"Why Do I Need Insurance?": Clients Want To Know

Copyright 2010 Oliver Publishing Inc. All rights reserved.
31

Clients want to know:
Why do I need insurance?

After reading this chapter you should understand:
The ways that life insurance can lessen financial risk.
_____________________________________________

The Risks Addressed by Life Insurance
All people experience risk in their lives. No matter how cautious a person is,
there is always the risk of the unpredictable or the unknown. An accident may
cause death, sickness, or disability, a disease may be fatal or financially
devastating, or perhaps the bite of taxes after death prevents children from
receiving an expected inheritance.

Risk has an impact on both individuals and their families. Married people worry
about what might happen if their spouse should die or how they will pay the bills
in case of an illness that prevents them from working. People with children are
rightly concerned about the financial future of their children if they die. Those
who are single and without children may be worried about who will care for them
as they age.

Most fears about risk boil down to a single issue: money. How would the
surviving spouse support the family? Can the spouse fund future education costs
for the children? People ask themselves, Where would the money come from if I
died? If I got sick? If I lived to age 97? If, if, if.

Ensuring financial
protection of loved
ones will always be a
primary reason to
buy life insurance.
LLQP
32 Copyright 2011 Oliver Publishing Inc. All rights reserved.

Life insurance was invented to address the risks of living. In fact, life insurers
define the three predictable risks of living as death, disability, and old age.
Very simply, life insurance provides the financial security people need in order to
live their lives without worrying about the ifs. It does that by providing a wide
range of products that address predictable risks. The product choice is
personalized, according to the amount and type of risk a person wishes protection
against. The insurer charges a fee based on the risk of the person and of the
product solution for that risk, and ultimately provides the financial benefit if the
risk should come to pass.

Life insurers weigh the proposed risk of the person to be insured against the fee
the premium that they will receive.

Understanding the concepts of risk and risk management is fundamental to being
a successful life agent.

Managing Risk
The study of risk is a science. There are two measures of risk: severity and
frequency. In other words, one has to assess how bad the risk is and how often
it is likely to happen. A loss of life can happen only once, but certain risks may
increase the chances that death will occur. The risk of death faced by an average
person is less than that faced by a race-car driver, because deaths during race-car
driving are relatively frequent. Conversely, less-severe risks are likely to happen
more often. A sickness, such as pneumonia, could strike many times during the
course of a lifetime.
An agent will analyze client
information to find where
risk exists, and then show
the client how risk can be
managed by a combination
of risk retention, risk
avoidance, and risk transfer
via life insurance. In this
way the agent can
significantly affect a clients
life by removing what if?
worries.
The Need for Insurance
Copyright 2011 Oliver Publishing Inc. All rights reserved. 33
The financial implications of the most severe risks are critical. Financial ruin
(i.e., bankruptcy) could result. Risks that are less severe require financial
adjustments that could result in a lower standard of living. When the severity of
a risk may lower the standard of living, the risk is said to be material.

There are certain risks that we face whose frequency may be medium or low, and
whose severity has a financial implication, but not to the extent that it affects the
standard of living. The severity of such risks are said to be minor.

Being exposed to risk is inevitable: you cannot live without being exposed to
some types of risk, in some measure. However and this is crucial to life
insurance risk can be planned for, controlled, and managed. By doing so, you
can decrease the probability of loss, and you need not fear it as you might
otherwise. Life insurance is the key risk management tool.

Risk is managed by:
Risk avoidance;
Risk control, which includes loss-prevention and loss-reduction
techniques;
Transferring and retaining risk, also called risk financing;
Risk retention.

Risk Avoidance
This is a strategy that must be used when the frequency of risk is high and the
severity is critical. For example, take the case of a person who participates in
dirt-bike racing as a hobby. If he has a young family, and the family is dependent
on this persons income, in the case of death the family faces the risk of
bankruptcy, which is critical. Risk transfer for a high-frequency critical risk
could be prohibitively expensive and can perhaps be afforded only by
professional dirt-bike racers who may have sponsors. Therefore, a solution would
be for the person to avoid participating in dirt-bike racing. All of us practise
some amount of risk avoidance.

Risk Control
This is a strategy that generally falls into the realm of safety. All of us practise
risk-control strategies. For example, workers wear hard hats at a construction site
or wear safety shoes when entering manufacturing plants. We maintain our cars
in good condition and change worn tires to reduce the risk of skidding. We get
vaccinations against diseases to reduce the chance of getting the disease. Risk
control may not eliminate any risk, but it certainly reduces the chances of
LLQP
accident, injury, or illness. Risk-reduction strategies work for risks that are high-,
medium-, or low-frequency, but the severity could be critical, material, or minor.

Risk Transfer
This is a strategy by which the financial implication of the risk is transferred to a
third party (an insurer) in exchange for premium payments. This strategy is used
when the frequency of the risk is medium or low, but the severity is critical or
major. For example, the death of a person may lead to bankruptcy of the
survivors or lower their standard of living. In this case, risk transfer is
recommended as a strategy. The frequency of a person dying in a car accident is
low, but the severity could be critical or major, in which case a risk-transfer
strategy is recommended.

Risk Retention
This is a strategy used for risks whose frequency is medium or low and whose
severity is minor. For example, a young healthy family may not be at risk for
medical treatment and the associated costs in the immediate future. They may
choose to retain the risk and spend the money as and when required for small
ailments that the family members may suffer. Risk retention is a strategy that all
of us practise to some extent. The deductible for car insurance or an elimination
period for disability insurance is the amount of risk that the person is willing to
retain. The balance of the risk is transferred to an insurer. Retaining more of the
risk lowers the premium.

The Process of Transferring and Retaining Risk

One way to lessen the financial implication of a risk is to transfer some of the
risk to someone else. Life insurance transfers risk of a loss of income or a loss of
wealth from the policy owner to the life insurer.

To transfer risk, the amount of risk facing an individual must first be quantified.
This means, a dollar figure must be calculated for the risk. For instance, if a
person fears losing his income if he should become disabled, then it is necessary
to assign a dollar figure to that income loss. That person may have savings that
could be used for some part of the period he is disabled. He then transfers the
balance of the loss to the insurance company via a disability income policy.

Determining the severity of a loss is a first step in the insurance process. It is
accomplished in a needs analysis. In other words, the amount of insurance that is
needed is determined in consultation between the agent and the life insurance
A needs analysis tells me the amount of
insurance coverage my client needs. In
other words, it provides a dollar figure for
the amount of risk she faces. That risk is
transferred via the insurance policy.
It is important my client knows what the
needs analysis recommends as the correct
amount of insurance, even though she may
disagree and pick another amount.
applicant. Life insurance need is calculated very differently from disability
insurance need. You will learn how to make these calculations.
The amount of insurance determined in the needs analysis may, or may not, be
accepted by the applicant. He or she may retain some risk by planning to use
personal resources to foot the bills. The applicant will also retain some risk if he
or she is willing to decrease expenses, thus reducing the amount of insurance that
is needed. There is also the option that he or she may end up picking the amount
of insurance according to the cost of the premium.

Term life insurance provides a large amount of insurance for a small premium;
thus, a large amount of risk can be transferred inexpensively. However, the policy
owner risks paying the premium and never receiving the insurance benefit. This
would be the case if the life insured did not die during the term of the policy.
Term insurance is used to cover temporary risks faced by individuals. A
temporary risk is defined as a risk for which an end period is determinable. Say
parents of children aged five and six want to cover themselves for their childrens
period of dependency. One can determine that the childrens dependency period
will last for a maximum of 20 years for this couple. Therefore, they could cover
this risk with a 20-year term insurance policy. Similarly, a couple that has a plan
to clear their mortgage within a specific period can cover their outstanding
mortgage with a term policy, since they can determine the term of the risk.
Term insurance is the
least-expensive way to
transfer risk.

LLQP
Permanent insurance is more costly, because it is in force until death. Because
death is inevitable, the life insurance company knows it will have to pay a death
benefit at some point. The risk to the insurer is absolute. Permanent insurance is
best suited to cover permanent risks, such as funeral costs, estate taxes, and estate
creation (leaving money for a loved one or a charity; this may also be called a
legacy or a bequest), or estate equalization (to achieve equitable distribution
amongst heirs). It is also useful to assure that, when the first spouse dies, money
is left for the surviving spouse, so that the surviving spouse can maintain their
desired lifestyle.

Disability income insurance is quite costly. This is because the risk of
disability is much higher than the risk of premature death. Also, disability income
insurance must address the frequency with which sickness or accident may occur
over the duration of the policy. The insurance company therefore takes on
considerable risk, and in turn transfers some of its costs back to the policy owner
in the form of high premiums.

Loss of Income

Loss of income can result from both death and disability.

Death
Premature death permanently deprives dependents of a source of income, and
saddles them with expenses that result from death.

Two forms of expenses will be experienced by the remaining family: last or final
expenses and continuing expenses.

Last expenses are one-time costs. Once paid, they will not have to be paid
again. They include the cost of a funeral, legal and tax issues that must be settled
after death, and usually the elimination of debt, such as a mortgage. Paying off
the mortgage is typically considered a final expense, because it is assumed that
the survivors would want to continue to live in the family home without the
financial burden of mortgage payments.

Permanent insurance
includes whole life
insurance and universal
life insurance.

There is a much higher
probability of disability
than premature death.

Last expenses are paid
once.

Ensuring home
ownership without a
mortgage is an
objective when paying
final expenses.
Continuing expenses are ongoing costs that the family must pay after a death.
When the income earner who makes the greatest financial contribution to the
family dies, those expenses will be significant out-of-pocket costs. They can
include day-to-day living expenses, education savings, and perhaps retirement
savings for the remaining spouse.

If the spouse who dies was responsible for child-rearing and family management,
then continuing expenses will include the cost of replacing the contribution of
that spouse. Money will have to be found for child care, for instance, or for
tutoring, house cleaning, and maintenance, etc.
It is very important to be able to cover all family costs during the dependency
period for children. This is the time until the youngest child is no longer
dependent on the parent. For normal children, this is usually considered to be up
to age 18, or to age 25 if the child is attending school full-time.

Disability
Disability, whether brought about by sickness or an accident, is measured by the
inability to work. It can deprive an individual of an income, either permanently
or temporarily. This can have a significant impact on an individual and his or her
dependent family.

Loss of Wealth

Wealth can be diminished as a result of:
Medical expenses that are not covered by provincial health-care plans,
medical expenses incurred while travelling abroad, or long-term-care
costs for a nursing home or other care for seniors;
Age, in which financial resources are outlived;
Financial inadequacy of the estate (typically addressed by estate
planning) to pay bills that will be due upon death and to ensure that
bequests can be granted as desired by the deceased.

Estate
The estate is the
whole of ones
possessions,
including all the
property and debts
left by one at death.

Estate planning
The activity of
planning for the
distribution of the
estate according to
the wishes of the
estate owner.

LLQP
Medical Expenses
Government health care covers a wide range of needs. However, expenses such
as prescription drugs are not covered. Having to pay costs that are not covered by
government programs can:
Diminish the family or individual standard of living;
Interrupt programs for savings;
Deplete savings; and
Reduce the ability to budget and make future plans.

This need for insurance will be addressed by the variety of accident-and-sickness
policies that you will learn about in this course.

Age
Our aging population indicates the need for considerable wealth to pay for long-
term health-care costs, such as for facility health care for seniors who choose
to live at a old age facility. The cost for such services can run into hundreds of
thousands of dollars over a lifetime.

Another risk of aging is outliving financial resources and suffering a decline in
the standard of living as a consequence. This risk can be addressed by investment
and retirement planning. Investing and retirement are modules in this course.

Estate Planning
Estate planning may be concerned with issues of estate equalization that is,
ensuring all beneficiaries of an estate are treated equally.

It will also address the taxes that will be due upon death. These taxes range from
a settlement of income taxes through to the more complex issues surrounding the
taxation of assets, such as a second home (perhaps a cottage or cabin).

While assets may pass tax-free to a spouse, when the last of two spouses dies, all
tax must be paid. Some assets, like investments, can be sold easily and
typically without emotional attachment in the amount needed to cover the tax
bill. Other assets are less easily disposed of, such as ownership of a small
business.
Long-term health-care
costs deplete savings.


Some assets, such as the cottage or cabin, are often to be retained by a
remaining family member or members but to do so, the tax bill must be paid.
These bills, which are sometimes substantial, can seriously erode the inheritors
savings or personal wealth, and if funds are not available to pay the taxes, then
the property must be sold.

As you will learn, life insurance provides valuable solutions to these risks.

You should now have a good understanding of how risk is transferred from the
applicant to the insurance company in an insurance contract.

Classifying Risk and Pricing Premiums
Insurers price the risk they assume by charging premiums according to the risk
represented by the proposed insured. Underwriters may require additional
information to make the correct risk assessment, and the additional information
may be obtained from a variety of sources, including:
The applicant;
Third-party sources that report on medical, consumer, credit, and
lifestyle issues;
Credit and motor-vehicle reports.

There are three classifications of risk that are used, and on which policies are
issued.

Preferred risk
This classification is used for a person whose physical condition, occupation,
way of life, and other characteristics indicate that their prospect for longevity is
better than that of an average person of the same age who is unimpaired.

Keeping the cottage in the
family can be a highly
emotional issue. Life
insurance can control the
risk of keeping such an
asset by ensuring tax can
be paid when the cottage
owner dies.
LLQP
Standard risk
This classification will be used for a person who is entitled to insurance
protection without extra rating or special restrictions.

Sub-standard risk
Roughly 10% of applicants are identified as special risks or substandard risks
when they apply for life insurance. This actually means that they present a
greater risk to the insurer because they are more likely to make a claim. A
medical condition, medical history, occupation, or lifestyle can give rise to higher
mortality rates than those used to determine the insurance companys standard
premiums.

For substandard risks, one of the following treatments compensates for the
additional risk posed by the life insured:
A policy is rated, which means the insured must pay a higher premium
than a standard person of the same age;
Exclusion riders or waivers are added, which means the condition
causing the additional risk is excluded from coverage.

If the applicant is offered a rated policy that carries higher premiums, the
insurance company should confirm that the applicant will accept a rated policy
before it is issued. The insurer will issue the policy with an amendment that the
policy owner must sign before the policy can come into force.

For life insurance policies, rating is generally used to deal with medical and other
risks that make the life insured a substandard risk, though the insured may be
offered a choice between getting a rated policy or a policy with an exclusion
rider. For instance, a person who scuba-dives may be given an option of getting a
rated policy or an exclusion. If he elects to go for an exclusion rider, the policy
will be issued as a standard policy, but excluding death while scuba-diving.

For disability insurance, the premiums are rated based upon the occupational
classification of the insured. Such a rating is automatic. However, for other risks,
such as medical conditions, the underwriter generally excludes such conditions
from coverage by the policy. For example, an insured who applies for a policy
and who has suffered earlier from knee injuries will be given a policy with
exclusion for claims arising from the knee. Such a policy with an exclusion rider
is called a modified coverage policy.

The rated policy will increase premiums on a:
Permanent or temporary basis;
Flat-dollar or percentage-increase basis.

Permanent or Temporary Increase
The extra premiums are either permanent or temporary, depending on whether
the special hazard or risk is expected to last for the complete term of the
insurance or for only a portion of it. If the policy was issued at a substandard rate,
and the cause for that rating no longer exists, a request from the client,
accompanied by medical evidence, is usually enough to remove the substandard
rating.

After a standard policy has been issued at regular rates, the insurance company
cannot later convert it to a substandard rate.

Flat Dollar or Percentage Increase
The higher premiums for a substandard rating may be set out in the policy and
applied in a variety of ways. They can be based on a flat-dollar amount per unit
of coverage or on a percentage-increase basis. A flat-dollar amount might, for
instance, be calculated as $15 per $1,000 face amount of coverage. So, if a policy
had a face amount of $100,000, the premium would be increased by $1,500.

For disability income
insurance, the insured
who has a history of
lower back pain and an
occupation in which
lifting is involved may be
offered a policy that
would exclude any claim
originating from
problems with the lower
back.
LLQP
If a percentage rating is used, the standard premium is increased by a stipulated
percent. These are also referred to as table ratings.

Sometimes both methods will be used. For example, if the condition that gave
rise to the rated premium is severe, but is expected to abate if the life insured
survives for more than three years, the rating might be based on a 40% increase
in the standard premium for life, plus an additional $15 per $1,000 for the initial
three years.

A decline to issue insurance to an applicant will occur when no amount of
premium is sufficient to convince the insurance company to accept the risk. The
insurance company will avoid accepting the risk by:
Rejecting the application.
Offering a modified life insurance contract that would exclude a specific
risk. This is called an exclusion rider.

Rejecting the application
When an applicant poses too great a risk, an insurer will deny the application.
Less than 2% of all life insurance applicants and over 10% of disability income
and health insurance applicants fall into this category.
It may be difficult for the agent who has sold the policy to tell the applicant that
the policy will not be issued, but it is the responsibility of the agent to do so. The
rejection of the insurance must be confirmed in writing, and any money paid by
the applicant returned to him or her.

Exclusion Rider
The exclusion rider would describe the circumstances under which the life
insurance benefit would not be paid. For example, if a proposed life insured
skydives, the applicant may be offered or opt for a policy with an exclusion rider
that would not pay the death benefit if the life insured died in a skydiving
accident.

My client, Rick, is a motocross stunt rider. He
would not ordinarily qualify for insurance, because
stunt riders often die while competing.
However, we managed to qualify Rick for a life
policy by taking on an exclusion rider that would
eliminate any claims that might arise from his
riding.

+ FILE
See file 3
for discussion on
reinsurance

Selling Risk Management as a Concept to Clients
Your job as an agent includes looking at the total financial situation of the client
to determine where that client faces risk before recommending any financial
and/or insurance solutions. The agent may identify a large mortgage that would
need to be paid off, a tax liability that needs to be funded, or the necessity to get
the value from a business. This is one aspect of the process of financial planning.
Once risks have been identified, the agent can illustrate the correct policy and
coverage that will manage the risk.

Decision-making in regard to insurance will be motivated by personal need. It is
often difficult to convince a client that he or she needs insurance if that client
believes that the probability of loss is low or that the severity of a loss would not
severely affect his or her financial security. Therefore, the agent must
communicate both how probable a loss is and the impact of that loss.

Risk comparison is an effective way to approach the concept of risk with a client.
A comparison of risk between two time periods (e.g., risk of death today when
children are ready to go to university compared to the risk of death ten years
from today, when the children will have graduated), or comparing the risk to a
benchmark (e.g., the risk of long-term disability for a person in the same
occupation as the client) can assist in making the concept of risk less abstract.

Another approach involves comparing the risks of doing or not doing something
(e.g., establishing a retirement savings plan or not), or the risks that arise from
one option compared to others (e.g., the earnings that accrue from interest,
against the earnings that are possible from a high-growth mutual fund).

The agents objective is not to make the client feel exposed to risk, but instead to
reinforce the concept of risk as a manageable part of living.

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