Lecture 8-Insurance

Question 1

The importance of insurance/protection.

Answer 1

• Protection is the foundation of wealth accumulation.
• Protection needs to be in place for protecting ourselves and our loved ones from the negative impact of potential loss and misfortune.

Question 2

What is human capital explained by economists?

Answer 2

-is arguably the most important and irreplaceable asset that needs protection. The value of human capital is defined as the present value of lifetime earnings. Therefore, its value is maximum in the early years of life and gradually reduces with time.

Question 3

What is financial capital?

Answer 3

(for example house, car and other assets) moves in the opposite direction and its value increases with the passage of time.

-al capital, on the other hand, moves in the opposite direction and rises over
time, as human capital is assumed to transform into financial capital through savings and investments

Question 4

What are the different types of insurance/protection?

Answer 4

• General insurance

- Life and health insurance

Question 5

What is general insurance?

Answer 5

provides protection against the loss of financial capital. Examples of general insurance include car insurance, building insurance, contents insurance etc

Question 6

What is health and life insurance

Answer 6

-products provide protection against the loss caused to human capital arising from:

The risk of premature death
The risk of poor health
The risk of unemployment

Question 7

What is human capital and the importance of it?

Answer 7

• measure of an individual’s skills, knowledge, abilities, social attributes, personality and health attributes and is measured in monetary terms as the total potential future earnings.
• Human capital is different from traditional financial assets as it is illiquid. Future earnings cannot be sold for immediate consumption
• Over time, with career progression, human capital is transformed into financial capital through savings. Even for investors in their 50s it is assumed that human capital represents at least half of their total wealth.
• Human capital decreases when we reach 60 years of age and so it is imperative to have other forms of capital to sustain us after that age.

Question 8

Why is human capital hard to quantify?

Answer 8

-The value of human capital is hard to quantify as it involves not only an estimate about our current worth but also involves making key assumptions about our future potential, training, education and earnings growth

Question 9

What are the 3 types of risk exposed to human capital?

Answer 9

• Risk of premature death
• Risk of poor health
• Risk of unemployment

Question 10

The impact of premature death on families

Answer 10

• The greatest risk to human capital is premature death, defined as the death of a breadwinner with financial obligations, normally before the age of 75.
• These obligations include the need to support dependents, pay the mortgage and maintain school fees.
• The death of the breadwinner can create financial difficulties for the surviving family members if they do not have financial resources to replace the lost income or their replacement income is lower than what they have been used to.

Question 11

Global health risk ratings

Answer 11

• High blood pressure
• Smoking
• High BMI
• Diabetes
• Diet in salt
• Diet low in fruits
• Air pollution
• Household air pollution
• High cholesterol
• Alcohol use

Question 12

UK health risk rating

Answer 12

• Smoking
• High blood pressure
• High BMI
• High cholesterol
• Low physical activity
• Diet low in fruits
• Diabetes
• Kidney diseases
• Alcohol use
• Diet low in vegetables

Question 13

The impact of premature death on families

Answer 13

Firstly, the human life value of the breadwinner is lost forever. This loss can be substantial.

Secondly, additional expenses may be incurred because of funeral expenses, probate and estate settlement costs and inheritance taxes. Many people may not be able to afford these costs.

Thirdly, some families might struggle to make ends meet due to insufficient income. Some may even lose their homes if they cannot afford to pay mortgage instalments

Question 14

How to mitigate the risk of premature death?

Answer 14

• Self-insure through personal savings

- Take out life insurance

Question 15

What is life insurance?

Answer 15

also known as life cover or life assurance is a way to help protect your loved ones financially if you were to die during the length of your policy

-You choose the amount of cover you need and how long you need it for and you can pay your premiums monthly or annually. In return, your family has the reassurance of knowing that if you died while covered by the policy they could receive a cash sum pay out if a valid claim is made.

Question 16

What is the advantage of a life insurance?

Answer 16

-Is that you will have immediate access to the capital.

Question 17

What is a disadvantage of precautionary saving?

Answer 17

requires time to

build up the required savings/capital, and exposes individuals to insufficient funds in the meantime.

Question 18

What are the advantages of precautionary saving?

Answer 18

First, the risks to be covered do not need to be specified in a formal contract. Insurance only covers risks defined in the insurance contract.

Second, there might be high costs involved in getting insurance policies as individuals might need several to cover different types of risks, whereas the costs for precautionary saving are quite low.
One saving account might be sufficient.

-Third, unused precautionary savings can be used for alternative consumption or for any purpose if the risk decreases, whereas
any unused premiums are usually lost

Question 19

What are the factors affecting insurance?

Answer 19

• Capital needs
• Short term capital needs
• Income needs

Question 20

Capital needs as a factor affecting insurance purchase

Answer 20

-The amount needed to pay off any mortgage and any other loans, set-up an emergency fund, legacies and any inheritance tax liability.

Question 21

Short-term capital needs as a factor affecting insurance purchase

Answer 21

-this is the amount needed to take care of costs such as funeral expenses.

Question 22

Income needs affecting insurance purchase

Answer 22

-this is the amount required to replace the loss of income and may include the provision for income to support the children’s education and upbringing, and income required to support a dependent relative or a partner.

This is an important consideration because without an income, surviving family members may live in impoverishment

Question 23

What are the types of insurance covers?

Answer 23

Families should insure a lump sum amount worth between 5 and 10 times someone’s annual salary.

People buy two main types of insurance covers

• Term Insurance
• Whole of Life Insurance

Question 24

What is term insurance

Answer 24

-Term Insurance provides coverage for a limited (fixed) period.

Benefits are paid only if death occurs in within this period.

The chances of death at a young age below 65 are low.

As this insurance provides benefits for a short period, it is a cheaper option compared to whole of life cover.

Question 25

What is whole of life insurance

Answer 25

-Whole of life insurance has no expiry date and the policy pays out whenever the death occurs.

Whole of life insurance has to elements to the policy, i.e. investment and insurance.

As the policy has an investment element, the policy may have value when policy holder decides to cancel the policy. Term insurance, on the other had has no value if cancelled before death/maturity.

Question 26

Risk of poor health

Answer 26

• Accident or illness can result in taking time off work, loss of earnings and financial problems.
• The risk of being off work due to illness or accident is much higher than death.
• There is also a risk of critical illness which is life threatening and full recovery may not be possible. This may include cancer, heart attack and strokes.

Question 27

How to mitigate the risk of poor health?

Answer 27

UK healthcare system (NHS) provides some support.

Benefits can be claimed for disability.

However, these benefits are very insufficient to finance average monthly expenses.

Precautionary savings can assist in dealing with financial hardships in the event of illness or accident. . However, savings may deplete leading towards financial difficulty especially in the case of expensive or prolonged illness.

Various insurance covers can be used to protect against these risks.

Question 28

What are the 3 types of insurance covering poor health?

Answer 28

• Accident and sickness
• Critical illness cover
• Income protection

Question 29

What is Accident and sickness insurance?

Answer 29

-It is a short term policy, providing cover for up to 2 years. Benefit is usually a fixed sum not related to earnings.

Question 30

What is critical illness cover?

Answer 30

• Pays a lump sum or income in case of diagnosis. This cover may be complied with life insurance cover.
• A critical illness often requires a 3days’ survival before pay-out. Death before 30 days often results in non-payment.

Question 31

What is income protection?

Answer 31

Permanent Health Insurance: Provides cover for long term disability. It provides cover until the insured gets better or retires.

• This cover allows to protect a large percentage of their income, that is, up to 75%, which is paid out tax free.
• This cover is good for high earners as it provides cover based on income instead of expenses

Question 32

Risk of unemployment as insurance option

Answer 32

Loss of employment poses another threat to financial security.

-Unemployment can result from business cycle downturns, seasonal factors, structural and technological changes in the economy as well as imperfections in the labour market.

Question 33

How can prolonged unemployment cause financial difficulties

Answer 33

-Firstly, individuals lose their earned income and benefits associated with their employment.

Secondly, they may only apply for part-time jobs due to economic climate.

Thirdly, savings may deplete as individuals dip into these to fund themselves

Question 34

How to mitigate the risk of unemployment?

Answer 34

-Redundancy insurance is a short-term income protection policy providing cover for up to 12 months should you be unable to work due to involuntary redundancy. It can be used to protect things such as your income, mortgage payments or loan and credit card repayments.

Question 35

How are the young affected by unemployment?

Answer 35

-Young people’s concentration in assets comes from human capital.