“Prediction is very difficult, especially about the future.”
-Neils Bohr, Danish Physicist
The Challenges of Choosing Life Insurance
Should you buy term insurance, permanent insurance (also called whole life or cash value), or both? It’s a major financial decision everyone must make. And one of the challenges in buying life insurance is that you have to make a decision regarding an unknown future event which could occur as soon as tomorrow, or 50 or 60 years in the future.
Since the particulars of life are constantly changing, the odds are high that your financial decisions will be modified at a later date. In this constantly changing environment, how likely is it that a life insurance program established years (or decades) ago will still fit today’s needs?
Many consumers end up repeatedly changing their life insurance coverage, just as they make other adjustments to their financial life. They drop existing coverage, change policy types, switch companies, add or subtract benefits.
While these changes may be reasonable based on current circumstances, they may not be financially efficient. If a change in life insurance represents a “new beginning,” there’s a strong possibility previous life insurance decisions resulted in financial waste.
Some might say this financial inefficiency is to be expected with all insurance. People pay premiums for protection against an event they hope will not occur – an accident, fire, theft, or illness. If things go well, nothing bad happens, and the money spent on insurance is “lost.” The expenditure did not provide a benefit, other than peace of mind. And since the best-case return on insurance is a financial loss, the primary financial objective is to find the lowest rate to minimize anticipated losses.
But life insurance is a unique financial product with different parameters, so focusing exclusively on the lowest rate is not always the best criteria. Because of these differences, what some consider the most “expensive” type of life insurance may deliver the best benefits – over a lifetime and in the short term.
The basic concepts of life insurance are fairly straightforward: A policy in force at death will deliver a cash benefit to beneficiaries. The applicant’s good health is a qualifying factor in securing coverage. These components aren’t much different than other types of insurance. But there are other considerations unique to life insurance.
First, everyone dies. You may never have an accident, your home may never burn down, but mortality is a certainty – it’s just a matter of when. So if you’re going to buy insurance for something you know will happen, it makes sense to structure the coverage so that a lifetime of premiums can be recovered by the inevitable claim. (Even better, you can structure life insurance so that you are likely to enjoy benefits yourself!)
The cost of life insurance increases as people age, because insurance companies have a shorter time to accumulate the reserves needed to pay death benefits. In addition, future good health is not a given. Both these factors provide incentive for consumers to obtain life insurance sooner rather than later.
But in order to keep a life insurance benefit in force until death, policy owners are faced with the possibility of years, even decades, of premium payments. In light of the other financial changes that are certain to occur, keeping life insurance policies in-force can become problematic. Regular premium commitments may not match an up-and-down financial life.
This tension between the desirability of securing coverage as soon as possible and the logistical challenge of keeping it in force for a lifetime often makes it challenging for households to construct a life insurance program that delivers protection today and maximum benefits over time. In response, the life insurance market provides two basic options: term insurance, or permanent/whole life insurance that builds cash value.
Term vs. Whole Life Insurance: Which is Right for You?
In regard to initial premium outlay, term insurance is definitely less expensive. But term insurance is a limited contract; the premiums paid provide a death benefit only during the specified term (10 years, 20 years, etc.). If you don’t (or can’t) pay a premium, the coverage ends. If the term expires, you may re-establish coverage at a higher rate, but might be required to undergo a new health evaluation. With most term polices, there is no refund of premium (those that offer this feature do so by increased premiums).
In contrast, permanent or whole life insurance is a financial product with options, choices, and the capability of adjusting to changing circumstances. Unlike term, whole life is designed (and priced) to provide an insurance benefit for a lifetime, not just a 10- or 20-year period.
Once premiums have been paid for two or three years, and cash values have accumulated, automatic loan provisions* may keep coverage in force during periods when cash flow isn’t available. Cash values and insurance benefits can be increased incrementally through the purchase of paid-up additions. In a typical dividend-paying** whole life policy, cash values may exceed premiums paid (usually before fifteen years). So even if you surrender the policy and forfeit the insurance benefit, there can be a positive return from the premiums paid. These multiple benefits result in substantially higher initial premiums, and the challenge for some consumers is justifying the difference in premiums compared to term insurance.
Besides the long-term advantages of permanent insurance, it is also worth considering how these same features perform in the short-term, under changing circumstances. To illustrate, let’s examine a possible scenario in a ten-year period following the purchase of a 10-year term policy and a permanent policy:
Scenario One: In the fourth year, suppose the policy owner or their spouse experience a layoff or termination of employment, resulting in a significant decrease in monthly income. How will the life insurance coverage remain in force? With a term policy, they must maintain premium payments or lose the insurance. If budget constraints mean deciding between some necessity and an insurance premium, they may surrender the coverage. On the other hand, a well-designed whole life policy could use a premium loan from cash values to keep the policy in-force until finances stabilize.
Scenario Two: In the tenth year, just before the term policy ends, the insured is diagnosed with a serious form of cancer. Surgery and chemotherapy are required. Recovery is possible, but not guaranteed. However, now the policy must be renewed, and a health evaluation will be required. Will they be able to get coverage at all? And if so, at what rates? If the term policy simply ends, the anticipated death benefit, along with a decade of premiums, is gone.
However, the person with whole life in this situation does not have the stress of trying to renew their policy at a time when it is most at peril and most needed. Not only that, but they can again take a break from paying their premiums if needed, or even withdraw some of the accumulated cash value to get through this challenging time, if necessary.
Term, Whole Life, or Both?
Once consumers understand the benefits and flexibility of a permanent insurance policy, most people opt for whole life. However, many must still resolve how to meet the higher premium requirements. A knowledgeable advisor or insurance agent can be invaluable in this process, because many permanent insurance policies have riders that allow for combinations of term and permanent features, with options to convert or change the configuration over time. This format secures coverage today under the most favorable terms, anticipates a lifetime benefit, and makes provision for adjustments along the way.
Since change in the rest of life is certain, why not have a life insurance that can remain a profitable asset through the years, while ensuring you will have benefits when you need them the most?
Is it time to review your life insurance needs and policies?
For a limited time, Partners for Prosperity, Inc. is once again offering no-cost, no-obligation life insurance reviews to our readers. We’ll help you understand how your needs might have changed, and how your insurance policies can help you accomplish your financial goals. (And by the way, we won’t advise you to scrap your existing whole life policy and “start from scratch” just so we can sell you a new policy! Not our style, because it’s not good for you!) Just give a call at (877) 889-3981 ext. 120 to schedule your review, or contact your own Prosperity Economics Advisor!
* Loans and loan interest reduce policy benefits. Dividends, if any, are affected by loans and loan interest.
** Dividends, while historically reliable, are not guaranteed and are declared annually by the company’s board of directors.