Life Insurance and the Role It Plays in Risk Management - Assignment Example

The paper "Life Insurance and the Role It Plays in Risk Management" is a worthy example of an assignment on finance and accounting. Life insurance is an essential part of financial planning to mitigate the risks of death and the consequential financial difficulties of family members. An insurance company creates the common corpus fund out of the premiums received from subscribers and pays out claims from the same. Different types of policies cater to the specific needs of individuals and the cost/benefit analysis is important before choosing the right type of policy.

 Life Insurance

1. Principle of life insurance

The word ‘insurance’ means a provision against risk. Hence, life insurance is a cover for any possible risk of loss of life. By taking a life insurance policy, the insured is transferring the risk of financial loss to which his/her family may be subjected in the event of death, to the insurer. In practical terms, life insurance is a business activity and has three dimensions to it viz., the social, business and legal (Anon, n.d., the americancollege.edu). In social terms, a large number of people pay premiums to create the corpus fund from which the insurance company pays out claim checks; in business terms, the insurance company does not pay anything from its pocket but creates and manages the corpus fund, which is used to cover the management and administrative expenses, payout claims and invest the balance in profitable ventures; in legal terms, the insurance policy is a contract on the basis of agreed terms, between the insurer and the insured to indemnify the insured against financial loss caused by death. Under the contract, the risk is transferred from the insured to the insurer, for the consideration of premiums paid.

2. Why do people buy life insurance?

Life insurance is a risk management act (Anon, n.d., americancollege.edu). While death is certain as one age, there is always the risk of a person dying before accumulating enough wealth to take care of his/her obligations including the financial security of the family. In the normal course, the person would have planned to discharge the obligations from out of his earnings, investments, and savings. If the person’s life is cut short for any unexpected reason, the financial burden of obligations like mortgage payments, children’s education, healthcare and retirement expenses, etc. would shift to the rest of the family members, who may not be in a position to honor/bear them. Hence, people buy life insurance to at least partly mitigate such risk.

3. What are the benefits/drawbacks of universal life insurance?

Universal life insurance is a policy that provides for life cover and tax-deferred savings facility simultaneously (Sage, n.d, about.com). It is thus a life insurance plan as well as an investment plan. One of the benefits of universal life insurance is that if the policy period is long enough to permit good accumulations in the tax-deferred savings part of the policy, it will not be necessary to pay premiums for the entire policy period. At the same time, for this benefit to accrue one has to have the policy beyond the age of 70 or so at which point in time, most people do not need life insurance at all. While it is possible to access funds from the savings part of the policy to meet any contingency, the corresponding amounts are reduced from the payout to be given to the beneficiary (Anon., 2009, goinsurance.com). Finally, this type of policy may be more expensive than normal term policies.

4. Why would compare only the cost of life insurance coverage not be a completely valid approach to determining the best policy?

A person’s insurance needs depend upon several factors such as age, education, nature of employment and related risks, current/potential future earnings, financial needs of the family, etc. With so many variables, it is natural that different insurance products with differing costs are available. Individuals have to choose such a policy that best fits their life situation and financial planning needs, and consider the costs as secondary. Once a policy type is chosen, then the coverage value can be tailored to be within affordable costs.