Trieschmann, Hoyt & Sommer

Life, Health, and Loss of Income Exposures

Chapter 4

©2005, Thomson/South-Western

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Chapter Objectives• List and describe the types of potential losses associated with the

risk of premature death• Discuss the factors influencing the need to partially or fully replace a

deceased’s income for his or her surviving children and/or spouse• Describe ways a business can lose money when an employee or

owner dies prematurely• Explain the nature of a mortality table and give examples of how it

can be used for personal risk management• Describe several types of medical expense loss that can be incurred• Distinguish between types of disability loss and explain the nature of

the subjective element in disability• Explain the general principles underlying unemployment insurance

that exists in all states• Describe several factors influencing the frequency and severity of

income losses due to retirement

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Exposures Due to Premature Death

• Most people face a risk associated with death – That of timing

• Death is sure to occur ultimately but the specific day and time it will strike are generally unknown for most of a person’s life

• If death occurs suddenly when an individual is performing important and unique functions for an employer – The resulting financial loss to the business can be significant

• If death occurs during a period when an individual is a major financial provider for young children or other dependents – The effects on the survivors can be devastating

• If the death occurs “too late” – A person may outlive his or her financial resources

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Exposures Due to Premature Death

• Premature death– Death that occurs before the life stage where death

becomes increasingly accepted by society as part of the natural, expected order of life

• On average baby boys born in the U.S. in 2000 can expect to live for 74.1 years – Baby girls can expect to live for 79.5 years

• Some persons believe that for newly born children, any death that occurs prior to these ages is premature

• For risk management purposes, it is helpful to classify any death prior to a planned retirement age as premature

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Executor Fund

• When a person dies, there are some immediate expenses associated with the funeral and burial or other disposition of the body – These services can be paid for on an itemized basis

or through package plans – Average over $5,000.00 in addition to the cost of a

cemetery plot and headstone • Soon after the funeral, arrangements must be

made for paying the deceased’s outstanding debts – And for transferring any remaining assets and

personal effects to survivors

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Table 4-1: Services that can be Provided for or Arranged by Funeral Directors

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Executor Fund

• Sometimes used to refer to these expenses because the executor of the estate needs funds to pay for the expenses incurred as a result of the death

• Executor fund expenses arise no matter when death occurs – Some expenses such as estate taxes may

grow more burdensome as a person ages and accumulates large amounts of wealth

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Income Needs of Survivors

• If someone is providing full or partial monetary support for other family members – That person’s death will affect the family

financially as well as emotionally

• As a person passes through different stages of live – The degree to which others are financially

dependent on him or her changes

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Surviving Children

• Young children are usually totally dependent on their parents for food, clothing, shelter, and other necessities

• A parent’s death has the potential for eliminating a child’s primary or sole source of income

• The timing of a parent’s death will affect children differently – Depending on the ages and circumstances of the children

when the death occurs

• The parent must also decide whether or not they wish to contribute toward paying for a child’s college education

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Surviving Spouse

• During the course of a couple’s married lives, there be maybe many situations in which people shift the degree to which they depend on each other financially – Leads to the dynamic rather than static analysis of

potential income needs

• The relative degree of financial dependence of each spouse on the other is always subject to change

• When children enter the picture, work patterns may change

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Other Surviving Dependents

• An individual may provide some degree of financial support for persons other than a spouse or child– Examples include

• An elderly parent living with a grown child• Grandchildren living with their grandparents • Siblings living together

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Business-Related Exposures

• If an employee performs services that would be especially hard to replace – That person may be considered a key employee

• His or her death may cause plans or projects to be abandoned

– Or the business may seek a replacement person following the death of the key employee

– Costs involved may include

» Loss of efficiency for a period of time

» Increased salary to attract someone new

» Training and development expenses for the replacement

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Business-Related Exposures

• A person who has ownership rights in a firm may die – When a sole proprietor, partner, or a major

stockholder dies • That person’s ownership may pass to persons unfriendly to

the firm • It may even result in liquidation of the firm in order to pay the

person’s executor fund expenses • Competitors may obtain controlling ownership by purchasing

shares from families of deceased stockholders • Those who inherit the deceased rights may enter the

business – But due to inexperience may cause losses or even bankruptcy

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Likelihood of Premature Death

• Aggregate death rates in the U.S. have been declining for many years – Due to advances in medical technology and

improved economic status

• In calculating the probability of premature death, mortality tables have been developed – Express the probability of living and dying at

various ages in a convenient format for a particular assumed population of persons

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Likelihood of Premature Death

• Death rates in insurance mortality tables are purposely overstated for conservativeness– To reflect the possibility of unusual fluctuations in

death rates in some years • Figure 4-1 contains a graph of 2001 CSO death

rates on a semilogarithmic scale – Death rates during the first few years of life are higher

than they are following ages nine or ten – Beginning at about age 60 death rates began to climb

significantly – At every age, the death rate is higher for males than

females

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Figure 4-1: The Mortality Rate, 2001 CSO Mortality Table

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Needs vs Human Life Values

• Identifying needs and resources is consistent with the overall risk management process– Identified risks are analyzed and alternatives are

considered and combined into a comprehensive plan for their management

• Human life value may have relevance – The sum of money that, when paid in installments of

both principle and interest over the individual’s remaining working life

• Will produce the same income as the person would have earned after deducting the assumed amounts for tax and personal maintenance expenses

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Exposures Due to Loss of Health

• Losses resulting from health problems usually fall into two categories – Expenses that must be paid for medical care – Income that cannot be earned due to time

away from work while health problems persist

• While loss of health can be permanent, it is more often a temporary phenomenon

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Medical Care Expenses • Expenditures for medical care in the U.S. have exploded in recent

years – Now equal about 16.7 percent of disposable personal income

• Factors contributing to the high cost of health care – The mere fact that people are living longer

• Because health problems usually become more frequent and severe with age

– New medical technology and the demand by patients for state-of-the-art treatment

– The increasing frequency and severity of liability awards for medical malpractice

• Doctors and hospitals must pay higher malpractice insurance premiums • They may also performed extra procedures and tests in addition to those

that are probably necessary as a defensive measure – Cost shifting

• Higher hospital charges are assessed to some patients but not to others

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Medical Care Expenses: Hospitalization • Approximately 37 percent of personal health

care expenditures in the U.S. is attributable to hospital costs – Expenses are incurred for items such as room and

board, lab tests, supplies, prescription drugs, services by physicians, surgeons, nurses, etc.

• The frequency and severity of losses vary considerably by geographic location – The national average number of days for a hospital

stay is 5• However, in Nebraska and Hawaii the average is 8 • While in New Mexico, Oregon and Idaho the average is 4.5

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Medical Care Expenses

• Physicians and surgeons services – Fees vary according to the

• Geographic area • Medical specialty of the provider • Type of visit (initial, follow-up, or in the hospital)

• Dental care – About five percent of all personal health care

expenses – Some of the expenses are for major restorative work

• But many expenses result from procedures that are preventable

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Medical Care Expenses

• Prescription drugs and other expenses – Represent over five percent of U.S.

healthcare expense

• Mental health services – Common problems include depression,

anxiety, phobias, and obsessive-compulsive behavior

– In recent years the use of mental health services has increased considerably as have the costs of these services

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Medical Care Expenses: Long Term Care • Persons age 85 and over as a percentage of the

population have been growing at a fast pace – Diseases such as arthritis, Alzheimer’s and osteoporosis

become more prevalent with age • Persons with these ailments are less likely to be able to maintain

independent living arrangements

• Long term care options include – Skilled nursing home care – Custodial nursing homes – Personal care homes – Intermediate nursing home care – Home health care

• Expenses depend on the level of medical services provided– The cost for one year of custodial nursing home care can easily exceed

$50,000

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Loss of Income

• Disability loss – When a person is unable to work because of an

illness or injury • Most disabilities are temporary

– The person eventually recovers and returns to work • However some are permanent

• Disabilities can be further classified as– Total

• Person is completely incapable of gainful employment during the time of the disability

– Partial • Person experiences a decreased ability to earn a living but

not a complete cessation of employment possibilities

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Causes of Disability

• Accidents

• Illnesses – Most common cause

• There are differences between males and females regarding causes of disability – Males are more likely to experience accidents – Female are more prone to illnesses

• The risk of disability increases with age

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Length of Disability

• Continuance tables have been developed to gauge the likely severity of disability for personal risk management purposes

• Table 4-5 provides information regarding the likelihood of initial and continuing disabilities – For 25-year-olds employed in generally nonhazardous

occupations • While it is quite likely that many people will at

some point suffer a disability resulting in time lost from work – The probability that the disability will be permanent is

rather low

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Table 4-5: Disability Continuance Table …

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Effects of Disability

• Primary loss is the loss of income that would have been earned if the person had not become disabled

• The length of time of the disability is the major determining factor in determining the overall size of the income loss – Income losses can have varying impacts on family members

• Depends on the degree to which other persons rely on that income for their support

• In contrast to death, no significant decrease in living expenses is expected when a person is disabled – Living expenses may also increase if nursing home care or other

assistance is required

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Other Income Loss Exposures: Unemployment • During peacetime years the U.S.

employment rate has typically ranged between 4 and 7 percent

• Government unemployment insurance programs are in effect in all states – Designed to alleviate the effects of short term,

involuntary unemployment – Only offers a floor of protection, not full wage

restoration

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Other Income Loss Exposures: Unemployment• To be able to collect unemployment

insurance benefits – Unemployed worker must either have

• Worked for some minimum period during the previous twelve months

• Earned some minimum amount of wages

• Most states require a one week waiting period before benefit payments begin

• Claimants must be able to work if work is offered

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Other Income Loss Exposures: Unemployment• A worker may be disqualified from receiving

benefits – The worker may lose the benefits for a specified

number of weeks or for the duration of unemployment – Or suffer a reduction in benefits

• Reasons for disqualification – Voluntarily quitting a job without good cause – Discharge for misconduct connected with the work – Refusal without good cause to apply for or accept

suitable work – Unemployment due to a labor dispute

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Other Income Loss Exposures: Retirement • There is a high probability that most young people will live to the

traditional retirement age of 65• Sources of income for elderly persons

– Payments from employee retirement plans – Federal social security benefits – Part time earnings – Investment income from financial assets – Public assistance

• Unfortunately, many older people have very limited amounts of guaranteed income and few financial or property assets

• Experts believe between 70 and 80 percent of pre-retirement income is needed – For a retired, married couple to maintain the same standard of living

• Also few people know exactly how long they will live – People may outlive their retirement savings