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Type of Insurance
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How Does It Work?
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Life insurance
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Provides the beneficiaries of your life insurance policy with funds upon your death so that your assets will not need to be used to pay final expenses and estate taxes.
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Disability income insurance
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Pays benefits to replace part of your earned income while you can't work due to illness or injury so that you continue to meet your financial obligations (e.g., mortgage).
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Health insurance
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Pays medical expenses incurred as a result of an illness or injury, so that you do not need to use your assets to pay for them.
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Long-term care insurance
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Pays for certain in-home and nursing home care expenses, preserving your assets for your heirs.
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Homeowners insurance
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Pays for certain property damage and losses so that the property can be repaired or replaced without you having to use other assets to do so. Also covers certain liability claims.
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Automobile Insurance
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Pays for damage to your automobile so that you can fix or replace it (collision/other-than-collision coverage). Also covers certain liability claims (liability coverage).
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Umbrella liability insurance
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Provides liability protection above and beyond basic coverage provided by homeowners and automobile policies.
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Business or professional insurance
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Pays for certain business losses (e.g., property damage, business interruptions, liability claims).
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Information and articles are provided through Forefield Inc. for educational purposes only. Not to be relied upon for investment, tax, or other financial related decisions.
Life Insurance
What is life insurance?
Life insurance is a legal contract between an insurance company and a policyowner and is governed by state law. Under the terms of the policy contract, the policyowner pays premiums in exchange for the promise of payment of a specified amount of money to a named beneficiary when the insured dies. The policy itself contains provisions specifying the rights and obligations of the parties under the contract.
The specific purpose of life insurance is to replace the economic loss resulting from a person's death using money from a pool of funds to which many people contributed a relatively small amount.
When can it be used?
Personal Uses--At Death
Provide for final expenses
Life insurance can provide cash for final expenses such as your funeral and burial costs (which normally averages between $5,000 and $10,000).
Provide financial support for dependents
A major reason for having life insurance is to provide financial protection for dependents that are left behind. When an individual dies, the financial support he or she provided to the family ends. However, the family's need for income continues. Most families will have an ongoing need for housing, transportation, medical care, food, clothing, and possibly education and day care.
Pay off debt
The proceeds from life insurance can be used to pay off a home mortgage, automobile loan, credit cards, or any other debt that may have accumulated, relieving family members of the financial burden. Even persons who are single with no dependents should consider whether they could be leaving behind college loans or other debts for which co-signers may be held liable. Unfortunately, death does not relieve an estate of the deceased's contractual debt obligations. Insurance can provide the means to pay debts that are left behind.
Pay estate taxes
Many people think that only wealthy people have estate tax concerns (e.g., those with sprawling mansions or vast corporate empires). The truth is, if your estate is large enough, it could be subject to federal and state estate taxes, depending on the applicable law at the time of your death. The following list contains some of the items that may make up your estate:
· Home(s)
· Cash
· Automobiles
· Investments
· Jewelry
· Personal Property
· Business
· Assets owned with spouse, either as joint or community property
· Antiques, collectibles, etc.
Estate taxes can quickly erode the value of a sizeable estate (by as much as 50 percent or more). However, using life insurance in an estate plan can allow family members to avoid liquidating assets to pay these taxes.
Create an estate
Life insurance can be used to create an estate when time or other circumstances have kept you from accumulating sufficient assets in excess of what is needed to provide day-to-day financial support for your family after your death. The premiums you pay for life insurance may be significantly less than the proceeds paid to your beneficiaries at death. The death benefit can be used to provide your beneficiaries with a larger legacy than might otherwise be possible.
Personal Uses--During Lifetime
Create retirement or college fund
When you buy cash value life insurance, you can receive certain lifetime benefits. Cash value life insurance policies include a potential accumulation of funds that can be accessed during your lifetime (e.g., for retirement savings or education savings) through loans or withdrawals. In addition, the cash value grows tax deferred, meaning you don't pay taxes on the increased value until you actually access the cash value, and even then the distributions may be subject to favorable income tax treatment.
Business Uses
Employee benefit program
Life insurance can be part of an employee benefit program, with coverage provided under a group plan. Many employers offer life insurance group coverage to employees at low or no cost to the employee. Often, the death benefit provided is a multiple of salary, such as two or three times annual gross salary.
Caution: Employer-provided coverage over $50,000 has certain tax consequences to the covered employee.
Key person coverage
Some companies take out life insurance policies on certain key employees, such as officers or managers. The purpose of the policy is to protect the company from the loss of talent, goodwill, and profit that can occur at the death of certain high-level employees. In addition to the loss of the employee, the company may face recruiting and training costs arising from filling the vacancy caused by the employee's death.
Fund a buy-sell agreement
Life insurance can be used to fund a buy-sell agreement. Under a buy-sell agreement, life insurance can be used to provide cash for the purchase of a deceased owner's interest in the business, providing liquidity for the family of the deceased. If a cash value insurance policy is used, cash values may be accessed to help fund a buy out for a retiring partner's interest thereby creating a market for the retiring partner's interest.
Disability Insurance
What is disability income insurance?
Disability income insurance is insurance that pays benefits when you are unable to earn a living because you are sick or injured. Like all insurance, disability income insurance is designed to protect you against financial disaster. Most disability policies pay you a benefit that replaces part of your earned income (usually 50 percent to 70 percent) when you can't work.
Example(s): Lola, Lorraine, and Leslie were friends who never expected to become disabled. One day, however, Lola broke her leg in a car accident and wasn't able to work as a dance instructor for five months. Because she didn't have disability insurance, she fell behind on her mortgage payments, and the bank threatened to foreclose on her house. A few days later, Lorraine became ill and couldn't work for weeks. With no disability insurance, she was forced to rely on her family for support. Fortunately, Leslie was prepared. She had purchased a disability insurance policy. When she suffered a stress-related heart attack, her disability benefits allowed her to pay her expenses while she recovered.
Who needs disability insurance?
The odds are . . . you do
Your chances of being disabled for longer than three months are much greater than your chances of dying prematurely. One reason for this is that medicine has made treatable many illnesses and injuries that formerly would have killed you. Although this is good news, it increases your need to protect your income with disability insurance.
Working individuals
What would happen if you suffered an injury or an illness and couldn't work for days, months, or even years? If you're single, you may have no other means of support. If you're married, you may be able to rely on your spouse for income, but you probably also have many financial obligations, such as supporting your children and paying your mortgage. Could your spouse really support both of you? In addition, remember that you don't have to be working in a hazardous position to need disability insurance; accidents happen not only on the job but also at home and illness can strike anyone. Everyone who works and earns a living should consider purchasing disability income insurance.
Caution: If you work part-time, work in a hazardous occupation, or are self-employed, you may have a hard time buying a private disability policy. If you can purchase one, it will likely be expensive. You may have to rely on your group employer or association issued disability policies.
Nonworking individuals
If you don't work because you took an early retirement, or you live off your investments, you may still need disability income insurance. Although your income may remain constant after you get sick or hurt, your expenses may rise dramatically. You may need round-the-clock medical care or part-time help, and you may need special equipment. In addition, you may need to pay high medical insurance deductibles. If you don't have enough income or savings to meet those needs, you may financially burden your family. Many policies may not pay benefits, however, unless a disability results in a loss of income.
Caution: You may find it difficult or impossible to buy an individual insurance policy that will pay benefits if you don't work because disability income insurance is designed to replace the income you lose as a result of not being able to work and maintain your current lifestyle. In addition, in the eyes of the insurance company, you have no financial reason to get better; after all, your income stream from investments won't change. Your only option may be to buy an association policy (if available) or to buy a policy before you retire (unless disability benefits end at retirement). Even if a disability income policy is available to you, you should read it carefully to determine whether it will pay benefits to an individual who is not working at the time the disability occurs.
Long-Term Care Insurance
It's a fact: People today are living longer. Although that's good news, the odds of requiring some sort of long-term care increase as you get older. And as the costs of home care, nursing homes, and assisted living escalate, you probably wonder how you're ever going to be able to afford long-term care. One solution that is gaining in popularity is long-term care insurance (LTCI).
What is long-term care?
Most people associate long-term care with the elderly. But it applies to the ongoing care of individuals of all ages who can no longer independently perform basic activities of daily living (ADLs)--such as bathing, dressing, or eating--due to an illness, injury, or cognitive disorder. This care can be provided in a number of settings, including private homes, assisted-living facilities, adult day-care centers, hospices, and nursing homes.
Why you need long-term care insurance (LTCI)
Even though you may never need long-term care, you'll want to be prepared in case you ever do, because long-term care is often very expensive. Although Medicaid does cover some of the costs of long-term care, it has strict financial eligibility requirements--you would have to exhaust a large portion of your life savings to become eligible for it. And since HMOs, Medicare, and Medigap don't pay for most long-term care expenses, you're going to need to find alternative ways to pay for long-term care. One option you have is to purchase an LTCI policy.
However, LTCI is not for everyone. Whether or not you should buy it depends on a number of factors, such as your age and financial circumstances. Consider purchasing an LTCI policy if some or all of the following apply:
You are between the ages of 40 and 84
You have significant assets that you would like to protect
You can afford to pay the premiums now and in the future
You are in good health and are insurable
How does LTCI work?
Typically, an LTCI policy works like this: You pay a premium, and when benefits are triggered, the policy pays a selected dollar amount per day (for a set period of time) for the type of long-term care outlined in the policy.
Most policies provide that certain physical and/or mental impairments trigger benefits. The most common method for determining when benefits are payable is based on your inability to perform certain activities of daily living (ADLs), such as eating, bathing, dressing, continence, toileting (moving on and off the toilet), and transferring (moving in and out of bed). Typically, benefits are payable when you're unable to perform a certain number of ADLs (e.g., two or three).
Some policies, however, will begin paying benefits only if your doctor certifies that the care is medically necessary. Others will also offer benefits for cognitive or mental incapacity, demonstrated by your inability to pass certain tests.
Individual Health Insurance
What is individual health insurance?
Individual health insurance is a type of policy that covers the medical expenses of only one person. Unlike group insurance, you purchase individual insurance directly from an insurance company or through an insurance agent. When you apply for individual insurance, you are evaluated in terms of how much risk you present to the insurance company. This is generally done through a series of medical questions or a physical exam. Your risk potential will determine whether you qualify for insurance and how much your insurance will cost. Individual insurance is somewhat more risky for insurers than group insurance, since group insurance allows the insurer to spread risk over a larger number of people. For this reason, individual insurance is generally more difficult to obtain and more costly than group insurance.
The benefits of individual coverage
In the event of illness or injury, individual coverage is infinitely better than being uninsured. Although you may think that you can do without health insurance, you are taking a major risk if you choose not to get it. An unexpected illness or serious injury can put you and your family in financial peril. Remember that once you develop symptoms, it's too late to apply for coverage.
With individual health insurance, you're directly in control of your own policy. You may be able to negotiate to have certain provisions included or excluded, and you can choose your deductible amount and co-payment percentage. Keep in mind, however, that your choices will affect your premiums.
What you should look for in an individual policy
Try to find a policy with a guaranteed renewability provision. The guaranteed renewability provision means that the insurer can't cancel your coverage if you become ill. As long as you continue paying your premiums, your insurance coverage continues. Your premiums may go up over the years, but they will rise for all policies in your class, not just for your policy alone.
Be sure to check what's covered and when. Major medical coverage, which covers all hospital costs including rooms, emergency-room care, anesthesia, tests, X rays, and drugs, is preferable to hospital-surgical coverage, which covers only hospital and surgical services. Most insurance companies impose a waiting period before they'll cover pre-existing conditions. The shorter this period, the better. Three months to one year is standard; anything over a year is extremely undesirable. Most policies do cover outpatient treatment, although cosmetic and other truly elective surgeries are rarely covered. The easiest way to check what's covered is to look at what's not covered, by reading the Exclusions and Limitations section. You'll also want to check with your state insurance agency, since some states require nongroup insurance coverage to comply with a standard set of benefits.
You'll want to find a policy with the highest lifetime payout possible. Policies with unlimited payouts are less common these days, but anything less than $1 million may be insufficient to cover you in the event of a catastrophic illness.
You'll also need to choose a limit for your out-of-pocket costs. Lower deductibles and co-payments mean that your costs will be lower if you actually do get sick, but you'll pay dearly for this protection. By agreeing to higher deductibles and co-payments, you can cut your insurance premiums dramatically. As long as you retain a reasonable out-of-pocket maximum, you shouldn't have to worry about your medical costs getting out of hand.
Finally, look for an insurer that's financially stable--one with an "A" or "A+" rating from A. M. Best, Moody's, or Standard & Poor's. It does you no good to have guaranteed renewable insurance if your insurance company goes belly-up.
Information and articles are provided through Forefield Inc. for educational purposes only. Not to be relied upon for investment, tax, or other financial related decisions.
