annuity > Exchange of endowment contract for similar endowment or annuity contract > Exchange of annuity contract for another annuity contract > If involves life policies, must be on same life of insured > No cash or property received, no gain recognized, cost basis of new policy same as old (plus premiums paid - excludible dividends received after exchange) > If new policy carries same level indebtedness, exchange tax free |
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Nontaxable Policy Exchanges / Replacements
Four basic types of Life Insurance Policy replacement |
1: Replacing one term policy with another, least complex. No concern of built up cash values. Comparing costs simple. If Alt offers same coverage or less, should be considered.
2: Replacing term with cash value, normally done through term policy's conversion clause. Not always good alternative. Companies with acceptable term policies may not over desirable cash value policy 3: Replacing cash value with cash value, usually not advantageous. May have to pay another front-end load, insured older than when original policy issued so premium probably increased. If existing policy is more expensive then comparable alt then replacement considered. 4: Replacing cash value with Term, usually unwise. Once decent cash value policy in place usually unwise to replace it. Dividend accumulation low in early periods of policy, owner would take substantial loss if cash value policy replaced shortly after issuance. |
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Nontaxable Policy Exchanges / Replacements
What to consider before replacing any policy |
> Compare Costs
> Don't drop old till new is in force (Avoid laps in coverage) > financial rating of new insurance company > how does quality of coverage of new policy compare > consider agent service > discuss replacement with existing and proposed agents |
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Stage 12: Modify Goals
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If sufficient resources not available may have to modify goals...
Send child to less expensive college...less insurance would be required. Clients must understand potential consequences and decide on changes to be made. Planner shouldn't make these decisions for clients. |
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Stage 13: Purchase a Lesser Amount
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If client unwilling or unable to change goals, solution to purchase less insurance.
Means insuring only essential risk exposures or choosing cheaper form of insurance. How much insurance more important than what type. Compromise on type before amount of insurance If client won't change goals and choose to underfund insurance, planner should take accurate notes to document this discussion / recommendation. |
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Human Life Value
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Common needs-determination approach...Based on ability to earn income and requirement that someone else depends on that income.
Have no income, or no dependents, technically have no human life value, and needs no insurance. Subtract individual's current living expense from earnings. Then determine number of years of required income, interest / discount rate. Determine present value of lost income stream. Approach has number of difficulties. Many of other approaches available. All take interest earned on funds set aside, taxes, inflation, income from survivors, future inflation into account. Capital utilization / annuity = uses current resources, could outlive income. Best for those without heirs, or don't need to leave inheritance. Interest only / capital preservation = don't spend down principal, leaves an inheritance. Know example |
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Capital utilization / Annuity Approach
Interest only / capital preservation approach |
Capital utilization / annuity = uses current resources, could outlive income. Best for those without heirs, or don't need to leave inheritance.
Interest only / capital preservation = don't spend down principal, leaves an inheritance. Know example page 65. |
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Interest-Adjusted cost index Calculation
Future Value Factor Total interest adjusted cost as "payment" Page 66 |
Uses future value factor = value of premiums at interest - value dividends at interest - cash value end of period = interest adjusted cost
Total interest adjusted cost as the "payment" in financial calculator... example page 67 `\ |
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Premarital Agreements
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Potential divorce is consideration when looking at keeping or canceling insurance policy.
Prenup may have provisions preventing you from changing policies. Courts can still override prenups during qualified domestic relations order (QDRO) divorce proceedings. Prenups more common in second marriages, when there are children from original marriages. Protects assets for children. Must be in writing and signed by both parties, some states require witnesses of signing, notarizing, etc. Must have full disclosure of each party's net worth, cannot be clearly disproportionate to wealth of the other spouse, presumption of "designed concealment" Burden of proof then on the wealthier spouse to prove agreement was fair and valid. Must not be intended to facilitate or promote procurement of divorce. Must be shown to be signed willingly by both parties without duress or coercion. Some prenups have complicated estate tax implications. |