Continuing Case: Cory and Tisha Dumont
Continuing Case: Cory and Tisha Dumont
1.Using the earnings multiple approach would result in the following life insurance calculations for Cory and Tisha. Cory’s needs= $38,000 x (1 – 0.22) x 12.46 = $369,314
Tisha’s needs= $46,000 x (1 – 0.22) x 12.46 = $447,065
Cory currently has $76,000 (2 x $38,000) of term life insurance through his employer. Consequently, Cory should consider purchasing approximately $293,000 of additional life insurance coverage. Tisha has $69,000 of term insurance through her employer, as well as a whole life policy of $50,000. She should consider purchasing an additional $328,000 of life insurance coverage ($447,065 – $119,000). While Tisha or Cory would continue to earn their salaries, if widowed, and would receive some Social Security benefits, they would experience a significant reduction in their standard of living without adequate life insurance.
2. The Dumonts, and Cory in particular, take a big risk when their life insurance is entirely in the hands of their employers. If Cory or Tisha leave their jobs, their group term coverage ends. However, they may be able to convert the group coverage to an individual policy. Since the Dumonts need additional life insurance, they should purchase individual policies to supplement the coverage they have. This will reduce the risk of later becoming uninsurable or, if they were to lose their jobs, having no life insurance at all.
3.At their stage in the life cycle, term insurance is the best option for the Dumonts. It provides the greatest amount of insurance per premium dollar. Universal and variable life policies both include cash value components, through earnings from interest or mutual funds, respectively, which increase the cost of insurance coverage. These policies also tend to have high insurance, investment and administrative expenses, which add to their cost. The option to skip the premium payment on universal life or a variable universal life may prove too tempting, as it does for many policyholders, who subsequently let the policy lapse. The Dumonts would be well advised to purchase affordable term insurance and do their saving/investing outside of their insurance policies.
4. The life insurance policy features that should be explained to the Dumonts include: Type of policy: term or cash value. The Dumonts’ policies provided at work are group term insurance policies available for the duration of their employment. Tisha also has a whole life policy (cash value insurance) with $1,800 of accumulated cash value. Nonforfeiture clause (on Tisha’s whole life policy): options for receiving a policy’s cash value, a paid-up whole life policy with a reduced face value, or a paid-up term policy with the original policy face amount in exchange for ending the policy. The Dumonts could exercise this right if they are unable to pay the annual premiums to continue the coverage for an extended period of time. Beneficiary designation: persons named as primary and contingent beneficiaries to receive the death benefits from the policy. Coverage grace period: automatic extension, usually 30 to 31 days after a premium payment is due, before a policy lapses.
The premium may be paid without penalty. Loan clause: (on Tisha’s whole life policy) describes procedures and the interest rate charged for borrowing against the policy’s cash value. Suicide clause: clause stating that the face amount of the policy will not be paid for a suicide death within 2 years of the purchase of a policy. Incontestability clause: clause stating that the insurance company cannot dispute the validity of a contract after it has been in force for a specific period, usually 2 years. Settlement options: section that describes alternative ways that the beneficiaries of a life insurance policy can choose to receive death benefits. Riders: special provisions added to a policy that either provide extra benefits or limit the insurance company’s liability. Riders attached to one or more of the Dumonts’ policies could include: guaranteed insurability, multiple indemnity, COLA, waiver of premium for disability, or living benefits.
5. Life insurance is meant to provide funds to replace a breadwinner’s to protect and support dependents. Chad and Haley are dependents, not income
providers. Therefore, the purchase of life insurance is unnecessary and not recommended. The Dumonts should use the money they would spend on policies for the children to increase their own coverage.
The claim that Chad and Haley would always be insured is only relevant if (1) the Dumonts continue the premium payments and (2) there is a high probability, based on family health history, that Chad or Haley will contract cancer, diabetes, or heart disease. Otherwise, they will be eligible for insurance in the future and there is no need for “permanent” coverage starting at this young age.
6. As a “comprehensive major medical insurance policy,” the Dumonts’ coverage includes basic health insurance for hospital, surgical, and physician expense needs, as well as major medical expense coverage. The latter is very important to extend the basic coverage to protect the Dumonts from the financial effects of a catastrophic illness or accident. The policy has a very adequate lifetime cap of $3,000,000 per insured. The Dumonts should continually analyze the health plans from both employers to determine which offers the best overall plan. But, the annual coinsurance, stop-loss amount, and family deductible, are all standard policy features with reasonable amounts. They are currently paying annual premiums of $2,700 for the coverage, but the monthly opt out fee, from Cory’s employer, effectively reduces this by $1,020 (less the taxes paid on the increased income). Overall, their health care coverage is very cost effective, so no changes are recommended.
7.The Dumonts have four options for paying a $5,000 medical bill incurred through an auto accident, including payment by: Health insurance.
Medical expense coverage with their auto insurance. Bodily injury liability coverage on an auto policy, assuming someone else was at fault for the accident. Personal funds, or out-of-pocket. These funds would supplement the health insurance coverage, or be the only source of payment, should the Dumonts not have health insurance. Luckily, they do.
Expenses for an emergency appendectomy would be covered through health insurance and personal funds. Assuming no one else has made a claim this year, Tisha’s health insurance would pay $3,600: the $5,000 medical bill minus the $500 deductible and the $900 of co-insurance (0.20 x $4,500). Tisha would be responsible for the $1,400 of deductible and co-pay expenses because the Dumonts’ out-of-pocket expenses for the year have not yet exceeded the $5,000 stop-loss limit.
8. Advantages for the Dumonts of switching to an HMO include: regular physical examinations and preventive care, minimized paperwork, and lower costs. Tisha may be able to reduce the $225 monthly premium charged for her current coverage. Disadvantages associated with an HMO focus on concerns about quality of care stemming from the incentive system—quick, cursory services and the difficulty in receiving a referral, particularly outside the geographic region. Some fear the system does not allow for building a trusting relationship with a well-qualified physician. Restrictions on physician choices and the associated level of reimbursement vary with the HMO system: individual practice association, group practice plan, or a point-of-service plan. The Dumonts need to thoroughly comparison shop the plans; Checklist 9.2, Choosing an HMO, should be helpful.
If Tisha switches to a PPO, costs and paperwork may also be reduced. Members, typically representing an employer group, receive health care at a reduced cost—with the negotiating power of the group determining the level of discount. The disadvantage of a PPO is that participants must seek medical services from participating doctors and hospitals, thereby limiting their choice of care. With a PPO, a participant can go to a non-member doctor but must pay an additional, or penalty, co-payment to do so.
9.Assuming Tisha works for an employer with 20 or more employees, she is eligible—under the federal COBRA law—to continue health insurance coverage for 18 to 36 months, depending on the reason for leaving the company. Tisha would be responsible for the full cost of coverage, but it may be less expensive than an individual policy. Although this does not apply to every “opting out” situation, the Dumonts also have the option of enrolling for Cory’s health coverage. According to the Health Insurance Portability and Accountability Act of 1996, employees and their dependents must be allowed special enrollment rights, beyond the open-enrollment period, (1) if they declined coverage because of coverage through another plan or (2) if their family situation changes (e.g., marriage, birth, adoption). The former situation applies to the Dumonts, so if Tisha loses her family medical coverage, the Dumonts could enroll on Cory’s plan. To insure protection from preexisting condition exclusions, it would be important that the Dumonts arrange for continuous enrollment, with no breaks or lapses between policies.
Should Tisha decide to become a self-employed accountant, the Dumonts would have another option besides Cory’s coverage. The household would be eligible for a high deductible health plan and a Health Savings Account (HSA). Access to a HSA is limited to the self-employed, small business owners, employers of small to medium-sized businesses that offer very limited health benefits, and those under age 65 who individually pay for health care—all of whom must have a qualified high-deductible health plan. The combination is cost effective because high-deductible plans have lower premiums and annual HSA contributions (limits apply) are an adjustment to income, so the funds are not taxed and they grow tax-deferred, and tax free, if spent according to the HSA rules. The HSA funds accumulate for paying health care costs incurred prior to meeting the annual deductible or for health care expenses not covered by the high-deductible health plan. Funds not spent remain in the account for future expenses, such as for health expenses after retirement or long-term care expenses.
10. Disability insurance policy features that Cory and Tisha should purchase include: Definition of disability: Tisha and Cory should look for a policy that provides coverage if they can’t perform the duties of their current occupations (i.e., accounting and retail management). Residual or partial payments benefits: this policy feature provides partial payments if they were disabled and unable to return to work full-time, but could return part-time. Benefit duration: the Dumonts should select policies that provide benefits until retirement age (e.g., 65) or for their lifetime. Waiting or elimination period: the Dumonts should select a realistic waiting period (i.e. one to six months) during which they would have to “absorb” the income lost. They should consider their employer’s sick day policy (e.g., whether or not sick days can be accumulated) and emergency fund when selecting an elimination period. The longer the delay, the lower the premium. Waiver of premium: this important provision waives premium payments if a policyholder becomes disabled. Noncancelable: this provision protects against both policy cancellation and future rate increases and guarantees that the policy is renewable. Rehabilitation coverage: this provision provides for employment-related educational or job-training programs.
11.The Dumont’s $25,000 HO-4 renter’s policy amount is probably sufficient given their estimated personal property value of $12,000. However, their property insurance coverage is inadequate for two major reasons: It lacks replacement cost coverage on personal property, which provides for the actual replacement cost of a stolen or destroyed item (e.g., stereo equipment). Currently, the $25,000 coverage is actual cash value, or coverage for the depreciated cost of property. It lacks a personal articles floater to increase the limit of coverage on Tisha’s $19,700 antique jewelry collection. To improve their coverage, Cory and Tisha should add a replacement cost rider and a personal articles floater to the existing HO-4 policy. Increasing the deductible could offset a premium increase. See the response to question 14 below for other cost saving ideas.
12.The Dumont’s auto insurance is inadequate because of its low liability limits. The 25/50/25 split liability and property damage limit is extremely low in relation to current medical, repair, and liability costs. The Dumonts should increase their liability limits to at least 100/300/50. Otherwise, they could be liable for judgments in excess of their current liability limits. Higher limits, such as 200/600/100, are also available. The Dumonts also have low uninsured motorist coverage limits. These, too, should be increased to a minimum of 100/300/50 to provide adequate protection against negligent drivers who carry no or inadequate liability coverage. The $20,000 of medical expense coverage is far lower than the recommended $50,000 of coverage per person. Assuming the Dumonts increase their emergency fund or other savings, they should increase the $200 deductible amounts.
13.Cory and Tisha’s current auto insurance policy would pay $25,000 for bodily injury losses incurred by any one person hurt in the accident, a total of $50,000 for bodily injury losses incurred by all persons hurt in the accident, and $25,000 for property damage if they were judged to be at fault. In other words, these are maximum liability coverage limits. If the accident resulted in a total of $65,000 of bodily injury losses to more than one person, the Dumonts would be personally responsible for arranging payment for the remaining $15,000. However, if the $65,000 in bodily injury losses were incurred by only one individual, the Dumonts would be personally liable for $40,000. This coverage is not adequate; the Dumonts are risking their financial future in lieu of paying a slightly higher annual premium.
14.To reduce the cost of property and liability insurance, the Dumonts could: Make every effort to keep their insurance credit score high, to qualify for lower premium rates. Increase insurance deductibles (e.g., $200 to $500 or higher). Take advantage of multiple policy discounts (e.g., HO-4 and auto insurance with the same company). Pay insurance premiums less frequently (e.g., annually or semi-annually instead of monthly). Shop around and compare the costs of at least three insurance providers. Consider only high quality insurers, and possibly a direct writer. Install security systems or smoke detectors.
Inquire about ANY other available discounts; these can vary significantly by company and may relate to the property (home or auto, such as fire-resistant building materials, auto passive restraints or anti-theft devices) or the characteristics of the policyholder (e.g., over age 50 or 55, noncommuter, or good student). Buy a car that is cheaper to insure and consider low “damageability” models; be sure to check insurance rates when auto shopping. Drive less (e.g., fewer miles, join a carpool) and improve driving records. Double check your policy to insure that all features and endorsements are included as planned; a claim could be costly that you thought was covered, but was not because of an oversight in the policy. Include adequate liability insurance to avoid paying damage awards from personal assets or income.
15.When the Dumonts become homeowners, they should purchase an HO-3 policy. An HO-3 policy is the most comprehensive of available policies for homeowners because it covers losses to the structure from all perils except those that are specifically excluded. Typical excluded perils include flood, earthquake (supplemental coverage is available for both, if needed), war, and nuclear accident. Coverage on an HO-3 policy on the contents is limited to the named perils coverage provided in a broad, or HO-2 policy.
The Dumonts should strongly consider adding personal property replacement cost coverage for their contents. The additional premium cost of 5 to 15 percent over the cost of a policy without this coverage is meager when compared to the increased level of reimbursement. Inflation guard and personal articles floaters—particularly for Tisha’s antique jewelry or any other items that exceed the value of the policy limits—should also be added. The minimum level of $100,000 of personal liability coverage is likely inadequate, and should be increased to $300,000 to $500,000. However, the Dumonts should review this relative to their individual situation (i.e., pets owned or other unique situations). Cory and Tisha should consult Checklist 10.2, A Checklist for Homeowner’s Insurance, when shopping.
An umbrella policy extends the liability coverage of the auto and homeowner’s policies owned by the insured. An umbrella policy protects against large lawsuits and judgments associated with your home or auto. Umbrella policies do not cover activities with the intent to cause harm, activities with aircraft and some watercraft, and most business and professional activities. The latter require a separate policy.
Typical limits range from $1 million to $10 million; the policy does not become effective until the limits of the underlying policies have been exhausted. As the Dumonts proceed through the life cycle and attain more wealth, they may want to consider a policy of this type. However, in the
interim, a more cost effective alternative may be increasing their existing liability limits to $300,000 or $500,000.