INSURANCE PART III—LIFE INSURANCE

Most financial planners agree that there are four critical elements in any investment program:

1.????Your annual income (derived from your job or business)

2.????Housing—a place to live

3.????A Reserve or Emergency Fund—something safe and easily convertible into cash in case of an emergency, and

4.????A Contingency Fund—a really big reserve fund, usually in the form of life insurance, to be used by dependants if you die.

These factors are NOT something you establish early in life and then forget.?They should be viewed as the foundation on which any investment program is built; a foundation that may broaden as needs and financial situations change during your lifetime.

INSURANCE AND RISK

Note that the fourth element in the investment foundation is a Contingency Fund.?The objective of such a fund is to provide protection for your family if you die or if you are unable to work because of illness or injury.?Insurance serves the same purpose.?It can help you through, and provide protection for your family in case of illness or injury.?

Risk Management

Risk is "the chance of injury, damage, or loss".?Risk in an investment context is a measure of uncertainty about the outcome, i.e., the chance of loss in the future.?Risk management includes all the efforts necessary to conserve assets by reducing the uncertainty of financial loss.?

Risk of financial loss is the basic reason for the purchase of all forms of insurance whether it is homeowner's, motor vehicle, life, disability, or medical.?The purpose of insurance is to help protect the insured and his or her family against financial hardship due to natural hazard, accident, major illness, death, etc.

Simply stated, insurance reduces or replaces the uncertainty by transferring the risk to a large group of insured parties who have uncertainties of loss, just as you do.?As we noted earlier in this series, insurance companies offer financial protection against such dangers by promising to compensate the insured for a relatively large loss in return for the payment of a much smaller, but certain, expense—the premium.

WHAT IS INSURANCE?

INSURANCE IS PROTECTION

Although there are many types of insurance, they all have one thing in common—the peace of mind that comes from knowing that money will be available to meet the needs of your survivors, pay medical expenses, replace your home and belongings in the event of loss, and cover personal or property damage to your car or caused by your car.?Thus, the principle of all insurance is the same: IT PROTECTS PEOPLE AGAINST POSSIBLE FINANCIAL LOSS.

Life insurance replaces income that would be lost if the policyholder should die.?Health insurance helps meet medical expenses when the policyholder gets sick and disability insurance helps replace income lost when illness makes it impossible for the policyholder to work.

LIFE INSURANCE

We dealt with homeowners’ and car insurance in the earlier articles.?This week we will begin looking at life insurance.?And later on we will look at health and disability insurance.

Personal Goals and Insurance

Most financial planning is based on the assumption that we will continue to live for a long time and thus can provide a continuing stream of income for as long as we choose.?There is a possibility, though, that we won't live to a ripe old age or that we may be unable to earn as much due to a major illness.?Therefore, good planning must take this risk into account.?If our premature deaths or the effects of a disabling disease would disrupt or dry up the income stream needed to maintain our dependents, then life and health insurance should be used to prevent or reduce the impact of such FINANCIAL disruption.

Most financial advisers agree that a basic risk management plan must set goals to reduce:

1. Potential loss of income due to premature death, illness, accident, or unemployment of a wage earner.
2. Potential loss of income and extra expense resulting from the illness, disability, or death of a spouse.
3. Additional expenses due to injury, illness, or death of other family members.
4. Potential loss of real or personal property due to fire, theft, or other hazards.
5. Potential loss of income, savings, and property due to personal liability.

The Purpose of Life Insurance

Most people buy life insurance to protect someone who depends on them from financial losses caused by their death.?That "someone" could be the non-working spouse and children of a single-income family.?It could be the wife or husband of a two-income family.?It could be an aging parent.?It could be a business partner or a company.?Life insurance is one of the few ways to provide liquidity at the time of death.

The only purpose for insuring life is to provide income for dependants after your death.?Therefore, the first question that should be asked is: "Are there any dependants who should be provided for after the death of the insured?"?There may be none, and therefore little or no need for life insurance, if the person is single, or married without children or mortgage and both spouses are working.?Similarly, there may be little or no point in paying for the safety net of life insurance once children are independent and the individual has ample net worth.?However, if a spouse, children, and/or parents depend on the person's earnings, they may have to insure their life quite heavily.

There are two basic types of life insurance: Cash-value policies ("whole" life and "universal" life) and term insurance.?All policies fit into one of these categories.?Next week we will begin an in-depth look at the pros and cons of these types.

Cheers, Nigel?

Nigel Romano, Partner, Moore Trinidad & Tobago, Chartered Accountants