05. Insurance Planning Flashcards

1
Q
  1. What are the seven stages of adult life?
A
  1. Youth (independent)
  2. Young couples (interdependent)
  3. Young parents (dependent)
  4. Established parents (dependent)
  5. Mature parents (dependent)
  6. Pre-retirees (interdependent)
  7. Retirees (interdependent and independent)
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2
Q
  1. What are the types of insurance that should be considered for each age bracket?
A
  • Temporary disability
  • Death
  • TPD
  • Medical trauma
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3
Q
  1. What are the three needs required to be met after the death of a person?
A
  • Money to cover the cost of the death
  • Money to repay debts
  • Money to replace the family income.
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4
Q
  1. What needs are included in the ‘first need’ which is cost associated with death?
A
  • Funeral and burial expenses
  • Expenses of final illness
  • Legal fees and probate costs
  • Government charges
  • The cost of child care
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5
Q
  1. The ‘second need’ of death cover is covering debt. What is included in these costs?
A
  • Home mortgage
  • Hire purchase debts and credit cards
  • Personal or business loans
  • Unpaid bills
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6
Q
  1. What are three key statistics with disablement?
A
  • 7 of 20 men aged 25 will be disabled for 3 months or more before age 65
  • 10% of disabilities will be permanent
  • For every person killed on Australian roads 30 are hospitalised
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7
Q
  1. What questions need to be answered to determine the level of disability insurance required?
A
  • What benefits would come from the employer and for how long?
  • Would govt welfare or workers comp be enough to maintain a comfortable standard of living?
  • Could someone in the family assist personally or financially?
  • Would savings be sufficient to supplement income?
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8
Q
  1. What are the costs of living that are required to be met?
A
  • Mortgage repayments
  • Car repayments
  • Repayments on loans and credit cards
  • Children’s education
  • Bills - electricity, gas and phone
  • Food and clothing
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9
Q
  1. What benefits are available in a lump sum in the case of TPD?
A
  • Some superannuation plans
  • Workers comp only for certain specific injuries
  • Social Security does not.
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10
Q
  1. What are the three approaches to determining the amount of life insurance needed?
A
  • Human life value approach
  • Needs approach
  • Capital retention approach
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11
Q
  1. What is the human life value approach to determining insurance?
A

It looks at the present value of the family’s share of the deceased breadwinner’s future earnings.

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12
Q
  1. How is the human life value approach calculated?
A
  1. Estimate average annual earnings over lifetime
  2. Deduct taxes, life / health insurance premiums and money used for insured’s hobbies
  3. Determine number of years from not to retirement
  4. Using a reasonable discount rate, determine the present value of the family’s share of earnings
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13
Q
  1. What are the problems with the human life value approach?
A
  • Other sources of income are not considered
  • Income and expenses are assumed to remain consistent - which is unrealistic
  • Amount of income allocated to family is a critical factor but doesn’t take into account other factors (death in family)
  • Long run discount rate is critical, get this wrong and the amount may fall very short
  • The effect of inflation on earnings and expenses are ignored
  • It may not be necessary or affordable.
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14
Q
  1. What is the needs approach also known as?
A
  • the Capital liquidation approach
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15
Q
  1. What is the ‘needs approach’ to determining life insurance?
A
  • All the needs of the family are considered, along with all sources of income and future requirements.
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16
Q
  1. What are the family needs considered?
A
  • Estate clearance fund - cost of death
  • Income during readjustment period - 1-2 years
  • Income during the dependency period - till youngest child reaches 18
  • Income to the surviving spouse
  • Special needs - mortgage redemption fund and educational fund
  • Retirement needs
17
Q
  1. What is the purpose of a mortgage redemption fund
A

If interest rates on the mortgage are well below the current interest rates this may be used as a way to meet repayments while investing the full value. Care should be taken in this method because interest rates change.

18
Q
  1. What are the advantages of the needs approach?
A
  • Reasonably accurate method for determining amount of life insurance to own
  • Considers other sources of income and financial assets
  • Quick to identify if there are inadequacies in cover
  • Can be used to recognise needs during disability or retirement
19
Q
  1. What are the disadvantages of the needs approach?
A
  • Assumes life insurance settlement options are used to disburse the proceeds.
  • A computer is necessary to determine insurance amount
  • Needs re-evalutation periodically to determine changes
  • May or may not take into account inflation
  • Does not consider preservation of the estate for children
20
Q
  1. What is the capital retention approach and what is its alternative name?
A

Also called capital needs analysis, it preserves the capital needed to provide income to the family and leaves income-producing assets for distribution later to children.

21
Q
  1. How is the amount of life insurance calculated under the capital retention approach?
A
  • Prepare a personal balance sheet of asset and liabilities
  • Determine the amount of income-producing capital - from the assets take off all liabilities, money required for final expenses, Emergency / Education fund and any non-income producing capital included in the assets ie. Car and equity in home). This gives the amount of capital available for investment. Assume an interest rate, say 5%, which means the annual income provided would be the amount of capital available multiplied by 5%.
  • Determine the amount of additional capital needed (if any). If this works out to be $5K a year and you need $20K, then you are short $15K, divide this by the interest rate 15,000 / 0.05 = $300,000 is required.
22
Q
  1. What are the advantages of the capital retention approach?
A
  • Simplicity and ease of understanding
  • Preservation of capital (living only off income)
  • Emergency and education funds can be used as a partial hedge against inflation
23
Q
  1. What is the major disadvantage to this approach?
A

A larger amount of life insurance is required to produce a given amount of income.