Life insurance - for many people it ranks right there with buying a used car and getting a cavity filled at the dentist in terms of topics about which they wish to think let alone on which they want to act.
Why have life insurance?
First and foremost, a life insurance contract (the policy) provides money (the death benefit) to someone (a beneficiary) in order to pay for expenses that someone else (the insured) was going to provide but can’t because that person (the insured) died.
This blog focuses on that primary reason. There are additional uses of various types of life insurance contracts that deserve their own blog.
I’m Young... I’m Not Going to Die
The Lancet, an internationally renowned medical journal, reports that “In the first three decades of life, more individuals in the USA die from [unintentional] injuries and violence than from any other cause.” The Center for Disease Control and Prevention adds drug overdose, illness and suicide to the list of most common causes of death for people under 50.
Regardless of the reason half of all people do die before their “life expectancy”. As was explored in a previous JRW Advisory Services blog, life expectancy could be said to be the average period that a person may expect to live. As this is an average there are those who live shorter than the average. To keep it simple, let’s assume that half of Americans live shorter than the average (and half live longer)
So What if I Die Before My Time?
People need you in addition to want you and love you. Needs might be but certainly are not limited to:
“‘Til death do us part” - getting married
"Best day of my life” - having a baby
“Let’s shake on that, partner” - going into business
In these and other circumstances with the best of intentions and all of the optimism it takes to move through this life, promises and commitments - spoken and unspoken - are made. If all turns out well the promises are kept and the commitments are made good. No need for life insurance. But the ability to fulfill those promises is unknown at the time the commitment is made, and only is known once the commitment or obligation is fulfilled.
If a child is left without parents often they go live with other family members who take on the unexpected financial, emotional, spiritual, etc. burden of raising that child. If no family exists the government has a system to provide care for orphans. In either case, it’s possible that the proceeds from a life insurance contract on the parent(s) could have significantly and positively impacted the life of the child by providing money to pay for their health, education and welfare. Without that money destitution is not only possible, but in many circumstances, likely.
Debts accumulated at the beginning of adulthood also survive beyond the death of the person who got them. Credit cards, auto and home loans, medical bills, etc. are paid for after someone dies with the money that person left in their “estate”, that is whatever they left behind that has value. In the case of secured debt, for a car or home for example, the debt might be paid off by selling the item purchased with the debt in the first place. Any negative difference between what the item fetches being sold and the amount of the outstanding debt is still owed by the deceased’s estate, and cannot go to loved ones. If the sale covers the debt, any extra money goes to the estate to potentially cover other debts in total before loved ones get the remainder as an inheritance.
When is the Time to get Life Insurance?
Certainly life insurance can be purchased reactively: when a need arises buy just enough coverage for just long enough time to cover the obligation. For example, the USDA reports that “Middle-income, married-couple parents of a child born in 2015 may expect to spend $233,610 ($284,570 if projected inflation costs are factored in*) for food, shelter, and other necessities to raise a child through age 17.” If you have a baby in 2015 it might make sense to get a life insurance policy in the amount of $284,570 for a duration of 17 years, or a round $300,000 for 20 years, just in case the proverbial milk truck hits you on the way home from the hospital and someone else has to raise that child. The policy might be reduced by $15,000 each year that child grows since the parent paid for that year and no longer is on the hook in case they die.
Life insurance might be required in order to accomplish a certain desired outcome. For instance a bank might require a business owner to have a life insurance policy of equal amount to a loan so that the bank would be repaid if the business owner were to die before full repayment. Or a judge might require divorcing parents to carry life insurance to assure that certain costs associated raising a child until majority are covered for the surviving parent if the other dies before that time.
Alternatively, life insurance can be purchased proactively, to have in hand when expected life events, such as marriage, childbirth or business formation, occur. Why would someone buy it before they actually need it? Two reasons: availability and cost.
Can’t I Always get Life Insurance?
No, not everyone can get life insurance. Terminally or mentally ill people will not be offered life insurance, for example. The probability that the company will have to pay the death benefit is likely 100%. How much money would you demand in order to make a payment, say $100,000, to someone within, say, 1 year of taking the money? About, or perhaps more, than the $100,000 due at the end of that year. This makes little sense especially considering the administrative costs involved. Anyone with certain illnesses or physical or mental conditions that dramatically raise the probability of earlier-than-average death may find it impossible to find a company to sell them life insurance. Some of those conditions might appear as life progresses, such as diabetes, heart disease, epilepsy, cancer, etc. The ability to buy life insurance is not guaranteed.
Since life insurance companies pay when a person dies, and older people die with more frequency than do younger people, the cost of life insurance increases with age and is therefore lower during younger years. Combine the potential for illness or injury to develop such that life insurance cannot be purchased with the pricing being lower for younger people and there may be times and situations when it makes sense to purchase a life insurance policy before actually needing one.
What Types of Life Insurance Are There?
Simply put there are two kinds: term and permanent. Term life insurance policies provide coverage for a certain number of years the duration of which is called the “term”. At the end of the term the coverage ceases. Permanent life insurance policies pay a death benefit anytime the insured person dies, sooner or later.
Each category has sub-categories. There are level, yearly renewable and return-of-premium term life insurance policies, for example. Meanwhile, permanent life insurance can be whole, universal or variable, for instance.
This blog post focuses specifically on term insurance. Permanent insurance is saved for another blog post.
What Type Should I Get?
Life insurance is simply a financial tool; pick one that works for the purpose you intend. Term life insurance is well suited for a debt or promise of a certain duration, or term, say 10, 15, 20 or 30 years. Permanent life insurance is designed for lifetime coverage and might be helpful in estate planning, or assure a financial benefit for a dependent, a disabled adult child for example, regardless of age of death.
Can I Mix and Match and Adjust Coverage Amount Over Time?
Yes. As life provides necessities of more life insurance the same person could have multiple policies of various amounts and differing types.
Can Life Insurance be Canceled?
Yes, the insured person or the life insurance policy owner, not always the same person, can cancel, or at times reduce the amount of death benefit in, a life insurance policy. However, the company cannot unilaterally cancel a life insurance policy so long as the conditions of the contract are being met, namely the policy premium is paid as agreed in amount and time.
What Happens if the Life Insurance Company fails?
Businesses go out of business. That is common. It occurs in the life insurance industry also. State departments of insurance require all life insurance companies to participate in a proportionately fair effort to back stop the life insurance contracts sold or issued by all other life insurance companies licensed in that state. For illustration purposes only, suppose that Mary has a $100,000 20-year term life insurance policy created and sold by ABC Life Insurance Company (“ABC”), and ABC goes out of business. If Mary continues to pay on time the contractual premium, to the state or some entity it designates, her beneficiaries will receive full payment of the contractual death benefit listed in Mary’s contact. With this backstop in place Mary has confidence that her policy will pay even if ABC goes out of business. Without this backstop in place Mary and all other thoughtful people would be forced to question and doubt the long-term financial viability of each life insurance company when considering from which company to buy a policy. Most people would find that process to be more than they wanted or could perform and perhaps simply not buy life insurance.
Parents might buy 20 year level term policies for each of them each time they have a child. And, to make it a bit more specific, they might reduce each year the death benefit coverage, if permitted in the policy, each policy by some amount as they need one year’s less money to provide for growing children as they age. This could reduce the annual amount they spend on life insurance premiums.
Those same parents might each buy a small permanent policy to provide funds earmarked for memorial services and a funeral plot, for example, for whenever it is they each die.
Insurance companies always want to limit the total death benefit at any time to no more than the insured person’s human life value, basically how much the person is worth alive, so as to avoid creating a perverse situation in which someone is worth more dead than alive.
Human life value is often a function of age and income: the younger and more money one earns, the more years those higher earnings will accumulate and therefore the higher the human life value. A surgeon earning $250,000 a year at age 35 will have a higher human life value than a 50 year old public school teacher earning $100,000 a year, and therefore, the surgeon would be eligible for more life insurance coverage.
Where Can I Get Life Insurance?
Life insurance is offered in a number of ways. Direct-to-consumer companies might advertise online, on TV or in mail inserts. Associations, such as alumni groups, credit unions, etc. might offer life insurance to members. Employers often provide some amount of life insurance among the benefits, either paid for by the company or by the employee. And life insurance agents abound. Trusted friends, family or advisors should have a number of referrals they might make if asked.
Life insurance agents most often are compensated by the life insurance company and not by the buyer. This is an important point to mention. Life insurance agents are agents of the companies, by law. The state departments of insurance approve life, and other, insurance products to be sold in the state and the prices companies can charge. Those prices usually include the commission that will be paid to the licensed insurance agent(s) of record who complete the sale of the policy. Some limited number of life insurance companies sell non-commissionable policies through the independent registered investment advisors, though those typically are permanent policies rather than term policies.
In the end life insurance is not meant for the person who buys it, presuming that the owner and the insured are one in the same. It is for the benefit of loved ones who depend financially on that person. In this way life insurance is a gift to ease the financial burden created by the loss of a person who was going to finance, fund or pay for something to someone though because of death cannot personally fulfill that commitment or promise. While a person cannot be replaced ever, the absence of the money they would have provided can be replaced in part, large or small, with basic life insurance. This is a gift to surviving loved ones.