Life Insurance? Glad You Asked
June 27, 2017 by Dick Weber
We often learn about money and finances from our parents, but absent a formal education on how the economy works and how to find our place in that economy, a person’s financial knowledge is largely hit-or-miss.
This is especially true when it comes to assessing life’s risks. We start out absorbing the financial consequences of some of those risks, such as a tire blow-out and the out-of-pocket cost of replacement. We call that “self-insuring” and we typically self-insure many of the risks we know about – and obviously all the risks we don’t know about. We’re probably not overly concerned about the risk of replacing a tire, but which risks should we pay attention to? Which can be mitigated? And which have such great financial consequences that self-insuring could be a disastrous strategy?
So consider: we acquire a car – and then an apartment or condo or house. Our responsibilities increase with respect to a spouse and children – even parents – and possibly second families. The risks of loss – from fire, theft, sickness, accident, disability, and premature death – become a threat to our financial security. We readily make decisions about auto and homeowner’s insurance; it’s required if we want to own that home and drive the car. But consider life insurance. It is not required.
The 5 Most Important Things to Know
For most of us it’s about our love and feelings of responsibility for a family that needs to keep on going financially even if the bread-winner isn’t there. Life insurance responds to a calamitous loss, but no matter how much it might grieve us to leave our families destitute, we also would rather not think about what causes it to be paid out! Responsibility usually wins out, and when my clients ask “what do I need to know about life insurance?” “What should we know?” I take their questions seriously and try to share the five most important things I think they should know:
1) You don’t have enough
Perhaps the biggest deterrent to maintaining enough life insurance is that we quantify it as a large lump sum that – if invested wisely – could produce sufficient income to maintain our families in the lifestyle to which we had become accustomed. But a consumer’s calculated need for $2 million or more to replace the income she would no longer be able to earn is a daunting number. We’re likely to subjectively think “my spouse/my family doesn’t need that much.” So, most people don’t have enough.
Think of it this way: if you’re 35 and will work another 40 years or so (75 being the new 65), how much will you earn in total over that period of time? Currently earning $100,000 a year with three percent salary growth amounts to a lifetime $7.5 million; five percent annual increases raise that lifetime income to $12 million. You may not need to insure all of that, but you should probably consider a significant amount of that.
Whatever your number, it’s likely to be your biggest asset and most of us would want a significant portion of that asset to be “inherited” by our loved ones, to continue making mortgage payments and providing for allowances, braces, scouting, college, weddings – and retirement. The way to get over the enormity of the lump sum number is to focus on what it’s going to take to replace the economic engine. If we need to replace $100,000 a year in lost earnings, it gets us back to the $2 million, the death benefit from a life insurance policy payable to the survivor.
2) It’s not your father’s (or mother’s!) life insurance
When I was growing up in the 1950s, my dad had, at most, $35,000 of life insurance in addition to a nominal amount of group term insurance through work. A good salary was $12,000 a year, and a typical home mortgage payment might have been $125 a month. College tuition at a public university was $100 a year.
What a difference 50 years makes! Not only were the money magnitudes so different than today, but the number of policy types from which my dad might have chosen boiled down to just whole life and five-year term. He had a pension to look forward to that would cover a substantial amount of family expenses in retirement, so perhaps he opted for term, thinking he had no need for a savings element. On the other hand, it was quite common to own whole life insurance as a simple form of diversification. The ultimate “dad” on TV – “Father Knows Best” Jim Anderson – was a life insurance salesman in that popular series.
Today’s dads and moms have much greater complexity to work through when considering not just the amount (as described in important thing #1) but the types of life insurance. Term? Whole Life? That’s just where we start! Traditional Universal, Variable Universal, Adjustable Life, Guaranteed Death Benefit Universal, Index Universal, and all the optional riders and funding options on those policy types. From the standpoint of large numbers and an array of some pretty complex financial instruments, we have a variety of important decisions to make.
To simplify the choices: unless there is the luxury of current resources to immediately deploy cash value-type policies, you may need to use affordable term insurance for an appropriate duration to provide as much financial protection to the family as possible. Consider the likely longer-term, lifetime needs and plan on gradual conversion of term insurance to the various forms of a permanent life insurance as income and resources can allow.
In choosing what kind, you will want to consider whether your risk tolerance is relatively conservative, and for which guarantees would be important to you. In that case you should consider participating whole life (usually from mutual insurers). Universal, Variable Universal, and Indexed Universal require not only a tolerance for risk but a willingness to manage such policies throughout your insured lifetime. The good news: there’s a style of insurance to fit everyone’s risk tolerance and resources, and even opportunities to synergize different levels of risk tolerance in one policy. For example, The Guardian Life Insurance Company of America® offers a unique option with its Index Participation Feature (IPF),1 allowing dividends2 to be credited with indexed earnings while providing substantial minimum guarantees.3
3) It’s not as expensive as you think
It is natural to consider price as a critical part of buying decisions involving a car – a big screen TV – and a life insurance policy. In common with these three common purchases is that cars and digital TVs and insurance are complicated in design and difficult to discern quality differences based on their technology. As a result, we often defer to price as a key criterion for making our ultimate buying decision.
It’s ironic that while term insurance has the lowest initial price of all the available life insurance policy options, it potentially adds up to the highest long-term outlay for a lifetime need. Typically, when measured to average life expectancy, total lifetime term insurance premiums can add up to as much as 70 percent of the death benefit!
More practical for lifetime needs are policies designed for that purpose and which usually develop substantial cash value over the life of the policy, allowing for a focus on financial protection for our beneficiaries in the early years while the policy gradually becomes a substantial cash resource with competitive internal rates of return for its asset class and substantial income tax benefits.4 These benefits include a deferral of tax on cash value earnings and the forgiveness of those deferred taxes in the form of an income tax-free death benefit if the policy is in force at the time of death.
The cost of life insurance can also be appraised the way banks and businesses account for their substantial ownership of life insurance on key personnel: premiums are expensed as non-deductible outlays from cash while simultaneously crediting back onto the balance sheet the increase in cash value and any declared dividends when paying the current premium. As a long-term asset, such policies can “pay for themselves,” at least on a balance sheet basis, in as few as 10 years. This view of the true value of life insurance is uncommon knowledge, but a lesson well-learned by those with lifetime needs for life insurance and the desire to make a smart decision about the appropriate styles of life insurance compatible with their resources, risk tolerance, management skills, and investment acumen.
4) Insurance is foundational
Financial planners and economists will acknowledge that life insurance is a foundation asset. Because it is insuring our most precious and valuable asset – our ability to produce income for ourselves and our families – we should be focused on acquiring the appropriate amounts and kinds of insurance at the earliest opportunity.
The reason for some sense of urgency is it may not always be available based on medical, financial, and avocational criteria. It’s not that other financial priorities should be ignored, but foundational decisions should be made as early in our financial lives as possible. As already suggested, the first rule for this foundational asset is that adequate amounts of protection should be secured.
If that means an insurance portfolio made up entirely of term insurance – that’s perfectly OK. Forms of permanent insurance – preferably participating whole life bought from the professional agents of mutual insurance companies – are acquired for optimizing guarantees and internal rates of return for lifetime coverage needs.
Question: Is your foundation made of concrete? Or Styrofoam? Working with a professional life insurance agent skilled in aligning a consumer’s unique financial considerations with appropriate product choices is going to be the best strategy, along with a financially strong insurance company, to get the best results.
5) Understand your policy and its value
While every policy is a legal and binding contract between the insurance company and the policy owner, the policies available in today’s diverse insurance marketplace are almost always supplemented with a non-binding policy “illustration.” Especially for the more complex policies designed to be affordable for a lifetime, policy illustrations presume to portray both guaranteed and non-guaranteed “performance.”
Whole life policies are entirely guaranteed except for the illustrated dividend scale. Dividends are not guaranteed until declared and paid. Universal Life policies with their quite different crediting methodologies can be very complex – especially the newer indexed variety – and there is a tendency for agents and their clients to look to the illustration rather than the policy to fulfill their expectations about planned premiums and future performance. Yet, this understandable approach may be hazardous to your health, or at least the health of the policy!
Universal Life policies must be managed for the lifetime of the insured to make certain the policy can fulfill its expectations. In universal life, crediting rates will rise and fall (but not less than any policy guarantees), and expense charges are similarly subject to “experience” changes (but not more than policy guarantees). Consumers should expect to manage these types of policies and in turn should expect their agents to help them in that process.
Conclusion
Armed with this list of important things to know about buying life insurance, agents and consumers can bring skills and needs and resources together in an informed and transparent acquisition of life insurance. Lifetime forms of life insurance – “par” whole life on the guaranteed side and universal life based on current assumptions about future benefits and costs – protect the family’s financial viability in the early years. As retirement looms on the horizon and the need to replace earned income begins to taper off, cash value life insurance has the potential for transforming to other valuable uses, such as tapping substantial, tax-favored cash reserves in retirement.
There are many financial decisions we will make in our long lives as we begin our careers, start families, see our kids graduate from college, and then start their families. Of course in most cases, retirement is our end-game. Foundational life insurance for the short-term and long-term needs is an important part of those financial decisions – from the earliest commitments in which others are financially dependent – to the benefit of tax-favored resources for retirement and income tax-free death benefits. ◊
Endnotes
1. The Index Participation Feature (IPF) is a rider available with select Guardian participating whole life policies. With the new IPF, policyholders can now allocate between 0% and 100% of the cash value of paid-up additions (PUA) to the IPF each year. The IPF provides an adjustment to the dividend paid under the policy. This adjustment, subject to the cap rate (currently 12.5%) and floor (currently 4%), may be positive or negative based on the S&P 500 price return index performance. Adverse market performance can create negative dividend adjustments which may cause lower overall cash values than would otherwise have accrued had the IPF rider not been selected. While the adjustment provided by this rider is affected by the S&P 500 price return index, it does not participate in any stock or equity investment of the S&P 500 price return index. This rider incurs an additional cost.
2. Dividends are not guaranteed. They are declared annually by Guardian’s Board of Directors.
3. All whole life insurance policy guarantees are subject to the timely payment of all required premiums and the claims paying ability of the issuing insurance company.
4. Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation.
This material contains the current opinions of the Dick Webber and/or The Ethical Edge, Inc., but not necessarily those of The Guardian Life Insurance Company (Guardian), New York, NY or its subsidiaries and such opinions are subject to change without notice. Dick Webber and/or The Ethical Edge, Inc., are not subsidiaries or affiliates of Guardian. Material discussed is meant for general informational purposes only and is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice.
by Dick Weber, MBA, CLU, AEP (Distinguished) Mr. Weber is a past-president of the Society of Financial Service Professionals and is a fee-only Insurance Fiduciary consulting with clients and financial institutions. For the past decade, Dick has provided his consulting services to many carriers, including The Guardian Life Insurance Company of America. He makes recommendations based upon his relationships with the companies and the integrity of the products and people that back them. He can be reached at Dick@InsuranceFiduciary.com
