In a recent post, I started to touch on insurance. If you think about it, each and every form of insurance is one of those things that we purchase that we hope we never have to use. Auto, life, homeowners, disability, health – to use any of these means that there has been some crisis in our life, great or small. We use insurance to transfer the risk of something bad happening to the insurance company. That’s it, and nothing more. Any insurance that promises or tries to perform more than this is probably a bad idea because you end up paying for it in higher premiums. In the next few posts, we’ll look at a variety of insurance products to help you make smart consumer decisions.
Perhaps the oldest insurance product in existence is the life insurance policy. Simply put, life insurance is paid out in the event that the insured dies. The owner of a policy is typically the insured; it is illegal to own life insurance on an insured that is not aware of the policy’s existence. When you purchase a life insurance policy for yourself, you name one or more beneficiaries to receive the payout in the event that you die. Typically you make periodic payments called premiums to the insurance company to keep the life insurance in force. When you take out a policy, you will be asked to choose a one or more beneficiaries, which is the person(s) or organization that you want to receive the payout in the event of your death. There are primary and contingent beneficiaries that can be named on a life insurance policy. Choose your beneficiary wisely – the life insurance proceeds (or payout) passes outside of any will that the insured may have in place. This means that regardless of what any will might say, the beneficiary of the policy gets the payout, pure and simple. Additionally, most forms of life insurance proceeds are tax-free to the recipient.
For most life insurance policies, you will have to meet some underwriting guidelines. Underwriting is nothing more than a process of qualifying for the issuance of the policy. Most of the guidelines are health-related, which makes it extremely important to buy life insurance (and any other insurance) before you need it. If you are healthy and young, you will get the best rates simply because your life expectancy is very high. However, factors such as tobacco use, excessive drinking, weight or blood-pressure problems, chronic health issues such as cancer or heart disease, or a family history of any of these factors can negatively affect your rate.
The most basic form of life insurance is the term policy. In it, the insurance company issues the policy for a specified term, or amount of time. The most common terms are in five-year increments, such as 5, 10, 15, 20 year term and so forth. Level term insurance means that the payout in the event of death is the same throughout the term of the policy. Decreasing term insurance means that the payout goes down as you get further and further along in the term of the policy. As mentioned, this is the most basic form of insurance, and is by far the most highly recommended. You pay only for insurance and nothing more.
Next is the whole-life policy. Typically, this has some form of savings component in addition to the basic insurance, which of course is built into the cost of the insurance and translates to a higher premium. The savings component is called the cash value of the policy, which can be received by the owner by cancelling, or surrendering, the policy. Lately there have been variations on the whole-life policy – universal life, variable life, variable universal life. These are setup to handle the savings component differently, but in the end they are essentially the same as a whole-life policy.
Accidental-death insurance is another form of life insurance that covers for a specific peril, such as a car accident, plane crash, and so forth. It does not pay out for a health-related issue. Usually these are stated as a “double-indemnity” policy, meaning that they pay twice the face value. Rates are typically low compared to whole-life policies because they are so restrictive.
As mentioned at the outset, any type of insurance that attempts to do more than just deliver the insurance product is probably a bad idea. You may be asking yourself why would a savings component be a bad idea. The answer is simple – the rates on the savings are anemic, worse than you could easily get yourself through even a bank. Far worse, upon your death your beneficiary receives the face-value of the insurance only – the cash-value is retained by the insurance company. The new variable-life policies add some provisions to receive the savings plus the insurance, but the rates of return are never what is illustrated and, let’s face it, you don’t get to use the savings – your beneficiary does.
Your need to purchase life insurance, and the amount necessary, depends on several factors. You need to ask yourself does someone depend on your income to live and meet their basic needs, and if you have enough cash on-hand to meet your final expenses. A young married father of two definitely needs life insurance to see to it that his family is taken care of. A single adult with no assets needs only enough life insurance to cover their burial. An elderly couple with significant savings and no debt probably doesn’t need life insurance because their savings can generate sufficient income should one of them die. A good rule of thumb for a married person is to have life insurance at an amount of eight to ten times their annual income, so that withdrawing 10 to 12 percent of the income annually to live on replaces their income and, properly invested, should continue to grow enough to replace itself on average. Re-assess your needs occassionally, and as your kids grow up and move out, your savings grow, your house is paid off, then your needs will go down.
As you might guess, term insurance is all we recommend because it is just a basic insurance product. Term insurance is the cheapest type of policy by far, and many companies offer very competitive rates. You can get several quotes from top insurers by going to Zander Insurance (http://www.zanderins.com) and answering a few simple questions. If you have questions about assessing your life insurance needs, please give us a call at Dollars and $ense today.
