Choosing the Right Type of Life Insurance

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The Right Type of Life Insurance

Determining what type and amount of life insurance is right for you requires some careful thought. There are over 2200 life insurance companies in North America-and all insurance companies are not the same, despite what some agents or salespeople may tell you. There are big differences among them, differences that could cost you thousands of dollars in needlessly high premiums or limited coverage.

In addition, a number of derivative insurance products are marketed by some aggressive salespeople. These products are usually based on the three major kinds of insurance: term, whole life, and universal. These complex forms are usually designed to fit extremely specialized situations. They often don't make sense for most consumers.

In this chapter, we will consider how you can choose the kind of life insurance you need. We'll review the most common kinds of insurance-and the derivatives.

Renters versus Homeowners

The debate over whether term life or whole life is the better deal will likely go on as long as there is insurance. People who believe in (and often sell) term insist whole life is a rip-off. People who believe (and often sell) whole life swear that term is the rip-off. Like the Lilliputians in Gulliver's Travels who went to war over which end they crack first when eating an egg, both sides may seem obsessed with trivia to you.

But there are some important differences.

The factors that influence someone to rent are typically that he or she is:

An old insurance industry rule of thumb holds that people who rent their houses tend to buy term insurance, and people who own their houses tend to purchase whole life insurance.

• short on cash
• in transition-not settled in job, family or place
• facing financial uncertainty
• not in a position to make long-term commitments
• interested in investing money in other ways These are the same reasons people give to explain why they purchased term insurance instead of cash value insurance.

Other factors influence people to purchase a home. These typically include:

• belief in owning and building equity
• focus on long-term thoughts and plans
• sufficient stability to make commitments
• a desire to accumulate wealth and build savings
• a need for tax benefits . a desire to accomplish financial goals during working years
• a desire to pass wealth and assets on to children

If you answered yes to most of the questions in the survey, then whole life or other cash value life insurance may be of interest to you. These types of coverage make most sense for people in higher tax brackets and planning to maintain the coverage for more than 10 years.

On the other hand, even the most structured kind of term life insurance will offer you a steady price for 10 years but can raise the premium 900 percent or more if you don't pass a medical exam at the end of the lO-year period. Some critics of term insurance argue that term insurance companies reduce the premium for a few years so that they can coerce you into a medical examination in the future. This view may be extreme, but there is an element of truth to it.

Many consumers are seduced by initial low premium policies that require medical requalification to maintain a reasonable premium. To avoid this kind of problem, ask the following questions about any term policy you're considering:

• If you don't pass the medical requalification, what will the premiums be?
• Are they written in the contract? Are they guaranteed?
• If you're required to take and pass a medical exam in order to avoid dramatic increases, how extensive is the exam?
• What standards of underwriting will be applied at that time? r . Will the underwriting standards be the same for requalification as for new applicants?
• Will there only be a "pass'" or "no-pass" standard or will there be a range of ratings?

If the answers to these questions aren't in writing in the policy; get another policy.

If you're still unclear about what kind of life insurance will work most effectively for you, consider the following guidelines:

• If you have no need for the insurance for more than 10 years, term insurance is a better choice.
• If you clearly need it for more than 15 years, whole life or cash vaJue wins the race. If you need it for only 10 to 15 years, it's a toss-up.
• Don't buy a policy that you are afraid you can't continue. Cash value insurance only makes sense if maintained for more than 10 years.
• The higher your tax bracket, the more valuable whole life or other cash accumulating insurance will be-if you properly understand it.
• For older people (over 60), term is rarely useful because premiums quickly become unaffordable.
• If you are an equity investor, you can use cash value life insurance as the liquid part of your total portfolio.

Select the Best Company

Insurance companies are like any other business. Some operate more efficiently, some are more disciplined, some screen their insurance pool more carefully-which reduces their mortality costs. Some pay lower commissions and control overhead costs better.

Focusing on an insurance company before a specific policy may seem like an upside-down approach, but it will save you time, money and confusion.

When you sign an insurance contract, you probably assume that you are buying a concrete deal with specific terms. But-in most cases-the insurance company reserves the right to change:

• the premium the death benefit
• the rate of return (dividend) projected cash values
• mortality charges administration charges
• treatment of blocks of existing policyholders

Real estate people know that when you buy a home, location is more important than the price. A $100,000 house in one neighborhood may lose its value, in the same time that a $100,000 house in another neighborhood may gain value. Think of an insurance policy as located in the company that offers it. An excellent company will be a better buy over time if the premiums ate the same. It may even make sense to pay a little more for a good company.

When you select a life insurance company, you are picking the company that you plan to collect from 30, 40 or 50 years from now: Quality plays an important role in longterm stability-no matter what kind of business we're talking about.

The qualities of excellent insurance companies include:

• size
• financial rating
• low historical cost performance low death costs (mortality)
• low commissions
• low administrative costs
• strong cash reserves

Weaker companies will disguise their problems by diverting attention away from company financials and focusing on:

• cheap premiums new types of policies and terms
• easy underwriting special offers
• short-term price savings instead of long-term value (cash or otherwise)
• their company's age-rather than size or strength

Shifty companies and their sales people will also claim that all companies are "pretty good and pretty much the same." That's simply not true. Always be wary of a hard-sell insurance agent. Weak companies usually pay the highest commissions. In almost all cases, stock companies pay much higher commissions than mutual companies. If your agent only proposes stock company carriers, there may be selfish motives involved.

When to Use Term or Cash Accumulating

You don't have to bea rocket scientist to figure out that a two-seater sports car is not a family car. Similarly, you don't have to have an in-depth understanding of life insurance to eliminate some options.

• If you're young and have a family and you're broke, a term policy is where you start.
• If you're a young family trying to save money but it's hard to save, a mix of term and cash value might be ideal.
• If you're divorced and need to (or are required to) maintain life insurance until your children are grown, consider a level term policy for..the number of years necessary to fulfill the need.
• If you've decided to start a college savings plan for your children or grandchildren, a rapidly accumulating cash value policy might be best.
• If you're in your 40s and realize you need to increase your retirement savings, several types of cash accumulating policies will make sense.
• If you're over 60' and need life insurance to pay estate taxes, you'll almost certainly need a cash accumulating plan.
• If you're an active investor under 50 and want to accumulate cash for retirement, a variable life plan may be of interest because you get to control the investment.

The life insurance industry became quite creative in the 1990s. A number of combination and derivative coverages have developed in recent years to answer specific needs. A caveat: Some first-time buyers of life insurance will be sold one of these combination or derivative packages when their needs really are simpler.

Term/Whole Life Mix-Level

One of the most popular, and perhaps most useful, of the combination life insurance contracts is the tenD/whole life mix policy. Combining whole life insurance with decreasing term coverage, this policy provides temporary protection and permanent coverage. The term portion of the coverage provides monthly income benefits for the family and the permanent (whole lite) part of the policy provides a lump sum payment.

Therefore, a term/whole life mix policy has two time elements. The family income term portion of the policy corresponds to the decreasing term time period. The base part of the policy is usually whole life, and thus, some degree of protection is provided for the whole of life (to age 100).

Term/Whole Life Mix-Increasing

The family maintenance policy consists of a combination of permanent whole life insurance plus level term insurance.

It also consists of a temporary income period plus lifetime protection. The level term part of the policy provides a monthly income (triggered by the death of the insured person), and the whole life portion provides the 'lifetime protection. One adjusts for inflation the other doesn't. The increasing mix adjusts for inflation; the level mix doesn't.

Generally, family plans are sold or purchased with reference to units of insurance-worth a predetermined amount of face value. Therefore, a family plan might state that the husband/father has four units of coverage, the wife/mother has two units of coverage and each child has one unit of coverage. If a unit was worth $10,000, this would mean $40,000 in whole life and $20,000 and $10,000 each in term life-respectively.

Joint Life Policies

Joint life policies are whole life contracts written with two or more persons as named insureds. Most commonly; the policy is issued on two lives with the insured amount payable on the death of the first insured only. The "first to die" policy has not achieved popularity because actuarial costs result in prohibitive premiums. However, some policies pay on both deaths and even (usually for business insurance purposes) pay on the first death and then increase the amount of coverage on the remaining insured or insureds so that the total coverage remains the same.

A variation of the joint life policy is the last survivor policy. It pays the insured amount not to the beneficiaries of the first insured to die but to those of the last.

Modified Life

Modified life is typically a whole life product which is purchased at a very low premium for a short period of time (three to five years) followed by a higher premium for the life of the policy. The policy may be a combination of term for the modified period, automatically converting to a whole life premium so that premiums are lower than average during the modified period and slightly higher than average (to make up for the early deficit) thereafter.

Generally; this type of policy is sol4 to people who want whole life but, for the next few years, wiu be unable to pay the typical premium. The person can thus afford th"e opportunity to purchase whole life with a modified premium for the initial three to five years of the policy.

Graded premium whole life is similar to modified whole life in that initially the premium is very low Unlike modified life which has one increase to a higher, level premium for the life of the contract, graded premium policies provide for an increase in premium each year for the first 5 to 10 years of the policy. At the end of this step rated premium period, the premium remains level for the life of the policy.

Split-Life Policy

The split-life policy is a combination of a whole life or a term life insurance contr'!ct and an annuity contract. The savings feature is a retirement annuity to age 65, and the life insurance feature is usually yearly renewable term insurance.

The sale of the split-life policy has not been approved in all states, because it seems to discriminate in favor of those individuals who purchase annuities. Those who do not purchase an annuity along with their life insurance do not receive the same low cost benefits as those who do purchase the annuity. The insurance contract may be renewed as long as the annuity premium continues to be paid. The most common amount of coverage found is up to $10,000 of term insurance for each $10 of annuity premium paid.

Adjustable Life Insurance

Adjustable life is a policy which offers the policy owner the options to adjust the policy's face amount, premium, and length of protection without having to complete a new application or have another policy issued. This kind of insurance introduces the flexibility to convert to any,form of insurance (such as from term to whole life) without adding, dropping, or exchanging policies.

Adjustable life is based upon a money purchase concept. The basic premise becomes not so much which type of policy does a person buy but rather how much premium is to be spent.

Example: If a 25-year old applicant states that he or she can afford to pay a $500 annual premium, an'~ adjustable policy may be mostly term the first few years, then a blend of term and whole, then finally a whole policy several years later. By the time the insured is 50 years old and planning for retirement, the same $500 premium would be used for some form of permanent insurance protection with guaranteed cash values.

Industrial Life Policy

The industrial policy is written for a small face amount, usually $1,000 or less, and the premiums are payable as frequently as weekly. This coverage derives its name from the fact that it was originally sold in England to the industrial class of factory workers.

The industrial policy owner determines how much he or she can pay each week, and the face amount of coverage is determined from this. A company representative will call the policy owner each week, usually at home, to collect the premium. The policy benefit is usually used to pay for last illness and burial expenses.

This method of distribution is very expensive for two reasons. First, the mortality rates are higher for industrial policy owners because these people tend to have higher than average health risks and poorer than average living standards.

Second, having the agent collect the premium each week increases overhead costs.

Recently, a variation in the industrial life concept known as home service life insurance has emerged. Policies are usually modest in size, ranging from $10,000 to $15,000 in face value, and are typically sold on a monthly debit plan (automatic bank draft) or payments by mail.

Most of the provisions found in individual life insurance policies are also found in industrial life insurance. However, because the face amount of the policy is so small and the cost of this type of insurance is expensive, certain provisions do not have the same impact on industrial insureds as on individual insureds:

• The application is not required to be part of the policy.
• Medical examinations are not required.
• Cash values do not accumulate sufficiently to provide loans:
• Settlement options do not apply because of limited cash value.
• Suicide provisions are not included in the policy because of the small benefit amount.
• Nonforfeiture provisions do not allow the cash option until premiums have been paid for five years (compared to three years for ordinary policies).
• Dividends are always used to reduce the premium payment or to purchase paid-up additions.

Credit Life Insurance

The unexpected death of an individual who has time payment obligations can create serious problems for his or her family. Credit life insurance provides that, in the event of the death of an insured debtor, outstanding balances are paid off in full.

Usually, the individual debtor pays the total premiumeven though the creditor is the policy owner. The premium is added to the finance contract amount so that, in effect, the insurance premium is being financed along with the item being purchased.

Conclusion

Why is cash value insurance a poor short-term investment? The costs of operations, commissions, marketing, etc., are loaded into the first few years of the policy. Therefore, the cash accumulates slowly at first.

Why is cash value insurance a good long-term investment? The cash accumulates tax-free. Therefore, for people in higher tax brackets who need the insurance for more than 15 years, cash accumulating policies are the most cost-effective.

You must decide on which side of this issue your circumstances place you. That decision will usually tell you whether you need term or cash value life insurance.

But the decision is not always that easy. Specialized policy forms are designed to provide coverage in special situations.

These forms can vary from insurance company to insurance company but are designed to help you choose the right kind of life insurance for your specific needs.