At some point in your financial life, you will address the issue of life insurance. You will do so either because you recognize your death could create a financial hazard (to your family, your estate, your business), or because your financial advisor will bring it up. Either way, it’s probably not a topic you will drive into with enthusiasm.
This is understandable. After all, the “main event” in life insurance is your death. Not exactly a happy thought, or something that one wants to contemplate in any great detail. Considering this rather uneasy connection with dying, life insurance is an issue most people think about as infrequently as possible.
Adding to the contemplation of one’s eventual demise is the fact that consumers have a hard time understanding life insurance policies, a situation made even worse by the overwhelming variety of products to choose among. Then, consider that from a marketing perspective, life insurance is not a product with sex appeal. No wonder life insurance is almost a taboo topic for regular discussion, one to be avoided like religion and politics in polite company.
But that doesn’t make the topic any less important from a financial perspective. If properly structured, a good life insurance program has the potential to provide a host of prosperity-enhancing benefits. On the other hand, a poorly considered approach to life insurance can be the source of significant financial loss. Financially, if you blow it off, or neglect it, you do so at your own peril.
And while it may not be a hot topic for anyone else’s dinner table discussion, life insurance is also a passionately debated issue for financial planners. Some very divergent approaches to life insurance have emerged, and the supporters of the respective views are almost religious in their commitment to a particular philosophy.
The reluctance to discuss life insurance, combined with the diverse views about how to use it, leads to an almost schizophrenic application by the consumer. Current statistics indicate several curiosities regarding life insurance. First, almost 80 percent of all American households have life insurance protection. Second, a large percentage of those that have coverage (in some instances over 90 percent) don’t keep it.
Is life insurance a waste of money? Of course not. Life insurance has a legitimate place in almost every financial plan. The challenge with life insurance is how to make it a worthwhile financial asset, instead of a needless expense.
Here are some basic assumptions that should frame any evaluation of life insurance:
- Everyone dies. It’s a bummer, but it’s true. Notwithstanding the headlines in the tabloids about Elvis and JFK, mortality is a 100 percent guaranteed occurrence— for everyone.
- Life insurance is unique. Unlike automobile, home, health or disability insurance, life insurance is the only type of insurance involving a guaranteed event— your eventual demise. Thus, every life insurance policy could conclude with a payment of a death benefit.
- Life insurance is a business proposition—for you and your business company. In order to make an intelligent financial decision about life insurance, you must understand the financial incentives and constraints that drive the insurance company. Life insurance companies understand the unique characteristic of their policies. They know that once someone is approved for coverage, the company is on the hook as long as the policy stays in force. They price their products accordingly, because they must be able to guarantee that enough money will be available to meet the death claim, should it occur.
- Life insurance prices are based on statistics and probabilities. No matter what type of coverage you consider— term, whole life, universal, variable, etc.— all policies are priced according to statistical models constructed by actuaries. The insurance company will use every available piece of information (age, sex, medical history, activities, etc.) to place each prospective policyholder into an identifiable statistical category, one they can evaluate in terms of risk versus reward.
This explains why the premiums for life insurance increase as you get older. The possibility of the insurance company paying a claim is much more likely, and the company knows it must collect enough premiums to make insuring you a reasonable financial proposition— for you and the company.
This is also why insurance companies prefer to insure those likely to live a long time. A longer life expectancy means more premiums to be collected, and a longer time before a benefit must be paid. For this reason, companies require examinations— to help determine factors that indicate the people who are most likely to be “long-livers,” and those who are not.
With an understanding of these issues, two general conclusions can be made:
- The sooner you obtain life insurance, the better. This isn’t philosophy, it’s statistics. Two critical factors are age and health. Every year you put off purchasing life insurance, you risk pricing yourself out of having the option of getting it.
- Keeping life insurance in force until you die is the only way to guarantee a return on the dollars spent on coverage. Regardless of the type of life insurance you buy, you must keep the coverage in force for the rest of your life so that a claim is paid at your death. A death claim is the only way to guarantee a financial benefit from the insurance expense. If you keep the life insurance, the death benefit can be considered an asset, not a liability.
Having an insurance benefit creates a certain financial transaction at your death. This guaranteed “financial transaction” can be used as a powerful, positive influence on other financial transactions.
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