We live in an increasingly disposable consumer culture. Many products, from razors to writing instruments, are designed to be used and thrown out – refills and maintenance are too much of a hassle. If something breaks, it’s often cheaper to buy a new one rather than fix it.
In the financial services world, more and more products have been adjusted in response to this trend toward disposal and replacement. Where many financial instruments once included either significant up-front fees or surrender charges that encouraged consumers to keep these investments for long holding periods, many financial institutions have altered their products to lower or eliminate these fees. Now you can change your investment allocations as easily as changing your shirt, and sometimes the “substantial interest penalty for early withdrawal” from a Certificate of Deposit isn’t really that significant. If it appears the old product is no longer performing, it’s easy to dispose of what you don’t like, then get what you think you want.
But there are some things that don’t work as well when they are treated as disposable items (marriage comes to mind, as does nuclear waste). In the financial products arena, life insurance is a financial instrument that doesn’t perform well when considered a disposable commodity. This is primarily because of the unique nature of life insurance.
First and foremost, the ability to obtain personally owned life insurance is conditional on your health. For many financial products, the only barrier to acquisition is money; if you have the cash, you can buy it. But obtaining life insurance requires the prospective insured to meet the company’s underwriting standards as well as pay the premiums.
As long as you are in good health, insurability may not seem like a major impediment. But life insurance is a future-oriented product. Both the insurance company and the policyholder expect the life insurance benefit will not be used today, but sometime later (hopefully, much later). If you decide – for whatever reason – to terminate a life insurance policy, you have forfeited the certainty of your insurable status. Any attempt to obtain life insurance in the future will require another underwriting assessment. Who knows what your health status will be in five, ten or twenty years? Since future insurability cannot be guaranteed, disposing of life insurance – for any reason – could be detrimental to your financial well-being because you may not be able to obtain replacement coverage.
Life insurance is unique in another way: It is the only type of insurance where the covered event – one’s death – is 100% certain to occur. And unlike many other types of insurance, the covered event isn’t subject to changeable definitions or adjustable benefit periods. Disability can be defined in many ways, auto insurance can limit exposure through deductibles, and a homeowner’s policy can differentiate between assessed value and replacement costs. But with life insurance, there is no wiggle room for defining what is or isn’t covered – you are either dead or alive.
The only adjustments to a life insurance policy’s terms come during underwriting (when the insurance company may accept, decline or charge a higher-than-normal premium to insure an individual life), or in the premium structure (this applies particularly to term insurance). For the most part, the terms you receive on the day the policy is put in effect will remain for the duration of the policy. If you are a healthy, slim, athletic non-smoker when you obtain the insurance at age 35, your premiums will reflect that status even if 10 years later finds you an overweight, cigarette-smoking diabetic. Since the general trend for everyone is declining health over time, it doesn’t make sense to dispose of a favorable insurability status. If anything, you want to keep it for as long as possible.
This awareness, that life insurance is not a disposable financial product, should prompt you to carefully consider the long-term disposition of your life insurance policies, whether they are cash value policies or level term insurance. If you have obtained a favorable rating classification from a life insurance company, you should consider how this asset (your insurability) can be enhanced or preserved.