RMIN 4000 Risk Management and Insurance Pottier Exam 2 Study Guide UGA
RMIN 4000 Risk Management and Insurance Pottier Exam 2 Study Guide UGA RMIN 4000
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RMIN 4000 Exam 2 Study Guide Life Insurance, Annuities/IRA’s and Social Insurance Exam Breakdown: Social insurance: 14 , life insurance: 19, annuities/iras: 11, medicare presentation (from March 3): 3 Chapter 11: Life Insurance Key Terms Capital Retention Approach—a method used to estimate the amount of life insurance to own. Under this method, the insurance proceeds are retained and not liquidated Cash-value Life Insurance—the amount paid to a policy holder who surrenders the policy Convertible—when term policies can be exchanged for a cash -value policy without evidence of insurability Dependency Period—period of time following the readjustment period during which the surviving spouse’s children are under 18 and, therefore, dependent on the parent Endowment Insurance—a type of life insurance that pays the face amount of insurance to the beneficiary if the insured dies within a specified period or to the policy holder if the insured survives to the end of the period Human Life Value—present value of the family’s share of the deceased breadwinner’s future earnings Limited-payment Policy—a type of whole life insurance providing protection throughout the insured’s lifetime and for which relatively high premiums are paid only for a limited period Needs Approach—method for estimating the amount of life insurance appropriate for a family by analyzing various family needs that must be met if the family head should die and converting them into specific amounts of life insurance, including the considerat ion of financial assets Ordinary Life Insurance —a level-premium policy that provides cash values and lifetime protection to age 121 Premature Death—the death of a family head with outstanding unfulfilled financial obligations Readjustment Period—one or two-year period immediately following the bread winner’s death during which time the family should receive approximately the same amount of income it received while the breadwinner was alive Reentry Term—a term insurance policy in which renewal premiums are based on select (lower) mortality rates if the insured can periodically demonstrate acceptable evidence on insurability “you’re eligible for a lower premium periodically if you can prove you’re in good health” Renewable—policies can be renewed for additio nal periods without evidence of insurability Single-premium Whole Life Insurance—a whole life policy that provides lifetime protection with a single premium payment Term Insurance—a type of life insurance that provides temporary protection for a specified number of years with no savings element —usually renewable and convertible Universal Life Insurance — (types A & B) a flexible-premium whole life policy that provides lifetime protection under a contract that separates the protection and savings components. The contract is interest-sensitive and unbundles savings, protection and expense components Variable Life Insurance —a fixed premium policy in which the death benefit and cash values vary according to the investment experience of a separate account maintain ed by the insurer Variable Universal Life Insurance — (types A & B) similar to universal life insurance with some exceptions — cash values can be invested in a wide variety of investments, there is no minimum interest rate guarantee, and the investment risk falls entirely on the policy holder Whole Life Insurance —a cash-value policy that provides lifetime protection 1 Chapter 12: Life Insurance Contractual Provisions Key Terms Accelerated Death Benefits—a rider or benefit in a life insurance policy that allows insureds who are terminally ill or who suggest from certain catastrophic diseases to receive part or all of their life insurance benefits before they die, primarily to to pay for the care they require Accidental Death Benefit Rider (double indemnity)—this rider doubles the face amount of life insurance if the death occurs as the result of an accident (in some cases, face amount is tripled) Class Beneficiary—a specific person is not named, but is a member of a group designated as a beneficiary—used when insured wishes to divide the policy proceeds evenly among members of a particular group Ex. “children of the insured” Contingent Beneficiary—beneficiary of a life insurance policy who is entitled to receive the policy proceeds on the insured’s death if the primary beneficiary dies before the insured or the beneficiary who receives the remaining payments if the primary beneficiary dies before receiving the guaranteed number of payments Cost-of-living rider—benefit that can be added to the life insurance policy under which the policy holder can purchase one-year term insurance equal to the cumulative percentage change in the consumer price index with no evidence of insurability Extended Term Insurance Option—when the net cash-surrender value is used as a net single premium to extend the full face amount of the policy (less any indebtedness) into the future as term insurance for a certain number of years Grace Period—period of time during which a policy holder can pay an overdue life insurance or health insurance premium without casing the policy to lapse Incontestable Clause—contractual provision in a life insurance policy stating that the insurer cannot contest the policy after it has been in force two years during the insured’s lifetime Interest Option—life insurance settlement option in which the principal is retained by the insurer and interest is paid periodically Irrevocable Beneficiary—beneficiary designation allowing no change to be made to the beneficiary of an insurance policy without the beneficiary’s consent Life Income Options—life insurance settlement option in which the policy proceeds are paid during the lifetime of the beneficiary—a certain number of guaranteed payments may also be payable Misstatement of Age or Sex Clause—contractual provision in a life insurance policy that states that if the insured’s age or sex is misstated; the amount payable is the amount that the premium would have purchased for the correct age or gender Ownership Clause—provision in life insurance policies under which the policyholder possesses all contractual rights in the policy while the insured is living. These rights can generally be exercised without the beneficiary’s consent. Reduced Paid-Up Insurance—the cash surrender value is applied as a net single premium to purchase a reduced paid-up policy—the policy purchased is the same as the original policy, but the face value is reduced Revocable Beneficiary—beneficiary designation allowing the policy holder the right to change the beneficiary without the consent of the beneficiary Specific Beneficiary—beneficiary is specifically named and identified 2 Suicide Clause—contractual provision in a life insurance policy stating that if the insured commits suicide within two years after the policy is issued, the face amount of the insurance will not be paid. Instead, premiums are refunded. Waiver-of-premium Provision—benefit that can be added to a life insurance policy providing for a waiver of all premiums coming due during a period of total disability of the insured 3 Chapter 14: Annuities and Individual Retirement Accounts Key Terms Annuitant—person who receives the periodic payments from an annuity Annuity—periodic payment to an individual that continues for a fixed period or for the duration of a designated life or lives Annuity Certain—pays a life income to the annuitant with a certain number of guaranteed payments, and if the annuitant dies before receiving the designated number of payments, the remaining payments are paid to a beneficiary Cash refund option—the balance of an annuity is paid in one lump sum to the beneficiary after the death of annuitant, if the total payments do not equal the annuity purchase price Deferred Annuity—a retirement annuity that provides benefits at some future date Equity-indexed Annuity—a fixed, deferred annuity that allows limited participation in the stock market but guarantees the principal against loss if the contract is held to term Exclusion Ratio—calculation used to determine the taxable and nontaxable portions of annuity payments, which is determined by dividing the investment in the contract by the expected return Fixed Annuity—annuity whose periodic payment is a guaranteed fixed amount Individual Retirement Account (IRA)—individual retirement plan that can be established by a person with earned income, that enjoys favorable income tax advantages IRA Rollover Account—a tax free distribution of cash from one retirement plan, that is then deposited into another retirement plan Ex. If you quit your job and receive one lump-sum payment from the retirement plan you held in that company and then deposit it (or roll it over) into a special IRA Rollover Account Joint-and-survivor Annuity Option—annuity based on the lives of two or more annuitants, where the annuity income (either full amount of the original income or only two-thirds or one- half of the original income when the first annuitant dies) is paid until the death of the last annuitant Liquidation Period (Payout Period)— refers to the period in which funds are paid to the annuitant Nondeductible IRA—when taxpayers with incomes that exceed the phase-out limits contribute to an IRA but cannot deduct the contributions Roth IRA— an IRA in which the contributions are not income-tax deductible but distributions are received income-tax free if certain conditions are met Single-premium Deferred Annuity—a whole life policy that provides lifetime protection with a single premium payment Straight (pure) Life Annuity—annuity that is paid as long as the annuitant lives, and stops when the annuitant dies—no survivor benefit, no guaranteed number of payments Temporary Life Annuity Due—when annual premiums are paid only for a temporary period the premium is a temporary life annuity due Traditional IRA—an IRA that allows workers to deduct part or all of their IRA contributions if taxable income falls under a certain limit, and distributions are taxed as ordinary income 4 Chapter 18: Social Insurance Key Terms Assumption of Risk Doctrine—defense against a negligence claim that bars recovery for damages if a person understands and recognizes the danger inherent in a particular occupation or activity Average Indexed Monthly Earnings (AIME)—under the OASDI program, the person’s actual earnings are indexed to determine his or her primary insurance amount (PIA) Currently Insured—status of a covered person under the Old-Age, Survivors and Disability Insurance (OASDI) program who has at least 6 credits out of the last 13 quarters, ending with the quarter of death, disability or entitlement to retirement benefits Delayed Retirement Credit— credits used to increase the amount of your old-age benefit amount. You may earn a credit for each month during the period beginning with the month you attain full retirement age and ending with the month you get to age 70 Disability Insured— status of an individual that is insured for disability benefits under the OASDI program Experience Rating—(1) a method for rating group life/health insurance plans that uses the loss experience of the group to determine the premiums to be charged. (2) as applied to property or casualty insurance, the class or manual rate is adjusted up or down based on past loss experience (3) as applied to state unemployment insurance programs, firms with favorable employment records pay lower unemployment compensation tax rates Extended Benefits Program—provides up to 13 additional weeks of benefits in states with high unemployment to workers who exhaust their regular benefits Full Retirement Age—age at which full, unreduced retirement benefits are payable to beneficiaries under the Social Security Program Fully Insured—insured status of a covered person under the OASDI program—to be fully insured, 40 credits are required Hospital Insurance (Medicare Part A)—Part A of Medicare that covers inpatient hospital care, skilled nursing facility care, home health-care services and hospice care for Medicare beneficiaries Medical Insurance (Medicare Part B)—Part B of the Medicare program that covers physician’s fees and other related medical services. Most eligible Medicare recipients are automatically included unless they voluntarily refuse this coverage. Medicare Advantage Plans (Part C)—Part C of the Medicare program; private health care plans that allow beneficiaries to chose alternates to the Original Medicare Plan, like Medicare HMOs, Medicare PPOs, Medicare special needs programs and Medicare private-fee-for-service plans. Medicare Prescription Drug Coverage (Part D)—Part D of the Medicare program that covers prescription drugs—beneficiaries have a choice of Medicare prescription drug plans Primary Insurance Amount (PIA)—monthly cash benefit paid to a retired worker at the full retirement age, or to a disabled worker eligible for benefits under the OASDI program Social Adequacy—the benefits paid by social insurance should provide a certain standard of living to all contributors, meaning benefits are heavily weighted in favor of low-income persons, large families and the presently retired aged 5 Social Insurance—government insurance programs with certain characteristics that distinguish them from other government insurance programs. Programs are generally compulsory, specific earmarked taxes fund the programs, benefits are heavily weighted in favor of low-income groups and programs are designed to help achieve certain social goals Unemployment Insurance—programs that are federal-state programs that pay weekly cash benefit to workers who are involuntarily unemployed 6 Lecture Notes – Exam 2 Important – example • Insurance industry has 2 sides –life/health (group/employer and individual/on your own) and property/car (home/auto) • Most people don’t have enough life insurance • Life insurers do not reevaluate your risk periodically • Premature death o In regards to the financial loss—this is when a person dies before their planned retirement age (retirement age is usually in their 60s) o Idea—once you retire, you are no longer earning income, only generating expenses, so the loss is related to the people who are financially affected by premature death (surviving spouse, children, business, etc.) o Still keep life insurance policy after you retire o A little adverse selection is inevitable in life insurance due to chance o Mortality curve in book (?) § One axis has annual probability of dying (between 0 and 1), age (probably up to 100) on other axis • How does life insurance work? (not on lecture slides) o Financial asset that accumulates savings value o Life insurance contracts have 3 key people § Policy owner (holder) – person with the right to name beneficiary, must have an insurable interest in the insured § Insured – when this person dies, a death benefit is paid § Beneficiary – this person receives the death benefit, but does not have to have an insurable interest • How do we decide how much life insurance to buy? (4 Methods) o Things to consider: preexisting assets, financial goals, financial obligations, preexisting conditions etc. 7 o Each method produces a different answer to “how much to buy?” as each considers different factors o Multiple of Earnings—considers age, income § Look at a table, find where age and income intersect, find multiple, multiply number by income to find how much insurance to buy o Human Life Value Approach—calls for present value of the family’s share (subtract out insured’s own living expenses/taxes/insurance premiums AKA self- maintenance) of the insured’s future earnings aka factors in the interest that the income could generate § Does NOT depict actual needs of family § Does NOT consider other assets/income (no social security, no investments) § Requires lots of projecting estimated income over estimated life span • Ch. 13 ppt, slide 4 § Needs Based approach—based on the estimated need of how long the surviving people live with idea that, if all estimations are correct, there will be no money left at the end of their estimated lives – survivors use part of the interest AND part of the capital each year • Book definition: the various family needs that would have to be met if the main breadwinner dies is calculated, then the total amount of existing life insurance and financial assets is subtracted. This remaining amount is how much life insurance should be posted § Capital Retention approach—same idea as needs approach but with a capital lump sum leftover – survivors only draw on interest each year to survive and capital amount is leftover at end of estimated life spans of survivors, needs are met with interest only • Will produce a higher amount of life insurance needed than needs based approach • Needs approach—what are the family’s needs? o Very comprehensive o Immediate § Debts: typically pay off credit card loans here because they have high interest rates o Income needs § Readjustment period—survivor may need to cut back hours due to grief or family obligations, like young child § Dependency period—may want to extend this until child is 21 or 22 on your policy § Life income—survivors may be entitled to social security benefits which would reduce needs o Special needs—what else do you want to plan for? Enough $ to pay off mortgage? Would your wife need to go back to school after you die or just stop working totally? Do you want your kids to want to go to college on this $? 8 • How do you calculate the needs approach? o Identify ALL sources of income and prepare a personal balance sheet o Determine all familial needs and necessary capital to meet them o Huge present value calculations to make • Two Main life insurance categories o Term insurance—does not accumulate cash value, not intended to still be the insurance you have at 90 yrs. old § Cons: Temporary, can be denied renewal based on age, premium can increase at end of term based on reevaluation of your risk § Pros: cheaper, renewable regardless of health, can’t increase premium a renewable policy based on health § At the end of every term, they increase your premium, and at a certain age they will not let you renew anymore o Cash-value/permanent/whole-life—accumulates cash value § If you want $1mil death benefit, term insurance premium is lower at the start but increases at end of each term // whole-life premium may be a little more in the beginning, but is FIXED o Death benefit = face amount of policy § Often cash value is LESS than face amount • Term Insurance o Term may expire before Joe expires o Renewable REGARDLESS of heath o Yearly-renewable o Convertible-term—can be changed to a whole-life insurance policy with a higher, annual premium that doesn’t increase, without having to reapply having to prove that you are still healthy § When converting, you cannot get more insurance than you had with your term policy § Ex. Say you have a convertible term-policy for $250,000—you can convert all OR some of it, so that after conversion, you have $250,000 to whole- life OR $50,000 whole-life and $200,000 term insurance (still = $250,000) • Uses and Limitations of Term Life Insurance o Appropriate when: § The amount of income that can be spent on life insurance is limited § The need for protection is temporary § Insured wants to guarantee future insurability o However: § Term insurance premiums increase with age and is inappropriate if you want to save money for a specific need • Types of Cash Value (whole life) insurance o Whole Life Insurance § Accumulation of cash surrender values 9 • Policyholders over pay in the beginning of their policies, which creates an accumulation of cash values • Policy owners have the right to borrow the cash value or exercise a cash-surrender option § Use and Limitation of Whole Life Insurance • Appropriate when: o Used as lifetime protection, tax shelter or a tool for savings • Major limitations: some people are still underinsured, effective rate of return on the cash value is not disclosed and loading for expenses are high compared to other investment options like mutual funds o Limited-Payment Life Insurance § Under limited-payment, the insured has lifetime protection, and premiums are level, but they are paid only for a certain period • Cash values grow more quickly the shorter the period over which premiums are paid § Single premium whole life policy—lifetime protection with ONE premium payment o Ordinary Life § Level-premium policy with lifetime protection § Premiums payable for life § Cash-value life insurance § Excess premiums paid during earlier years are used to supplement the inadequate premiums paid during the later years, creating a reserve which is approximately equal to the cash value o Variable Life § Fixed premium policy in which the death benefit and cash values vary according to the investment experience of a separate account maintained by the insurer § Entire reserve is held in a separate account and invested in other stocks and investments—if experience is favorable, face amount of insurance is increased § Cash surrender values are not guaranteed o Universal Life (Types A & B) § Flexible premium policy with lifetime protection § After the first premium, the policyholder decides the amount and frequency of payments 10 § The protection and savings components are unbundled • The policyholder’s statement shows the premiums paid, death benefit and value of the cash value account, and the mortality charge and the interest credited to the cash value account § Option A: pays a level death benefit during the early years—death benefit increases in later years to meet the corridor test required by the internal revenue code § Option B: provides for an increasing death benefit—the death benefit is equal to a constant net amount at risk plus the accumulated cash value o Variable Universal Life § Policy owner decides how premiums are invested § Policy does not guarantee a minimum interest rate or minimum cash value § Most are sold as investments § These policies have relatively high expense charges, front end loads for sales commissions, back end surrender charges and investment management fees • Single most important tax benefit for life insurance: death benefits paid to beneficiaries are not taxable for income tax purposes • You can delay paying on investments if the money is in a retirement account (Roth IRA), until you withdraw it • If you invest a death benefit, the interest it accrues IS taxable in regards to income tax, but the ‘principle’ is not • It is an option to leave the death benefit with the insurance company, and the insurance company will pay the beneficiary interest on the policy o Attractive option bc the insurance company will (lately) offer you a much higher interest rate than current interest rates on investment accounts § Interest rates are lower than they have EVER been!! o You can withdraw the death benefit at any time • Before the insured has ever died, interest is being added to cash value of the policy, which is not subject to income taxes • You cannot deduct premiums on taxes as an individual, businesses can deduct premiums if purchased as an employee benefit • If you cancel your policy and ask for your cash value, you might have to pay some income tax on the cash value • Over 5 mil when you die? Probably have to pay estate tax • Contractual Provisions o Ownership clause: policy owner possesses all contractual rights in the policy while the insured is living § Rights include: naming beneficiaries, surrendering policy for cash value, receiving dividends, taking a policy loan against cash value § Policyholder can designate a new owner through a process, aka the policyholder can transfer ownership (assignment) 11 o Incontestable Clause: the insurer cannot contest the policy after it has been in force two years during the insured’s lifetime § Insurer has two years to detect fraud, and the insurer can contest a claim after the incontestable period ONLY if: • The beneficiary takes out policy with intent to murder the insured • The applicant has someone else take medical exam • Insurable interest does not exist at inception of policy § Insurance doesn’t get into whether or not a misrepresentation on an application was an accident or not • Misrepresentations can be minor or material (major) – I wont expect you to know the difference between minor and material beyond obvious things (diabetic, cancer, etc.) o Suicide Clause: states that if the insured commits suicide within two years after the policy is issued, the face amount of the policy will not be paid, only the premiums will be refunded § Reduces adverse selection against insurer o Grace Period: life insurance policies have a period of 31 days to pay an overdue premium—gives policyholder additional time to pay without policy lapsing § Death benefit gets reduced by face amount less past due premium o Misstatement of age or sex § Death benefit is adjusted based on premiums actually paid § Incontestable clause doesn’t apply o Common disaster clause § Assume beneficiary died before insured if it cannot be definitely determined who died first § Why does that matter? As soon as the insured dies, the money belongs to the beneficiary. But if the beneficiary dies before the insured, they cannot own the death benefit. This is why insurers ask you to name a secondary/contingent beneficiary—the death benefit will now belong to the secondary beneficiary § Ex. Beneficiary and insured are in a car together and get in a fatal accident. When you don’t know who died first, you assume the beneficiary died first. If Joe (insured) and Jim (primary beneficiary) die in a car accident together, the death benefit belongs to Jack (the secondary beneficiary) o Disappearance of the insured § Missing but no sufficient evidence of death § Must be missing 7 years § Must keep paying premiums § If insured reappears after death benefit is issued, the beneficiary must return it with interest to insurer • Beneficiary: party named in the policy to receive the policy death benefit o If beneficiary dies before insured, the contingent beneficiary receives death benefit 12 o A revocable beneficiary—the owner of the policy has the right to change the beneficiary as long as the insured is still alive o Irrevocable beneficiary—you are giving up the right to change the beneficiary § Often used in cases of divorce § Beneficiary can be named irrevocable at any point o Specific beneficiary o Class beneficiary • 2 major causes of death (very general): Natural and Accidental o both causes are reflected in the premiums for life insurance o chances of accidental death are higher the younger you are • Coverage Options Life Insurance o Waiver of premium—if INSURED becomes disabled § If the insured becomes totally disabled from bodily injury or disease before some stated age, all premiums coming during the period of disability are waived § like disability income insurance ON your life insurance policy § If the policy owner and insured are two different people, you should probably get waiver of premium-payor for when policy owner/premium payer is disabled § Usually doesn’t add much to the premiums (like $25/yr.) o Accidental death benefit § Higher death benefit when death is accidental (ex. Car accident, falling off balcony, getting murdered) § How much higher? Depends…. doubling death benefit is most common § “Double Indemnity” is the term for this, movie about it called that o Accelerated death benefit § When insured is terminally ill § Pay an additional premium for this option § Paid to policy owner, NOT beneficiary § All OR some is paid before the insured dies § No additional amount paid when the insured dies § When death benefit is paid out early in this case, you don’t have to pay premiums anymore—policy basically doesn’t exist anymore § Ex. Insured becomes terminally ill with a $100,000 death benefit and you request early benefit. Insurance company says “ok, we will pay you $80,000 today and none when you die” § Hefty interest rate!!! 100/80= 25% interest rate!!! § The way this provision is written, requires specific conditions/diagnoses (for which there is reliable mortality data) in order to take advantage of this – all about variability and statistics and reliability of data § Viatical Settlement (started in about 1989) • Not from insurance company • When an investment firm buys the life insurance policy of a terminally ill insured person 13 • Company buys policy, you get immediate $, they name themselves beneficiary o Cost-of-Living Rider § Allows the increase of your death benefit each year based on inflation § Creates a little higher premium every year § Do not have to continually prove that you’re in good health § Often has a maximum percentage increase allowed per year § You can’t do this randomly—must do it every year • Surrender Options (DOES NOT APPLY to term insurance—applies only to whole life insurance) o Can not mix & match these options, must chose one o Lots of reasons why you might do this § Ex. Laid off and can’t afford premiums o Cash surrender value § Amount paid to a policy holder who surrenders the policy § Guaranteed minimum § No more insurance—policy basically doesn’t exist anymore after this o Reduced paid-up insurance § Take cash value of EXISTING policy, and use it to buy a DIFFERENT, WHOLE LIFE POLICY, with as much life insurance as you can with a single premium § Lower death benefit, permanent insurance § No more premiums due o Extended term insurance § Same death benefit, temporary insurance § No more premiums due § These people want the same benefit level but aren’t concerned with the fact that it is temporary • Why would people do this? The person is already really old, have a serious health problem, or terminal illness…they’re already not expecting to live very long • Annuities and Individual Retirement Accounts (IRAs) • Longevity Risk: you may run out of money before you die • Three main sources of retirement income 1. Employer sponsored retirement plans (two types) § Defined benefit: fixed monthly retirement income for life starting at normal retirement age for the rest of your life • Work for a company for 20 or 30 years, get to retirement age, company starts paying you X amount every month § Defined contribution: usually employer and employee make contributions, does not have a promised monthly retirement income for life 14 • Ex. 401(k)/matching plans, company puts .50 cents in for every $1 you contribute, which earns interest the whole time • Risky/more likely to run out of money 2. Social security: similar to defined benefit, also adjusts for inflation § Covers ALMOST everyone 60+ 3. Personal savings & initiative § Part-time employment after retirement § Any other source of $$ that social security/retirement plans, INCLUDING inheritance • Annuities o Annuity: a contract that promises to pay the recipient a periodic (usually monthly) payment § Some depend on life span (stops paying at death), some do not (keeps paying after death), can pay “up to 10 years,” can pay “at least 10 years” etc. § If annuity is based on how long you live, can be sold ONLY by life insurance companies bc mortality risk is factored in o Annuitant: a person who receives the periodic payment under an annuity o Annuity Benefit/Annuity Income: the periodic payment o Annuity Premium/Annuity Purchase Price/Principal: cost to purchase the annuity o Ex. Purchase price is $100,000 on 3/1/16 for 10 yrs. guaranteed § Benefits start 4/1/16 § for 120 mo., A (benefit) = $1,000/mo. § company pays out $1,000 every month for 10 years, and if you die in the middle of it, the rest will be paid to your beneficiary § when all is said and done, you get $120,000—extra $20,000 comes from the investment returns made from the company investing your $100,000 o Periodic Payment under annuity (three elements) § Principal—what annuitant paid for annuity (also known as premium) § Investment Earnings § Survivorship Element (life annuities, NOT annuities certain) • Annuitants that live LONGER than average time benefit from premiums paid by annuitants who live SHORTER than average time o Remember!! Insurers pool risk o Consider three annuitants, one lives to collect one benefit, one lives to collect two, and the third lives to collect three (average is two benefit payments)—premiums plus investment earnings must be adequate to cover two benefit payments • When do benefits begin? o Immediate—one payment interval (usually 1 month) after purchase § Ex. Pay premium on May 1, 2016; benefits begin on June 1, 2016 15 o Deferred—more than one payment interval after purchase, usually years after first premium is paid § Ex. Pay premium on May 1, 2016; benefits begin September 1, 2025 • What determines amount of monthly annuity benefit on immediate life annuity? o Premium paid—all else equal, higher premium produces a higher benefit o Age—older person, higher annuity benefit o Gender—males, higher annuity benefit bc lifespan is shorter o Period-certain guarantee—longer guarantee period lowers annuity benefit • ANNUITY PREMIUMS ON SLIDE 6 and 7 HAVE A ONE TIME PREMIUM • Immediate Annuity • How Long are Benefits Payable? o Annuity certain § Length of payments does not depend on how long the annuitant lives (if you don’t live for the whole time of the set annuity payment time period, the payments continue to a beneficiary” § You chose the length of time when you purchase the annuity § No mortality element/no survivorship element § Period Certain Guarantees (Slide 7) // same thing § Premium on a 10 yr. annuity would be more than a 20 yr. annuity o Straight/Pure life annuity § Ends when the annuitant dies § “life” in name of annuity—indication that the payment is directly tied to how long the annuitant lives § maximum survivorship element § consider: if annuitant dies before 1 month (first payment), the annuitant doesn’t get anything back § highest ratio of all types of annuities • for all annuities that pay as long as you live, monthly annuity benefit/premium purchase price o Life Annuity with Period Certain—not in slides § pays as long as you live, but also guarantees a minimum # of payments o Joint-and-survivor (a type of life annuity) § Payment is connected to more than one life § Assume 2 annuitants (husband + wife) § Pay as long as husband OR wife is alive § On average, pays longer than an annuity on only one person (because the chance of one person outliving the other is higher than them both dying at the same time) § The amount of $$ doesn’t decrease when one annuitant dies—there is a 100% survivor benefit o Cash Refund Guarantee § Pays as long as annuitant lives § Purchase price (p) minus annuity benefits up to the annuitant’s death (x) = cash refund 16 • Ex. Purchase annuity for $100,000 and live long enough to get back $84,000, $16,000 gets paid back to your beneficiary • “I won’t expect you to calculate benefits or refunds, but you should understand the general idea” • if premiums are the same “there cannot be one annuity that is better than another in EVERY way” o Temporary Life Annuity § No other annuity has a maximum # of payments § Benefits end at death if the annuitant dies before max # of payments § Higher monthly benefit than a period certain for same amount of time • Consider: for the same benefit…. o I want $1,000 benefit every month—which policy has higher premium? Life annuity 20 year (vs life annuity 10 year) o life annuity period certain (vs pure life annuity) • Is the Annuity Fixed or Variable? o Remember: variable is referring to how you want your premium invested and the ROR you want o Fixed: insurance company invests and takes on all risk o Equity-Indexed Annuity § Guaranteed minimum rate of return § Plus potential for higher return § Classified as a FIXED annuity • Individual Retirement Accounts o Two types: traditional and Roth o Traditional has been around longer o Traditional IRA § Your contribution is tax deductible aka lower your income tax § Withdrawals are taxed as income tax § If a married couple makes $100,000+, you can’t have one of these (based on current year’s taxable income) o Roth IRA § Not tax deductible § Withdrawals are not taxable § If a married couple makes $190,000+, you can’t have one of these (based on current year’s taxable income), which makes more people eligible for these times of IRAs • ***Annual $$ contributions are limited (Roth + Traditional) cannot exceed $5,500 o Conversion § When you move all your money from a traditional to a Roth § You have to pay income taxes on traditional withdrawal but not on roth deposits o Rollover § Employer retirement plan à IRA account 17 • Reasons for Social Insurance o Need to solve social problems that affect a large portion of society o Most people financially unable to insure against personal loss exposures throughout life § Personal loss exposures-premature death, disability loss, loss of health, loss of income o Many Americans expect the government to provide at least a degree of economic security against personal loss exposures o Some people don’t want the government not to get involved at all o Social security is social insurance • Characteristics of Social Insurance o Compulsory employment related coverage § Widespread participation needed to reduce average cost and administrative cost o Partial or total financing § Employer or employer and employee pay bills o Benefits prescribed by law § Not necessarily uniform for everyone § Covered persons cannot change benefit levels o Benefits as a matter of right § Under presumption of need rather than needs test o Emphasis on social adequacy § Minimum floor of the income to all beneficiaries (and max benefits) § Contributions may be higher or lower than expected benefits o Not Needed in Social Insurance: Means test- must show you need it § Medicaid § Food stamps • Expected benefits/ expected costs o Expected benefits: social security retirement $ o Expected cost: what you pay Ex. Social security taxes o Social security doesn’t look at demographics or salary to determine benefits • Social Security (OASDI) & Medicare (HI) o Old-Age- Retirement o Survivors insurance o Disability insurance o Hospital insurance § Medicare part A o Supplemental medical insurance § Medicare part B o Medicare prescription drugs 18 § Medicare part D • Social Security & Medicare- tax rates and wage bases (employee portion) o Social security taxable wages= $118,500 o Social Security Tax Rate= 6.2% o Medicare Taxable Wages= no limit (all earned income) o Medicare Tax Rate= 1.45% o Social security taxes collected is about $850 billion § Payout= $800 billion o When cash in is greater than cash out they put money in a trust fund § The trust fund is putting the money in treasury bonds o About 57 million beneficiaries • SS- Retirement Benefits 1 (see chart slide 6) o Fully insured worker is eligible as early as age 62, but benefit is permanently reduced § “early” in relation to NRA o Full Retirement Age § Non-reduced retirement benefit § Aka “normal retirement age” NRA § Benefit known as “primary insurance amount” o To get social security, you must pay into it for 10 years and pay the minimum amount o Cost of living adjustments applies to everyone • Adequacy of financing o Current gov’t debt is $19 trillion right now o But assets = liabilities and the US gov’t has a TON of assets—land in the US (more than 600 million acres in the country, which covers tons of oil and natural gas reserves) • Unemployment insurance o Usually must have worked during prior 52 weeks and earned a minimum amount of wages and/or worked a minimum period of time o Must actually be unemployed when you apply and don’t receive benefits for 1 week o Joint federal and state financing o Be able and available to work and actively seeking work o Payroll taxes are paid BY EMPLOYER (1% of payroll is the payroll tax, but it’s higher the more employees a company lays off on a regular basis— “experience rated”) so employee doesn’t pay for it at all o Free of disqualifications § Voluntarily left work without good cause • Being laid off or fired is involuntary, so it is a good cause § Discharged for misconduct § Refused to accept suitable work 19 o Avg weekly benefit is $300, can get regular benefits for max of 26 weeks, can get it extended for 13 weeks o 35-40% of unemployed people receive benefits (most of the rest of people don’t qualify or have exhausted their benefits) o been around about 80 years in the US • Social Security—last comments o Max retirement benefit $2,639/mo. o Average retirement benefit $1,341/mo. • Medicare—last comments (from article he said he will send out) o Demographics of Medicare beneficiaries § 55% female, 45% males – females live longer § 77% are white § 44% are 65-74 years old § 13% are 85+ years old § 16% are under 65 years old • to get Medicare under 65, you must have been on SS Disability benefits for at least 2 years § Half the people on Medicare have household annual incomes of $23,500 § 5% of people have household annual incomes of $93,900 or higher o What benefits are used the most? 1. Prescription drugs – most common 2. Physician office visit 3. Inpatient hospital stay 4. Home health visit 5. Skilled nursing facility stay (under 1 year in duration) 6. Hospice days o 70% of Americans are on at least one medication • What is Medicare Advantage? o A substitute for Medicare A and B o You cannot have all 3 in any given year, A and B OR C o Dual eligible – people who are eligible for both Medicaid and Medicare o Almost $2 of every $4 government spent dollars is spent on Medicare, Medicaid and Social Security • How is Medicare paid for? o 88% of cost of Part A is paid for by tax o about ¼ of cost for Part B (for gov’t) is covered by the premium (paid by insured) for part B – “I’d like you to know this” • Review from last class o Characteristics of social insurance § Compulsory employment related covered o Medicare Part A & B § Fed gov’t is the insurance company o Medicare Part C § Private insurance § Substitutes for parts A & B o Normal retirement age depends on the year you were born!!! 20 • SS—retirement benefits 2 o Certain people who have a special connection to the worker have the right to receive a benefit, but are not entitled to the same amount of $ § Ex. if Joe is getting $1,000 a month, his spouse/children can get, at most, $500 (half) o Family maximum—maximum amount of total benefit that his dependents/spouse can get in connection with him from SS o Benefits of retired worker receiving benefits § Spouse age 62+ (even if spouse has never paid into social security) § Divorced spouse, if married 10+ years § Spouse of any age if they are caring for the retired worker’s children under age 16 § Dependent, unmarried children under the age of 18 § Disabled children of any age disabled before age 22 o You can collect EITHER on your OWN earnings…OR…the earnings of your spouse—but you can’t get both • SS—Retirement benefits 3 o The longer you wait to collect your benefits after retirement, you get more $ a month o No increase after 70 years old o 8% increase per year, 24% increase at 70 o Primary Insurance Amount—social security benefit, based on normal retirement age o VERY basic explanation of how benefit is calculated § Only wages up to taxable wage base are used § Highest 35 years included, converted to a monthly amount § Lower layers of indexed wages receive more weight in calculation of benefitàlower income earners receive higher benefit as percentage of pre-retirement income than high income earners § Inflation adjustments are done • SS—Disability benefits o If you become disabled AFTER retirement age, you get the normal SS benefit o Still some minimums of how long you’ve had to pay in, but its not as long as 10 years (like retirement) o Must meet SS definition of disability: mental or physical impairment that prevents the worker from engaging in any substantial gainful employment, must be expected to last 12 months or result in death § Substantial: $1,090+ a month or more § People may thrk and still get disabilities o Benefits begin in 6 full calendar month of disability o Disabled spouse/dependent children may also be eligible • Adequacy of Financing o Cash inflows (SS taxes + interest in trust funds) – cash outflows (benefits + administrative costs) 21 § If the CI > CO then the excess goes into a trust fund that buys U.S. gov’t bonds o Four separate trust funds § Retirement and survivors § Disability § Medicare A (hospital insurance) § Medicare B (physicians services) o Trust fund surplus invested in treasury obligations (US gov’t debt) o Significant reforms in 1983 o SS trust funs projected to run out in 2033 § Projected to keep growing until 2020 § Projected to have enough cash flow to cover 77% of promised benefits through 2087 o Medicare trust funds projected to run out in about 2026 § 1.45% for part A § Beneficiary pays premium, which covers part of the cost (the rest is covered by general revenues of the gov’t) —part B • 65 or older OR been on SS Disability for 2+ years o Changes to increase revenues or decreased benefit costs § See insight 18.2, ch 18, “what are your solutions for reforming social security?” (pg. 392) • Notes on Medicaid (slide 11) o Nations publicly-financed medical and long-term care insurance coverage program for the poor o Medicaid is financed partly by the federal gov’t and partly by the state o Covers 70 million low-income Americans (1/5 of the population) o $414 billion annual expenditures § 65% on elderly and disabled § About ½ the people on Medicaid are children, but they account for 21% of the cost o Main source of financing long-term care • Over 100 million people on Medicare OR Medicaid—roughly 1/3 of the population • “I won’t ask you a specific dollar amount” • Medicare DOES NOT cover long term care!!! Aka assisted living/nursing home for over a year 22 Review for Exam 2 in-class 3/15 • Know that social security is based on your highest 35 years of income • Original retirement age is 65, retirement age now is 67 • “Roth” – $ goes in on an after-tax basis, so no income tax when withdrawing $ • Delayed collection credit on retirement—8%/yr o can’t delay past 70 years old • Social security is defined benefit • Remember, assume beneficiary died first if you don’t know • Grace period is 31 days, but death benefit is reduced by past due premiums if insured dies during grace period • Death benefit, premiums, and dividends from death benefits are not taxable for income tax purposes • Pure life annuity: maximum income per dollar premium • Reasons for social insurance o Need to solve social problems that affect a large portion of society o Most people financially unable to insure against personal loss exposures throughout life o Personal loss exposures—premature death, disability, loss of health, loss of income o Many Americans expect the government to provide at least a degree of economic security against personal loss exposures • Medicare Part C is a SUBSTITUTE for part A and B! • Know who is eligible for disability benefits • Variable universal—you get to chose how the $ is invested • Universal Life Insurance o Option A—death benefit is level, so as the cash value goes up, the net amount at risk goes down o Option B—if your cash value goes up by $100, your death benefit goes up by $100— constant net amount at risk, with cash value added to calculate death benefit 23 • Difference between Medicare and Medicaid o Medicare is a federally funded program that provides healthcare coverage if you are 65+ years old or have a severe disability, no matter your income § Social insurance o Medicaid is a federal and state program that provides healthcare coverage if you have very low income § MUST show financial need § Not social insurance • Summary of A Primer on Medicare (from email) o What is Medicare? § Medicare was established in 1965 under Title XVIII of the Social Security Act to provide health insurance to people age 65 and older, regardless of income or medical history. § Medicare benefits are divided into four parts: • Part A: hospital insurance—inpatient care, skilled nursing facility, home healthcare, hospice • Part B: medical insurance—physician’s fees, outpatient, some home health and preventative services • Part C: Medicare advantage – private plans • Part D: prescription drugs o Who is eligible/what does Medicare cover? § Most people age 65 and older are eligible for Part A, as are some people under age 65 with permanent disabilities and those with ESRD or ALS. § People eligible for Part A are also eligible for Part B. § People may choose to enroll in Part C, also known as Medicare Advantage, if they are entitled to Part A and enrolled in Part B. § People are eligible for Part D prescription drug coverage if they are enrolled in Part A, Part B, or both o What are the characteristics of people with Medicare? § Medicare covers a population with a diverse profile in terms of demographics and health status. A majority of be
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