Steak or lobster?
Dogs or cats?
Ginger or MaryAnn?
Why do some people insist on turning every issue into a black-or-white, either-or decision? In theory, this mindset might simplify one’s life (or simply provide time killing conversation at the local watering hole), but most of the time an either-or approach is neither necessary nor desirable; quite often, finding a “C” option is much better than choosing Option “A” and rejecting Option “B” (or vice versa). Hey, why insist on diners having to choose between lobster or steak when they can have surf and turf, right?
The either-or mentality shows up with some frequency in financial commentary. For example: Stocks or bonds? Pre-tax or after-tax savings? Group or individual benefits?
Looking at these “A” or “B” sample issues, it should be obvious that “C” options are both available and practical. A balanced portfolio usually includes a mix of investment vehicles, not just one type. Pre- and after-tax savings plans each serve important functions in individual finances, depending on when the accumulation might be needed. And a blend of group and individual programs can provide customized security at an affordable price. Despite an attention grabbing either-or headline, the answer to most “A”-or-“B” financial questions is usually “C” – “both.” But what about this question:
Permanent or Term life insurance?
A quick survey of opinions about life insurance (in financial publications, at bookstores, on the Internet) finds mostly a polarity of opinions; it’s either “A” or “B,” permanent or term. “C” options, those that might recommend both permanent and term, can hardly be found. But considering how many other financial issues seem to include practical “C” options, why is the discussion about life insurance so polarized and dogmatic? There are several possible explanations.
Why people can’t seem to find the “C” option for life insurance
Permanent policies are complicated. In comparison to other financial products like stocks, bonds and mutual funds, permanent life insurance can legitimately lay claim to being the most complicated and multifaceted financial instrument available to the general public. This complexity is not only because permanent life insurance consists of a blend of savings and insurance benefits, but because different contract formats allow for an endless variation in how the cash values and insurance features can be combined to meet individual desires.
There is no uniformity in the evaluation process. How does an individual determine the financial value of life insurance? This is a challenging question, one in which there is very little consensus. For example: In a net worth statement, what is the value of a life insurance benefit? Until the insured has died and a claim has been paid, there is no recognized dollar value (for a term policy). Yet having life insurance certainly results in greater financial security. Because of the difficulty in quantifying the financial value of life insurance, the methods of comparing and evaluating life insurance are numerous, reflecting a broad range of financial philosophies.
Even for term insurance, where the typical method of evaluation is price (the lower premium is considered the best value), other factors come into play. A 10-year term policy will almost certainly be cheaper than a 20-year term, but what about the cost of maintaining or re-insuring when the term expires, especially if one’s health changes? How can one accurately assess this factor from a financial perspective?
In some evaluations, critics of permanent life insurance will point to low rates of overall return in comparison to other accumulation vehicles. Yet permanent life insurance isn’t just an accumulation vehicle; the life insurance benefit is part of the package as well, and the two components are interrelated. How accurate is an evaluation process that attempts to separate what was intended to be combined?
There are commissions involved. Almost all life insurance is provided by agents who receive commissions from insurance companies when they help an individual obtain coverage. Permanent policies have larger premiums, and larger premiums mean bigger commissions. For some observers, this commission arrangement creates a conflict-of-interest for agents, in that they may be induced to recommend higher premium policies that are perhaps not suitable for consumers. Another frequent critique of permanent life insurance policies is that the agents’ commissions come at the expense of greater cash values for the policyholder.
Over the past few decades, the combination of complex products, poorly defined evaluation processes and implied potential for a conflict of interest over commissions has led many public “experts” to offer this advice: “Just get term insurance. It’s simple and cheap, and you won’t have to worry about getting ripped off.” In response, knowledgeable commentators within the life insurance industry often feel compelled to focus on strategies that justify permanent policies for almost every scenario, both to explain their products and defend their integrity. In a way, the strong philosophical differences about how to view the two forms of life insurance have left little room for discussing ways to make them fit together. Yet there are many workable formats for making life insurance a product with “C” options.
The “C” Options in Life Insurance
Both term and permanent policies have a long history in the marketplace because consumers have shown a demand for both forms of life insurance. Any economist would tell you that consumer demand validates the worth of a product or service. In real life, no matter what the “either-or” fixated experts might say, consumers find both term and permanent insurance are valuable financial products. Consumers shouldn’t have to choose between the two products when they say they like both.
In general, both term and permanent insurance provide immediate financial protection, while permanent life insurance allows this protection to become a long-term financial asset. From a “C”-option perspective, a good life insurance plan would be one designed to deliver maximum immediate and long-term benefits. Fortunately, there are several ways to accomplish this objective.
Conversion provisions for term insurance. Many term life insurance policies have provisions that allow the policyholder to convert some or all of the term coverage to a permanent policy, without requiring a new application or medical exam. Convertibility provisions allow you to start with Option “A” and change to Option “B.”
Guaranteed increase options “GIOs”*. These provisions allow policyholders to increase their coverage by specified amounts at scheduled intervals. For example, a $500,000 policy may give the policyholder the option to increase the insurance benefit by $50,000 every three years for the first six years of the contract without additional underwriting. Some GIOs can be triggered by birthdays (age 30, 35, 40 etc.), while others may be available based on events (the birth of a child). GIOs are an acknowledgement that as circumstances change, there may be a desire for more coverage.
*GIO rider incurs an additional cost.
Blended contracts. Most life insurers offer contracts that blend term and permanent protection into one contract. Typically, this blend of coverage transitions over time from a high percentage of term at the beginning of the contract to a 100% permanent policy. This can be an effective way to secure maximum coverage now while providing a long term insurance asset for retirement and estate planning purposes. Some of these contracts may require adjustment over time, but blended contracts are true “C” options in life insurance.
Dividend options. Many permanent policies feature dividend payments to policyholders. Dividends are a return of premium and while the typical default option is to add them to existing cash value accumulations, dividends may be applied or distributed in a variety of ways. One common dividend option is buying one-year-term insurance, allowing a permanent policy to add some term insurance. (Yes, this is another “C” option.) Note: Dividends are not guaranteed and are declared annually by the company’s board of directors.
Paid-up additions (PUAs). Most permanent life insurance contracts are based on fixed level premium schedules that determine the guarantees and payment periods; some permanent policies may be designed to be paid-up in 10 years, others when the insured reaches age 100. Shorter payment periods not only result in fewer premiums, but also increase cash value accumulations. PUA provisions allow the policyholder some flexibility in increasing cash values and shortening the payment period.
One key point that doesn’t seem to get much press: Personalized life insurance policies with features like those mentioned above aren’t something you can obtain by answering five health questions over the phone or over the internet. These policies require individual underwriting, because an insurance company wants a more in-depth picture of your health history and financial circumstances before offering a customized contract.
Since the general trend for most people is declining health as they get older, you are probably most insurable today. This makes a strong argument for applying for as much coverage as you can obtain as soon as possible (possibly this will be term insurance, with options to convert or restructure at a later date).
This brief overview of standard life insurance features should be enough to demonstrate that “C” options abound when it comes to life insurance. No matter what your current financial condition, it is obvious there are ways to design a life insurance plan that will meet both immediate needs and position life insurance as a long-term asset in your financial program.
CAN YOUR CURRENT LIFE INSURANCE PROGRAM COVER IMMEDIATE NEEDS AND BECOME A LONG-TERM FINANCIAL ASSET? ARE YOU USING YOUR “C” OPTIONS TO MAXIMUM ADVANTAGE?
(The next time someone asks you to decide between Ginger and MaryAnn, say “both.”)