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Personal Finance Chapter 10 - baj01275_c10_247-277 02:10am...

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10 FINANCIAL PLANNING WITH LIFE INSURANCE Thinking Long Term Starting Point Go to www.wiley.com/college/bajtelsmit to assess your knowledge of financial planning with life insurance. Determine where you need to concentrate your effort. What You’ll Learn in This Chapter Life insurance needs over the life span Key provisions in an insurance contract Insurers and policy types After Studying This Chapter, You’ll Be Able To Assess your life insurance needs Evaluate insurers and policy types to determine which best meet your needs Compare the terms and conditions in life insurance policies Choose the right policy for your needs baj01275_c10_247-277 2/09/07 02:10am Page 247
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248 FINANCIAL PLANNING WITH LIFE INSURANCE INTRODUCTION We begin the chapter with an assessment of your life insurance needs: What are your risk exposures, and what resources do you have to meet the needs created by those exposures? How might your needs change over the life cycle? After you identify your needs, you need to evaluate alternative methods of meeting them. This chapter describes the types of life insurance available, as well as combina- tions of insurance and investment plans. 10.1 What Is Life Insurance? Benjamin Franklin famously wrote, “In this world nothing can be said to be certain, except death and taxes.” Even though few would disagree with this sentiment, many people fail to adequately prepare for their deaths. We’ll first look at some general characteristics of life insurance and mortality risk. Then we’ll consider whether you require life insurance in your financial plan and, if so, how much you need. 10.1.1 How Life Insurance Works Life insurance basically works in the same way as property and liability insurance (explained in Chapter 8). In fact, it’s even simpler than those types of insurance because only one event—a death—can trigger a claim on a life insurance policy, whereas many different events can lead to a property or liability insurance claim. Because people die with a certain degree of predictability and each person’s death is, in general, independent of the deaths of others, mortality is a type of pure risk for which the pooling mechanism is particularly well suited. Like other insurance products, life insurance is based on the concept of risk pooling. You pay a premium that is small relative to the size of your potential loss, and if the bad outcome occurs (you die), your beneficiaries are paid a sum of money, which they can use to offset any losses incurred as a result of your death. Unlike property insurance, where the insurance benefit is designed to pay you back for a specific dollar loss, life insurance is designed to replace the income you would have earned if you hadn’t died prematurely. This is similar in concept to disability insurance (considered in Chapter 9); however, in the case of disability insurance, the policy usually pays out the lost income in installments, whereas it’s more common to get a life insurance benefit in a single lump sum.
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