Life Insurance Guide

Life Insurance is an economical way to financially protect your family from not having enough time to complete your plans.  It is part of an overall strategy of Financial Planning (video).   Life insurance can replace the income you would have earned to your family in case of an early death.

The buying of life insurance is at least partly an emotional decision that makes some people uncomfortable.  I guess it is because the process makes us confront that we are mortal, and some day will not be here to support the people we care about.  I think that some people feel that planning for what will happen when they are not here somehow makes the event of their death more likely.  Of course these fears are unfounded, but that does not mean they don’t exist.  It was almost two decades into my career before I got my first death claim.  I joked that buying life insurance from me was the best guarantee for a long life.

Life insurance is something we buy for others as we are not going to be the person who collects on our own policy.  But there can be great personal satisfaction from knowing that we have taken care of our family regardless of possible future circumstances.  It can also boost the confidence and happiness of our partner and children to know that we love them and have seen to it that they will always be taken care of.

Perhaps Winston Churchill said it best in a quote I found early in my career – “If I had my way, I would write the word “insure” upon the door of every cottage and upon the blotting book of every public man, because I am convinced, for sacrifices so small, families and estates can be protected against catastrophes which would otherwise smash them up forever.

It is the duty to arrest the ghastly waste, not merely of human happiness, but national health and strength, which follows when, through the death of the breadwinner, the frail boat in which the family are embarked, founders and the women and children and the estates are left to struggle in the dark waters of a friendless world.”

How Much Life Insurance Do I Need?

If you replace your income to your family if your income stops because of death, you should have enough insurance.

The financial cost to your family if something happens to you is the loss of your income.   There might be a lot of bills to pay like the mortgage, car payments, food, and living expenses and so on.  But as long as one’s income still comes to the family, they can pay those expenses and should be okay.  You can calculate the current value of the loss of your income here.

That does not mean that life insurance can’t be put to use for other purposes than just replacing your income to the family.  After all life insurance is just money paid at a future event and can be used how you want.  Other uses for life insurance often include –

  • To pay off the mortgage for the family.
  • To provide special funds for a special needs member of the family.
  • To provide for other family obligations such as children from a previous marriage.
  • To provide education funding.
  • To provide funding to charities or other causes you wish to support.
  • To fund business or contractual obligations you have.
  • To provide funds to pay the taxes on assets so the assets can be passed intact to the next generation.
  • To leave an estate free of debt
  • To provide money for funeral expenses.

Let’s get back to replacing your income for your family with life insurance.  We can use an example of someone who earns $50,000 per year.  If this person is 45 years old, then over the 20 years they could expect to earn $1,000,000 (not including future potential raises).  So $1,000,000 of insurance would at least cover the financial need to the family.

However this is not taking into the interest that could be earned on the money from an insurance policy.  If one could earn a 6% rate of return then $585,000 would be enough to fund the family for the next 20 years and have $0 left at the end.  If we also assume a 2% rate of inflation then we would need more insurance to cover increasing expenses, and in that case we would need $690,000 of insurance.  But if the actual interest earned was only 4% and there was 2% inflation, then we would need $820,000 of life insurance.  In all these cases this leaves us with a spouse just starting his or her retirement in twenty years with a zero balance in their insurance account.  They might have a problem with that thought, and so more insurance might be required to cover that which may bring us back to about $1,000,000 of coverage.

So what do all these different numbers tell us?

The amount of life insurance you need is an estimate!

We do not know when you will die, what future rates of return will be, what inflation will be, or what unexpected expenses your family may face in the future.  However the cost of insurance is much cheaper than the cost of your family running out of money, so it better to be a bit generous in your estimates.  I have delivered numerous cheques to worried surviving spouses who were now facing a lifetime of new obligations they did not expect, and have never heard one of them question if the insurance cheque they were receiving was too large.

One thing we have not yet discussed is how many assets you may have.  Net assets which do not include the family home can be used to reduce the amount of life insurance you need, and this can be considered.  At some point there may be enough assets that life insurance is not needed at all.  For example someone with $2,000,000 of assets and no debt might feel they don’t need insurance and they would have a point.

But if they are still working, it might be an indication that they still want to acquire more assets for themselves and their family, and that their family is relying on those increasing assets for their lifestyle.  Also people with higher assets often buy large amounts of life insurance to fund future liabilities like property taxes due at death as paying the insurance premiums to pay tax bills is much cheaper than using their own money to pay tax bills.

So ultimately the question of how much life insurance one needs can be based on replacing one’s income to the family, and taking into consideration other factors as one sees fit.  It is your decision.

What Type of Life Insurance to Buy

It is not surprising that over the decades that life insurance companies have competed against each other for your business they have developed a wide variety products to attract clients.  Although this may at first may seem to make picking the best policy for your circumstances to be more difficult, it actually gives you much better choices than would have otherwise been available if all these options didn’t exist.  So the trick is to educate oneself enough to be able to navigate this maze of options.  By understanding some basics, choosing the right choice is actually quite easy.

Two Concepts  – 

  1. It is cheaper to insure a younger person for a year than an older person for a year,
  2. People do not like to see their life insurance premiums increase.

So, let’s look at these two concepts in some detail as it will explain all life insurance policies.

How Life Insurance is Priced

When we look at mortality tables which record the historical death rate for a large group of people which is broken out for such factors as age, sex, weight, and smoking status, we see certain trends.  These are the life mortality  tables that all life insurance actuaries base their pricing on.

It makes sense that each year you get older, the risk of dying increases.  That means the risk of a dying for a 31 year old is slightly higher than that of a 30 year old.  Similarly the risk of a 51 year old dying is slightly higher than the risk of a 50 year old dying, but this increase is much greater than the difference between the 30  and 31 year old.  Every year you get older, the risk increases on a increasing basis.  So the risk of death compared to age is a curve.  This means the cost to insure someone increases every year as they age, it gets progressively more expensive to insure someone each year as they age, becoming much more expensive as they get into their later years.

Types of Life Insurance

 

Annual Increasing Term Insurance 

This is the first type of insurance we will discuss, and it often called Pure Term Insurance as it is simply the cost of the insurance company to insure one person for one year based on their current age and circumstances.  The cost of this insurance therefore increases each years as a person ages and these increases are a bit larger each year, and eventually a lot larger as the cost of insurance increases on a curve.  So to look at some examples of the annual renewal insurance cost for a male non smoker standard health person for $500,000 of life insurance are:

  • 30 year old $240 per year
  • 40 year old $310 per year
  • 50 year old $739 per year
  • 60 year old $2,165 per year

The second thing about insurance rates is that people do not like their insurance rates to increase.  So the annual insurance rate for a 30 year old is $240.   The annual insurance rate for a 40 year old is $310.   In-between these years they would see an increase in their premiums each and every year.

You can get your own instant online quotes for most types of life insurance here.

Term Insurance

Term Insurance takes the increasing cost of annual term insurance discussed above, and blends it into a level cost for the period of the term.  Typical term periods are 5, 10, 20,  and 30 year term periods.  Term to age 65 is also available.  The ten year term insurance policy blends the cheaper rates available closer to age 30 with the more expensive rates closer to age 40 into one guaranteed level 10 year premium which in this case could be $270 per year.  Instead of increasing each year in price like the annual term insurance policy,  the 10 year term policy increases in price once every ten years.  A twenty year term insurance would not increase in price for 20 years.

I use term insurance a lot with clients as you can guarantee a level premium for 10 or 20 years, and still have very affordable coverage.

One thing to keep in mind about term insurance it has an expiry date.  This can be somewhere between age 70 and age 85 depending on the company.  Even if you pay the increasing term premiums well into you retirement, the policy will still expire and your beneficiaries may never get paid.  So these are not good policies if you want the certainty of having a policy in force the day you die.

All good term insurance policies need to be Guaranteed Renewable and Convertible.  If you buy a term 20 policy, the premium will renew every 20 years at a new much higher premium.

When the renewal comes it is your choice whether or not to continue the policy.  What Guaranteed Renewable means is that you can renew the policy in 20 years, even if you health has worsened, or you are uninsurable.

Convertible means that at any point during the life of the term policy, up to a specified date, you can convert it into one of the companies’ pre-selected permanent policies, regardless of your current health.

Permanent Policies

Policies that stay in force for life

Term to 100

Term to 100 offers a guaranteed level cost of insurance for the rest of your life.  As long as you pay the premium the cost of the insurance will never get more expensive, and someday the death benefit will be paid.  These are simple policies, as long as you pay the premium, you are covered, that is about all there is to them.  There is no expiration date.  They blend the early low and later high cost of annual renewable term insurance into a level rate for your lifetime.

Whole Life

This was the first type of insurance available.  It again blends the low initial premiums for life insurance with the later high premiums.  Term to 100 discussed above, can be considered to be a stripped down whole life policy.

Whole life charges more premiums than are required in the early years to subsidize the later years when less premiums than are required are charged.  This difference in the early years builds up a cash reserve.  This cash reserve builds over time and will someday be used to pay part or all of the death benefit.

If you cancel this policy after a number of years, but before you die, you will receive a large part of the cash value back.  Some people may refer to this cash value as an investment, but it is really just part of how the program is set up.  Also these policies have a fairly complicated system of dividends.  This dividends are just re-payment of excess premiums not currently required by the reserve.

Universal Life

Universal Life policies where developed in part as a response to some of the perceived limitations of whole life policies.  A universal life policy can be thought of as an unbundled whole life policy.  The expenses, insurance costs and cash values of a universal life policy are more explicit, and the client has more control over the outcome of this type of policy.  This also puts more onus on the client to monitor this policy over time.

A universal life can have either term to 100 or annual renewable term as the type if insurance inside this policy.  If you contribute more than the actual premium this difference can be invested into funds with the company of your choice.   This can allow one to build up a value high enough that it may be possible for this fund to pay all future premiums.  So for example you could prefund the policy so you do not have to pay premiums in your retirement, but the insurance would be in force for the rest of your life.

One of the possible shortcomings of a term to 100 policy is that you have to keep making premium payments without fail to keep it in force.  That means if you miss a premium payment after decades of having the policy, after the 30 days of grace you can lose the policy.  This can happen fairly easily in one’s later years as their might be cognitive issues, or a snowbird might miss the renewal.   That is why I like to put term to 100 inside a universal life policy, and make sure there is at least one year’s of premium in the policy.  That way if a payment is not made on time there are enough funds to give time to get hold of the insured or family, and sort out the situation.

For these reasons I tend to use universal life when looking at permanent insurance.

Variable Life

Variable life is a type of insurance where some of the policy factors like the premium can be adjusted.  These type of policies become more prevalent when interest rates are low (like they are now) and insurance companies do not know if they can stay profitable.  There may be a formula that allows them to adjust premiums based on future interest rates.  Sometimes these policies may be necessary, but I am not a fan.

Controversy about Life Insurance – skip this part if doesn’t interest you

The weird and entertaining thing throughout my career has been the people who have been absolutely frothing at the mouth at the type of  life policy to purchase.  Some are “good” and some are “horrible” and you would have to be a complete fool to ever consider them.

The frothing started for me with a philosophy professor who insisted that term insurance was born on the wings of angels and permanent insurance was an evil by-product of the insurance industry.  As I was looking at a career of insurance at the time, and had industry access (before the internet) as to how pricing worked, I was captivated by his arguments.  I realized that the cost of of ten year term insurance was average cost over a ten year period just as permanent insurance premiums was the average cost over a lifetime.  They were both based on the same pricing model with the same profit expectations for the insurance company, and therefore the insurance company would not really care which product was sold, it was up to the consumer to make the best choice for their circumstances based on the options available.

As an example a ten year term insurance policy is great for a young family starting out who want the most protection available for the lowest possible current cost, it is a horrible policy for someone who wants to leave an endowment to a disabled child.

If you want a current example of excess frothing please check this youtube video of this video pundit.  He says that everyone needs a term insurance policy, and that permanent insurance is junk.  He cites the example of a 32 year old person with a family earning $40,000 a year.  He recommends a 20 year term policy because in 20 years this individual can expect a paid for mortgage and zero debt, up to $700,00 in his savings account, and children that will never be a cost in the future.

He also takes a stab at all insurance agents, assuming their only thought is to sell the most expensive policy possible.  That makes no sense because everyone has a budget, and an amount they can realistically spend on insurance.  Someone with a budget of $100 per month is not going to spend $700 a month just because it is recommended.  Can a Real Estate agent sell a million dollar house to someone who has a budget for a $300,000 house?  Brokers want long term relationships and are going to see to it that the $100 per month budget is spent as wisely as possible.  They get paid regardless of what type of policy is bought.  I am sure they exist, but I have never met a broker who did not want the best for his clients.

So let’s look at the likelihood of the above scenario working out.  To have 700,000 in a tax deferred account the above wage earner would have to invest about $1,000 per month into a vehicle earning an average 10% rate of return.  Perhaps the best investor in the world, Warren Buffet, recently said  that earning more than a 6 to7% rate or return is unrealistic going forward in current markets.  If our individual above also bought a $300,000 house, he needs to pay about $1,900 per month given a 5% mortgage to have that paid off in 20 years.  So that leaves him with about $1,100 a month to raise a family with and pay taxes.  Does that sound doable?  What happens to any of these lofty expectations if there is another stock market crash during his accumulation, or he is thrown out of work?

I knew this video was wrong before doing the math because family obligations last way beyond 20 years (ever had a child get married?) and because of the large amount of clients that found me in their 50s, 60s and 70s and still needed life insurance.  Telling your spouse and family that the value of their assets will decrease by $500,000 because your insurance expired is seldom.

So why do such people and many other shills put out this type of statement or video?  I can’t know what is in their mind, maybe they truly believe what they have been told because they have never examined the specifics.  Could it be that taking extreme positions leads to better viewings and books sales, whereas taking a reasonable position does not generate such heat?

Back to this badly informed pundit, let’s look at his recommendation of a 20 year term policy.  It is a good thing that no one was interviewing him that new anything about life insurance, as a 20 year term policy is closer to the permanent spectrum of life insurance policies than term, and he is evidently against permanent polices as they are a bunch of junk.  So why recommend a 20 year policy over a ten year term policy which is cheaper?  Because over twenty years it is a better value.  Let’s take a look at the math.

 

Buying the Least Expensive Life Insurance

The best way to buy the least expensive insurance is buy insurance that covers the term you expect to need it for.  If you have a 10 year business agreement that will expire, buy ten year term insurance.  If you are 45 and believe all your family obligations will be done at your age 65, buy twenty year term insurance.  If you want insurance to be in force when you die, buy permanent insurance, it’s cheaper.  Let’s look at a couple examples.

If you are a healthy 40 year old male non-smoker you can buy a $250,000 ten year term insurance policy for $205 per year.   At age 50 this policy will renew and the new annual premium for the next 10 years will be $1,075 per year.  So in twenty years you will have paid a total of $12,800 in premiums.

That same 40 year old could also buy a 20 year term $250,000 policy for $335 per year, which will not increase in price in 10 years, and will cost a total of premiums of $6,700 over 20 years.  That is about a 100% savings in premiums over what the ten year term insurance cost!

That ten year term insurance will have future annual premiums of $2,475, $7,965 and $17,250.  Then after paying all those premiums the policy will expire at age 85.  That 40 year old could also have bought a permanent policy at age 40 for $1,900 per year.  That premium will never increase and the policy will not expire and someday pay its benefit.   So ten year term insurance may be the cheapest, but it is not the least expensive, for your or your beneficiaries.  You can do your own instant quotations using my  online life insurance calculator.

 

 

Preferred and Rated Underwriting and your Health History

We have been mostly discussing life insurance issued at a standard rate.  However this is only one of the many rate classes that life insurance companies have.  They have better rates than standard for people who have better than average health (and this includes one’s families’ health history).  They also have smoker and non-smoker rates and the difference in premium between the two can be 70% or so.

I guess it is human nature that most clients I talk to say they are in great health and obviously will get the best rate available.  They say that their Dr. told them they are in great health.  My experience has been that when a Dr. tells you are in great health, they really mean that they expect you to at least live until your next office visit.

What can make you not get preferred underwriting, or even a rate policy include but are not limited to:

  • Have you visited a Dr. for anything other than an annual checkup during your life?
  • Do you have an illness?
  • Are you taking medication?
  • Is your weight ideal?
  • Is your blood pressure ideal
  • Have you declared bankruptcy?
  • Is there a history of mental illness issues or drug abuse?
  • Has there been any of the same issues with members of your family?

If you are answering yes to any of these questions, you should be getting the help of an experienced broker who can shop different companies to get you the best offer for your situation.  If so go to Step 7.

Tell the Truth on Insurance Contracts

Telling the truth on insurance contracts may seem obvious, but these are special contracts that come under the definition of “contracts that require the utmost good faith.”  The insurance company takes on a large risk when they insure someone in return for just the first month’s premium.  In order to do that they have to be able to rely on the information given to them in the application, and are entitled to do so under law.

A life insurance policy can be voided by the life insurance company for its first two years if there is a suicide, or if the applicant made a relevant mistake on the application.  However the policy can always voided for fraud.  What is fraud is a question for the courts but could include such things a misstating your smoking status, or not mentioning that you once visited a Dr. because you were considered symptoms you were having could be a serious disease like cancer or Multiple Sclerosis, but so far nothing has been diagnosed.

It is therefore to your benefit to be completely forthcoming and accurate on the application.

Summary

  1. Buy enough life insurance to protect your family. The economic loss to your family if you die is the loss of your future income.
  2. If your budget is an issue, cover this insurance need with the initial low cost of ten year term insurance.
  3. The cheapest insurance initially is not the least expensive insurance, buy the least expensive insurance your budget allows which covers the time period you expect to need the insurance.
  4. If you want your life insurance to pay when you die, buy permanent insurance.
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