When buying insurance, you can be overwhelmed by an information avalanche. To protect your future from poor choices today, organize your insurance search by reaching back to grade school and employing the use of the 5 W’s: Who? What? Where? When? Why? and How much?
The classic argument to avoid life insurance runs, “If I die, why do I need money?” You don’t — but your family, your business or your favorite charity might. So anyone with dependents, human or otherwise, might need life insurance.
Of course, if you don’t need to protect anyone else, insurance is not a wise way to spend money.
According to Steve Kramer, who has served on the members’ insurance and benefits committee of the California Society of Certified Public Accountants for 27 years, this group not needing insurance includes people who have raised and educated children now living independently, folks who have accumulated sufficient assets to support a surviving spouse and the single elderly (and not-so-elderly) population.
People approach life insurance with predisposed notions, says Rory Roniger, CLU, ChFC, head of the financial services arm of the Eustis Insurance Group in Metairie, La.
“They might be oriented to term insurance, yet don’t have a good argument as to why,” he says.
“Any kind of insurance is a contract with requirements on both sides,” says Dave Evans, CFP. “Unfortunately, too many people think life insurance is a commodity, like going to the grocery store and picking up a piece of fruit to judge.”
“Term” insurance forms the base of every life insurance policy. Think of it as renting a safety net: The owner pays a fixed premium toward a concrete payoff over a specific time. If you die during this period, the insurance company pays the promised amount. When the policy reaches its deadline, the coverage vanishes.
Lawrence Wentz, who owns the Kindt, Kaye and Wentz agency near Philadelphia, says that contracts aren’t that cut and dry. Many companies sell term policies that guarantee a rate for only 10 years of the protection. A few providers guarantee just a year at the starter rate.
After the secured period ends, the company can charge one of several rates filed with the state insurance commissions.
Speaking of rates, start by assuming the initial quoted rate for your age and life circumstances is too low.
“I’ve placed people of all age ranges, and not many get this thoroughbred rate after the physical exam and application submission,” Wentz says.
The good news: Changing health status during your term limits doesn’t affect premiums or payoff. The rub comes when that contract ends. Many companies allow you to buy another policy, but at higher rates to balance your changed health status.
Some insurers offer convertible policies that allow a return client to take out another policy at the rate of a healthy person, but you pay a higher premium for the privilege.
Insurance companies also offer three variations of permanent life insurance — that is, insurance that covers you for your entire life.
Whole life offers term insurance’s set payoff for a set premium, except this policy doesn’t come with an ending date. You’ll pay the premium for the rest of your life, unless you decide to cash in and receive the cash value as a lump sum.
According to the Life and Health Insurance Foundation for Education, “the cash value of a policy is different from the policy’s face amount. The face amount is the money that will be paid at death or policy maturity. Cash value is the amount available if you surrender a policy before its maturity or your death.”
With universal life, the insurance company separates the investment and death benefit portions, socking your investment dollars into its choice of bonds, mortgages and money market funds. Then your investment fund pays for the cost of the set death benefit. And, according to LIFE, no matter how badly the investments pan out, the insurance company guarantees you a minimum return.
You, as the policyholder, can change the premiums and death benefits to suit your current budget, so this appeals to younger crowds.
Finally, if you buy variable life, the death benefit payoff depends on your success in picking investment opportunities with the money (although the insurance company does cough up a guaranteed minimum death benefit at your death if you screw up too badly). These policies must be registered with the U.S. Securities and Exchange Commission.
According to Wentz, most Americans need a combination of these products to adequately protect their assets.
Approximately 90 percent of life insurance is sold at the kitchen table; a growing 7 percent to 10 percent is sold over the Internet, according to AccuQuote’s statistics. In either case, caution should prevail.
“This is not something you want to screw up and leave someone in the lurch,” Evans says.
First, do you buy through an independent agent or company representative? Independents contend that company representatives find motivation in the month’s sales contest to win a Caribbean cruise.
Calling the company directly also may add to your responsibilities, notes Cheryl Gentry, vice president of individual marketing support at American United Life Insurance Company in Indianapolis.
“You usually get a reduced cost in that product because you’re asked to orchestrate the medical exam, follow up with filings and handle your own account,” she says. AUL works through agents.
Agents, whether company-specific or lone rangers, should provide customer service that walks you through annual statements, untangles premium payment issues and interprets fine print. Good agents can find companies that do things like interpret high blood pressure or cholesterol history in laxer terms, or use unisex weight tables, which are kinder to heavier women.
Commodity-minded citizens — usually the same crowd that prefers online discount stock brokerages — tend to like the Internet’s no-nonsense quoting capability.
If you take this route, be careful. If you buy the wrong plan or choose the wrong company, you probably won’t realize the mistake for 20 years.
“In the end, consumers should buy their insurance from whomever gives the best advice,” says Byron Udell, founder and CEO of AccuQuote.
If you buy a term policy, there’s no penalty to committing today. Just as homeowners refinance mortgages at lower interest rates, life insurance policyholders can cancel a policy at any time to replace it with a less expensive equivalent — providing their health remains stable, of course.
Life insurance provides instant liquidity to meet the obligations that become due upon your death. It’s a pool of money to complete what you can’t finish. It’s also not taxable income, Evans notes.
Of course, don’t make it your sole investment strategy. Other vehicles’ returns beat permanent insurance products hands down, according to Wentz.
“The old story is to buy term and invest the rest. And that’s fine if you immediately put that extra money into an investment vehicle, but it does take discipline to do that,” he warns. “If you don’t, check universal or whole life.”
When pondering coverage, buyers first should inventory their assets: job insurance perks, Social Security benefits, IRA accumulations, stocks, bonds and savings accounts.
Then consider factors, such as how many people work in your household and if your need is temporary or permanent. For instance, do you want your spouse to stop working to care for the children?
“We don’t want to think about these objectives because it’s unpleasant for ourselves. It’s easier to flip on a computer, say I need $250,000 and discover it costs X amount per month,” Evans says.
Many buyers arrive at coverage numbers using the popular formula of four times their annual current salary. Wrong.
“Too frequently people go into this half cocked with numbers they literally pull out of the sky,” says Roniger. “Taking a simple multiple of your current earnings is so nonspecific, it doesn’t add up.”
He urges clients to rely on a capital assessment to determine coverage need.
“I typically tell people during the accumulation phase of their financial life that now is the time you can start cutting back on life insurance. Instead, build up your capacity to self-insure. Otherwise, here I am five years down the road with pay raises, and I’m still using a multiplier of four times whatever my income is. I’m basically buying more life insurance than I need.”
For a gut check, ask yourself Udell’s favorite question: “If I wrote you a check today for the amount on your insurance policy, would you work for me for the rest of your life at no pay?”
Next, is the price you pay reasonable? Insurance companies use life expectancy tables and risk classes to determine rates, then factor in underwriting costs. They consider mortality rates over time, so isolated events, such as the Sept. 11 attacks, don’t significantly impact rates.
Today, Internet speed means companies compete on rates by the minute, so overall life insurance rates have plummeted nearly 60 percent from their costs just seven years ago, Udell reports. Yet a 40-year-old in good health seeking a 20-year term policy can find quotes ranging from $27 to $189.
“The middle of the pack is almost double what you need to be paying, and believe me, plenty of companies in this level sell tons of life insurance,” Udell says.
However, a few extra bucks for an A-plus-rated firm makes sense, agents say. Niceties like convertibility and quick claims processing stack up, too. In other words, cheapest isn’t the only consideration.
“Anything within $30 to $50 annually isn’t worth the savings to deal with a crappy company,” Udell says.
“People often say, ‘When I buy life insurance I’m betting against myself.’ That’s the worst expression I’ve ever heard,” Evans says. “When you purchase insurance, you’re betting you’ll live but providing an assurance in case you’re wrong.”