Section 4 - R23 - Risk Management for Individuals

Question 1

Human Capital (Definition)

Answer 1

PV of future earnings and wages. Often the dominant asset in a household balance sheet

Question 2

Finance Capital (Definition)

Answer 2

Funds available for investment. They may be personal (for consume, eg house, furniture, auto) or investment (stocks, bonds, accrued pension plans)

Question 3

Financial Stages fo Life (List)

Answer 3

1. Education
2. Early Career
3. Career Development
4. Peak accumulation
5. Pre Retirement
6. Early Retirement
7. Late Retirement

Question 4

Traditional v. Economic Balance Sheet

Answer 4

Traditional: Asset - Liability = Net Worth

Economic: PV assets - PV current and implied liabilities = Net Wealth

Question 5

Investment Assets (Definition)

Answer 5

Investment assets are the components of an individual’s wealth

Question 6

Publicly Traded Marketable Assets (List)

Answer 6

Bonds, equities, REITs

Question 7

Non Publicly Traded Marketable Assets (List)

Answer 7

Real Estate, Annuities, Cash-Value Life Insurance, Business Assets

Question 8

Non Marketable Assets (List)

Answer 8

Employer Pension Plan (mNPV = taxa de NPV ajustada pela mortalidade), Government Pensions

Question 9

Economic Net Worth (Definition)

Answer 9

Net Worth = Assets - Liabilities

Economic Net Worth = Extend to Future Assets, eg Human Capital and PV of Pension Benefits

Question 10

Risk Management Strategy for Individuals (Framework)

Answer 10

1. Specify the objective
2. Identify risks
3. Evaluate risks and select appropriate methods to manage the risks (avoid, reduce, accept, transfer)
4. Monitor outcomes and risk exposures

Question 11

Economic Balance Sheet Items (List)

Answer 11

Assets: Human Capital, Pension Value

Liabilities: Mortgage, Bequests, PV of Lifetime Consumption

Result = Economic Net Worth

Question 12

Contrast Traditional Balance Sheet v. Economic

Answer 12

A traditional balance sheet includes assets and liabilities that are easy to quantify. An economic balance sheet provides a useful overview of one’s total wealth portfolio by supplementing traditional assets with human capital, pension wealth and additional liabilities, such as consumption and bequest goals.

Question 13

Individual Risk Exposures (List)

Answer 13

1. Earnings Risk (earnings potential of an individual)
2. Premature Death Risk
3. Longevity Risk (uncertainty of how long retirement will last)
4. Property Risk (damaged, destroyed, stolen or lost)
5. Liability Risk (legally liable for some financial cost)
6. Health Risk (illness or injury)

Question 14

Life Insurance (Definition and Types)

Answer 14

Insurance that protects a beneficiary from the loss of human capital due to someone’s death, affecting dependents from that individual’s earnings.

• Temporary (for certain period of time)
• Permanent (lifetime coverage)

Question 15

Life Insurance Elements (List)

Answer 15

• Term
• Type (Permanent or Temporary)
• Amount of Benefits
• Identity of the insured
• Policy Owner
• Beneficiary

Question 16

Insurable Interest (Concept)

Answer 16

An insurable interest means that the policy owner must derive some type of benefit from the continued survival of the insured that would be negatively affected should the insured pass away. Objetivo é que apenas pessoas emocionalmente ligadas à vida do segurado possam contratar seguros, de modo a previnir fraudes.

Question 17

Life Insurance Determinants (List)

Answer 17

• Mortality Expectations (actuarial estimates based in historical data and future expectations)
• Discount Rate
• Load (Other Expenses and Profit) = sales, physical exams, issuance, monitoring etc

Question 18

Net Premium and Gross Premium (Example)

Answer 18

150k policy for 1y with 0.15% mortality @ 5.5% discount rate

PV 1 = 0.015100k / 1.055
PV 2 = 0.99850k / 1.055
Net Premium PV Total = PV1 + PV2

Gross = Sum Loads (expenses and profit for the company)

Question 19

Premiums (Characteristics)

Answer 19

• Premiums for level term policies are higher than annually renewable policies in the early years

Question 20

Cash Value Insurance Policy (Concept)

Answer 20

Insurance Policy that provides the accumulation of a cash reserve based in the premiums paid. The cash value within the policy may be (1) withdrawn by the owner when policy matures or when he terminates the policy or (2) can be borrowed as a loan while keeping the policy in force.

Question 21

Premium Types in Policy Reserves

Answer 21

• Renewable
• Renewed each 10y
• Fixed for the whole life

Question 22

Comparison of Life Insurance Costs (Concept)

Answer 22

Cost per year of 1,000 coverage

1. Net Payment Cost Index: PV Future Premiums / PV Future Death Benefits.
   LOW = Good
   HIGH = Bad

• Surrender Cost Index: Custo de Resgate. Custo de Resgate Futuro / PV Premiums Futuros. Cost associated with surrendering, or terminating, a life insurance policy early.
  LOW = Good
  HIGH = Bad

Question 23

Policy Reserves (Definition)

Answer 23

Amount of money that an insurer (Itaú Seguros) sets aside in liabilities to cover its future obligations to policyholders

Question 24

Calculation Methods for Life Insurance Needs (List)

Answer 24

1. Human Life Value Methods: Replace the estimated net contribution to family finances that the insurance would generate. Salário do morto pra família beneficiária.
2. Needs Analysis Method: Soma dos custos dos beneficiários.

Question 25

Disability Income Insurance Types (Definition)

Answer 25

1. Inability to perform one's regular occupation (inapto a ser analista de crédito de IFs). Residual disability. 2. Inability to perform any regular occupation for which he is suitable (inapto a ser bancário). Partial disability. 3. Inability to perform any occupation (tetra)

Question 26

Disability Income Insurance Characteristics

Answer 26

- Benefit Period - Elimination Period (carência) - Rehabilitation Clause (paga a fisio) - Waiver of Premium (Não precisa mais pagar prêmio - em caso de sinistro) - Option to Purchase Additional Insurance Rider (allows the insured to increase coverage without further proof of insurability) - Non-cancelable and Guaranteed Renewable Policy - Inflation adjustments

Question 27

Property Insurance (Definition)

Answer 27

Insurance against one's property risk (including the risk of being damaged, destroyed, stolen or injuried). It may apply for homeowners or renters. It may include the risk of a housefire, automobile collision, stolen items and furniture or jewelry. It may be based in replacement cost.

Question 28

Deductible in an Insurance Policy (Concept)

Answer 28

Deductible é a franquia. Amount to be paid by the beneficiary in the case of an insurance claim before it receives additional financial coverage from its policy claim.

Question 29

Permanent Life Insurance (Types)

Answer 29

a. Whole Life: entire life, ongoing fixed premiums, generate cash value, non-cancelable, participating or not (value may grow) b. Universal: flexible, premium may be high or low, insurance stays in force as long as premiums are paid or cash value > policy expenses

Question 30

Riders (Definition and Examples)

Answer 30

Riders are additional provisions or clauses that can be added to a basic life insurance policy to modify its terms or provide additional coverage for specific circumstances. Examples: 1. Accelerated Death Benefit (if diagnosed as terminal) 2. Guaranteed Insurability (right to purchase more coverage a t predefined intervals) 3. Waiver of Premiums: if policy holder becomes disabled.

Question 31

Property Insurance (Types)

Answer 31

a. Homeowner Policy: Risks associated with personal property - Replacement cost or cash value - Deductibles (higher = lower premium) b. Auto Insurance: Collision v. Comprehensive (geralzão pra danos). Deductibles. Often mandatory.

Question 32

Health Insurance Characteristics

Answer 32

1. Risk Pool: premium collected for a group of individuals in order to diversificate the risk of filing claims. 2. Coverage Limitations: policies specifically define the covered and uncovered medical procedures and diseases. They also may be comprehensive. 3. Preexisting Conditions: they may have exclusions for pre-existing conditions.

Question 33

Health Insurance Items (List and Definitions)

Answer 33

1. Deductibles: Minimum amount policy that holder pays (franquia) 2. Coinsurance: Percentage that insurance company pays above the deductible. 3. Copayment: Fixed payment that holder must pay for obtaining particular services 4. Maximum Out-Of-Pocket 5. Maximum Yearly Benefit 6. Pre-Existing Condition

Question 34

Liability Insurance (Definition)

Answer 34

- Personal Umbrella Liability Insurance Policy

Question 35

Annuities (Definition)

Answer 35

Financial product that provides a series of regular payments to an individual over a defined period of time, typically until the end of their life. They are used as a retirement income vehicle, but can also be used for other purposes such as funding education expenses or providing a guaranteed stream of income.

Question 36

Annuity Parties (List)

Answer 36

1. Insurer 2. Annuitant 3. Contract owner (typically the annuitant) 4. Beneficiary

Question 37

Annuity Classifications (List)

Answer 37

1. Immediate (Pay now, Receive now) or Deferred (Income Stream Begins at a Later Date) 2. Fixed or Variable (like Mutual Fund but structured as an insurance, may include death benefit) Note: Payout for both is similar. Immediate Fixed is the most common. Add: Advanced Life Deferred Annuities (Pure Longevity Insurance - ALDA).P

Question 38

Health Insurance Types (List)

Answer 38

1. Indemnity Plan: Essential is covered + % of the "Reasonable + Customary" Fees 2. Preferred Provider Organization (PPO): network of physicians that charge lower prices within the plan. Dr. Consulta. 3. Health Maintenance Organization (HMO): office visits at little or no cost to encourage individuals to seek help for small medical problems before they become serious. 4. Comprehensice Major Medical Insurance: cobre quase tudo.

Question 39

Annuities: Advantages and Disadvantages

Answer 39

1. Volatility of the Benefit Amount (fixed, variable) 2. Flexibility (immediate, variable) 3. Lock / Depends on future market expectations (fixed v. variable) 4. Fees (variable > fixed) 5. Inflation concerns (if fixed with no adjustments) 6. Provide tax benefits (tax deferred growth, for example)

Question 40

Annuity Payout Methods (List)

Answer 40

1. Life Annuity: pay during life, cease at death 2. Period-certain annuity: pay during specified number of periods 3. Life annuity with period certain: period is determined in time (from / to) 4. Life annuity with refund: PMTs are "amount paid (-) less fees" 5. Joint life annuity: Two or more individuals (husband + wife, for example)

Question 41

Mortality Credit (Concept)

Answer 41

Some individuals pass away earlier in life. As a result, their premiums paid help subsidizing elderly insured people in the pool. High Mortality Credit: Others funding me if I am old. Increase during life.

Question 42

Strategies to mitigate risk (List)

Answer 42

1. Risk Avoidance (don't do certain things) 2. Loss Prevention (security cameras) 3. Risk/Loss Reduction (Sprinkler system for fire) or 4. Risk Retention (do not insure) 5. Risk Transfer (insurance)

Question 43

Retirement Income Efficient Frontier

Answer 43

1. High Annuity Allocation (Low Wealth + Low Probability of Having Sufficient Money) 2. Low Annuity Allocation (opposite)

Question 44

Factors affecting demand of annuities (List)

Answer 44

1. Longer than expected life expectancy 2. Greater preference for lifetime income 3. Less concern for leaving money to heirs 4. More conservative investing preferences 5. Lower guaranteed income from other sources. É basicamente uma Renda Fixa que gera cupons e a pessoa é independente e aproveita a renda ao invés de gastar com seguro para os outros.