Personal Finance Insurance and Risk Management Syllabus

What financial risk does disability insurance protect against?

Disability income insurance replaces a portion of your earned income if you become unable to work due to illness or injury. It protects your ability to earn (your human capital), which is often a person's largest asset.

Distinguish short-term from long-term disability insurance.

Short-term disability (STD) covers a few weeks up to about 3-6 months after a brief waiting period. Long-term disability (LTD) begins after STD ends (or a longer elimination period) and can pay benefits for years or until retirement age.

What is the "elimination period" (waiting period) in disability insurance?

The elimination period is the time between the onset of disability and when benefit payments begin (e.g., 30, 60, or 90 days). A longer elimination period lowers the premium; it functions like a time-based deductible.

Compare "own-occupation" versus "any-occupation" definitions of disability.

Own-occupation pays if you cannot perform the duties of your specific job (broader, more expensive, better for the insured). Any-occupation pays only if you cannot work at any job for which you are reasonably suited (stricter, cheaper).

Roughly what percentage of income do disability policies typically replace, and why not 100%?

Disability policies typically replace about 60% to 70% of gross income. Benefits are capped below full income to preserve the incentive to return to work; if premiums are paid with after-tax dollars, benefits are usually tax-free.

What does long-term care (LTC) insurance cover?

LTC insurance covers the cost of extended custodial and personal care not covered by regular health insurance or Medicare, such as nursing homes, assisted living, and in-home help with activities of daily living (ADLs).

What are the Activities of Daily Living (ADLs) used to trigger LTC benefits?

The six ADLs are bathing, dressing, eating, toileting, transferring (moving in/out of bed or chair), and continence. Most LTC policies pay benefits once the insured cannot perform two or more ADLs (or has cognitive impairment).

At what age is LTC insurance typically most cost-effective to purchase, and why?

LTC insurance is usually most cost-effective when bought in one's mid-50s to mid-60s. Buying while relatively young and healthy locks in lower premiums and avoids denial; waiting too long raises premiums sharply or makes one uninsurable.

Does Medicare cover long-term custodial care?

No. Medicare covers only limited, short-term skilled care (up to about 100 days in a skilled nursing facility after a hospital stay). It does not pay for ongoing custodial/long-term care, which is why LTC insurance or Medicaid spend-down is needed.

What is term life insurance?

Term life insurance provides a death benefit for a specified period (the term, e.g., 10, 20, or 30 years) with no cash value. If the insured dies within the term, beneficiaries receive the face amount; if the term ends, coverage lapses unless renewed.

What is level term versus decreasing term life insurance?

Level term keeps both the death benefit and premium constant over the term. Decreasing term has a death benefit that declines over time (often used to cover a mortgage) while the premium stays level.

What does "renewable" and "convertible" mean for a term life policy?

Renewable means you can renew coverage at the end of the term without a new medical exam (at a higher, age-based premium). Convertible means you can convert the term policy to a permanent policy without proving insurability.

What is permanent life insurance and its two core features?

Permanent life insurance provides lifelong coverage (as long as premiums are paid) and builds cash value that grows tax-deferred. The policy combines a death benefit with a savings/investment component.

Compare whole life and universal life insurance.

Whole life has fixed premiums, a guaranteed death benefit, and guaranteed cash-value growth at a set rate. Universal life offers flexible premiums and adjustable death benefits, with cash value that grows based on current interest rates (more flexibility, less guarantee).

What distinguishes variable life insurance from whole life?

In variable life insurance the cash value is invested in subaccounts (like mutual funds) chosen by the policyholder, so cash value and sometimes the death benefit fluctuate with market performance. This adds growth potential but also investment risk.

Why is term insurance generally recommended over permanent for most families?

Term insurance provides much larger death benefits per premium dollar during the years dependents need protection. The common advice is "buy term and invest the difference," since the cash-value component of permanent policies has high costs and modest returns.

What is the "cash surrender value" of a permanent life policy?

Cash surrender value is the amount the policyholder receives if they cancel (surrender) a permanent policy, equal to accumulated cash value minus any surrender charges and outstanding loans.

Explain the DIME method for estimating life insurance need.

DIME sums four needs: Debt (all debts excluding mortgage), Income (annual income times years dependents need support), Mortgage (payoff balance), and Education (future costs for children). The total suggests the coverage amount.

Using the income-multiple rule of thumb, estimate coverage for someone earning $60,000 who wants a common multiplier.

A common rule is 10 to 12 times annual income. For $60,000: $$10\times 60{,}000 = \$600{,}000 \quad \text{to} \quad 12\times 60{,}000 = \$720{,}000.$$

What is the "human life value" approach to determining life insurance coverage?

The human life value approach estimates coverage as the present value of the insured's future net earnings that would be lost to survivors. It discounts expected future after-tax income (less the insured's own consumption) over the working years.

What is the "needs approach" to life insurance and how does it differ from the human life value approach?

The needs approach adds up the survivors' specific financial needs (final expenses, debts, income replacement, education, emergency fund) and subtracts existing resources (savings, current insurance, Social Security). It focuses on what dependents need, whereas human life value focuses on lost earnings.

What does homeowners insurance typically cover in its two broad parts?

Property coverage: the dwelling, other structures, personal property, and loss of use (additional living expenses). Liability coverage: bodily injury or property damage you cause to others, plus medical payments to guests injured on your property.

What is the difference between actual cash value (ACV) and replacement cost coverage?

Actual cash value pays replacement cost minus depreciation, so older items pay out less. Replacement cost coverage pays to replace the item with a new equivalent, without deducting depreciation (a better but pricier option).

What does renters insurance cover and not cover?

Renters insurance covers the tenant's personal property, liability, and additional living expenses if the unit becomes uninhabitable. It does NOT cover the building structure, which is the landlord's responsibility.

Why does the HO-3 policy differ in coverage type for the dwelling versus personal property?

An HO-3 covers the dwelling on an open-perils (all-risk) basis—covering all causes of loss except those specifically excluded—while covering personal property on a named-perils basis, meaning only losses from listed perils are covered.

Are floods and earthquakes covered under standard homeowners policies?

No. Standard homeowners policies exclude flood and earthquake damage. Flood coverage requires a separate NFIP (or private) flood policy, and earthquake coverage requires a separate policy or endorsement.

What do the numbers in split-limit auto liability coverage such as 100/300/50 mean?

They are limits in thousands: $100,000 bodily injury per person, $300,000 bodily injury total per accident, and $50,000 property damage per accident. Liability coverage pays for injuries/damage you cause to others.

Distinguish collision, comprehensive, and liability auto coverage.

Liability pays for damage/injury you cause to others. Collision pays for damage to your own car from a crash regardless of fault. Comprehensive pays for non-collision damage to your car (theft, fire, vandalism, hail, hitting an animal).

What is uninsured/underinsured motorist coverage?

It pays for your injuries (and sometimes property damage) when the at-fault driver has no insurance or too little to cover your losses, or in a hit-and-run. It fills the gap left by an inadequately insured other party.

What is umbrella liability insurance and what must you typically carry first?

Umbrella liability provides extra liability coverage (commonly $1 million or more) above the limits of your home and auto policies, and also covers some claims those policies exclude. Insurers usually require you to first carry underlying home/auto liability at set minimums (e.g., 250/500/100). It is inexpensive because it only pays after primary limits are exhausted.