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Products PK ProductID ProductName Quantity UnitPrice UnitsInStock UnitsOnOrder Orders PK OrderID OrderDate ShippedDate ShipName ShipAddress Customers PK CustomerID CustomerName Address Phone Employees PK EmployeeID EmployeeName EmployeeAddress EmployeeTitle EmployeeHireDate Module_4_Written_Assignment_ERD_Example.vsd FIN 3660 Module 1 Assignment Chapters 1 - 3 Name: ____________________ Please be sure to cite sources for your answers, even if they come from the textbook or PowerPoints. All answers should be in your own words. 1. List the 5 steps in the recommended procedure to estimate a person’s monetary value for the purpose of life insurance. 2. List and describe the six categories of needs to consider in determining the amount of insurance a person should carry. 3. Explain and provide an example of the use of each of the following reasons for purchasing life insurance: a. Key person indemnification b. Credit enhancement c. Employee benefit plans d. Business continuation 4. Define and provide an example of the following: a. Risk pooling b. Adverse Selection 5. Discuss the following two types of coverage and explain two key differences between these: c. Yearly renewable term insurance d. Level premium insurance 6. Define, explain, and provide an example of: a. Preferred risk b. Substandard Risk 7. Explain the steps involved in estimating death rates at different ages for use in constructing a mortality table.

Paper For Above instruction

Introduction

The process of determining appropriate life insurance coverage and the underlying concepts involve a comprehensive understanding of valuation methods, needs assessment, risk management mechanisms, and statistical modeling. This paper addresses key procedures and concepts, including the steps to estimate an individual's monetary value for life insurance, categories of needs, reasons for purchasing insurance, critical risk management principles, and their application in constructing mortality tables. Proper comprehension of these topics enables individuals and businesses to make informed decisions about life insurance coverage.

Steps to Estimate an Individual’s Monetary Value for Life Insurance

Estimating a person's monetary value for life insurance purposes involves a systematic procedure comprising five essential steps:

1. Identify Economic Dependencies: Determine the financial responsibilities and economic contributions of the individual, including income, debts, and dependents' needs.
2. Calculate Lost Income: Estimate the potential income lost due to the individual's death over their remaining working years, often using average earnings and occupational data.
3. Assess Non-Earning Contributions: Consider non-financial contributions such as homemaking, caregiving, and community involvement that have monetary equivalents.
4. Account for Future Expenses: Factor in future expenses including education, healthcare, and estate taxes that the deceased's death might entail.
5. Incorporate Discounting and Inflation: Adjust future cash flows for present value using appropriate discount rates and inflation projections to arrive at a lump-sum monetary value.

This structured approach ensures a comprehensive valuation, aligning life insurance coverage with actual financial needs and dependencies.

Categories of Insurance Needs

Determining the appropriate amount of insurance necessitates considering six key categories of needs:

1. Income Replacement: Ensuring surviving dependents can maintain their standard of living by replacing lost income.
2. Final Expenses: Covering funeral costs, medical bills, and legal expenses associated with death.
3. Mortgage and Debts: Paying off outstanding mortgages and personal debts to prevent financial strain on beneficiaries.
4. Future Education Costs: Funding for dependents' education, especially for minors or college-bound children.
5. Estate Settlement: Covering estate taxes and administrative expenses to facilitate smooth transfer of assets.
6. Emergency Fund: Providing liquidity for unforeseen expenses or financial emergencies.

Evaluating these categories helps in setting a comprehensive coverage amount aligned with the actual financial responsibilities and future obligations of the insured.

Reasons for Purchasing Life Insurance

Understanding the motives behind purchasing life insurance involves exploring specific strategic purposes:

a. Key Person Indemnification

This reason pertains to insuring vital employees or key executives whose loss would adversely affect the company’s operations. For example, a major executive’s death might lead to significant financial disruption, and indemnification provides funds for recruiting or training a replacement.

b. Credit Enhancement

Life insurance can serve as collateral or security to enhance creditworthiness. For instance, a business may use life insurance policies on key individuals to secure loans, ensuring repayment if the insured person passes away.

c. Employee Benefit Plans

Employers often provide life insurance as part of employee benefits, such as group term insurance, to attract and retain talent. An example is a company offering group life coverage to employees at a standard or discounted rate.

d. Business Continuation

Life insurance facilitates the continuation of business operations after a key person’s demise by funding buy-sell agreements or covering income loss. For example, a partnership agreement may include life insurance to buy out a deceased partner’s interest.

Key Insurance Concepts: Risk Pooling and Adverse Selection

a. Risk Pooling

Risk pooling involves aggregating the risks of many individuals to spread the financial impact of losses. An insurance company collects premiums from policyholders with varying risk profiles and uses the pooled funds to compensate for claims. For example, health insurance pools contributions from thousands of members to cover medical expenses, thus reducing individual risk.

b. Adverse Selection

Adverse selection occurs when individuals with higher-than-average risk are more likely to purchase insurance, leading to imbalanced risk pools and potential financial losses for insurers. For instance, if only those with costly health issues buy health insurance, premiums may need to be increased, deterring low-risk individuals and further skewing the pool.

Types of Life Insurance Coverage: Yearly Renewable Term vs. Level Premium

Two common forms of life insurance coverage include:

c. Yearly Renewable Term Insurance

This policy provides coverage for one year, renewable annually without requiring proof of insurability, but premiums increase yearly as the insured ages. It’s often used for short-term needs or temporary coverage.

d. Level Premium Insurance

Level premium policies maintain consistent premiums throughout the policy term, often with the benefit of guaranteed death benefits. For example, a 20-year level term policy charges a fixed premium each year for 20 years, offering predictability and stability.

The main differences lie in premium structure and duration; yearly renewable terms increase costs with age, whereas level premiums remain constant, providing price stability.

Preferred and Substandard Risks

a. Preferred Risk

Preferred risks are individuals with health conditions and lifestyles that pose lower-than-average mortality risk, qualifying for lower premiums. For example, a non-smoker in excellent health may be classified as a preferred risk.

b. Substandard Risk

Substandard risks are individuals with health issues or risky lifestyles that increase their mortality risk, resulting in higher premiums. For instance, a smoker with a chronic illness would be considered a substandard risk.

Estimating Death Rates for Mortality Tables

Constructing mortality tables involves several steps:

1. Gathering comprehensive death data across different age groups from reliable sources like national vital statistics.

2. Calculating age-specific death rates by dividing the number of deaths in each age group by the population at risk in that group.

3. Smoothing data to correct inconsistencies or random fluctuations, often through statistical techniques such as graduation.

4. Adjusting for factors like improvements in healthcare or changes in lifestyle that affect mortality trends.

5. Validating the mortality rates using comparisons with established data to ensure accuracy.

These steps are fundamental in estimating death probabilities associated with specific ages, which are then used to develop mortality tables critical for pricing and reserving in insurance.

Conclusion

Understanding the procedures and concepts related to life insurance, from valuation and needs assessment to risk management and statistical modeling, is essential for effective insurance planning. Properly estimating an individual’s value, considering comprehensive needs, and understanding different policy types facilitate more informed decisions. Moreover, grasping the principles of risk pooling, adverse selection, and mortality rate estimation enhances the strategic use of insurance as a risk management tool for individuals and businesses alike.

References

• Bell, J. (2017). Principles of Insurance. Pearson.
• Cannon, P. (2020). Life Insurance Mathematics. Society of Actuaries.
• Gerber, H. U., & Weber, S. (2020). Statistical Methods for Life Insurance. Springer.
• Gordon, L. A. (2018). Fundamentals of Risk Management and Insurance. McGraw-Hill Education.
• Rejda, G. E., & McNamara, M. J. (2019). Principles of Risk Management and Insurance. Pearson.
• Society of Actuaries. (2021). Mortality Tables and Their Development. SOA Publications.
• Stulz, R. (2019). Risk Management and Insurance. Wiley.
• Vaughan, E. J., & Vaughan, T. (2017). Fundamentals of Risk and Insurance. Wiley.
• Watson, P., & Holmes, B. (2022). Modern Life Insurance Practice. Insurance Institute of America.
• Zanjani, F., & Dorson, P. (2020). Advanced Actuarial Modeling for Life Insurance. Wiley.