I recently ran across a blog article from a certified financial planner. In the article he described a situation where a 28 year old man with $5,000 in credit card debt and no heirs was sold a $200,000 whole life policy. The financial planner mentions term life as the best solution in this situation. However, his analysis relies on too many assumptions, including an assumption that disability will not occur. According to the US Centers for Disease Control and Prevention (CDC), 1 in 4 adult Americans will suffer from disability. The financial planner picked the cheapest term policy he could find when doing his analysis. The cheapest term policies typically don’t include living benefits. A living benefit provides an income stream to insureds if they become disabled. Cheap term policies may also lack valuable riders like the waiver of premium for disability rider, where the insurance company pays premiums for a disabled insured. People who become disabled are often unable to pay premiums, so living benefits are critically important. Don’t automatically go with the cheapest option.
I will agree with the financial planner that whole life wasn’t the best solution, but term life wasn’t either. A better solution would have been indexed universal life. With this type of policy, the insured could have paid the minimum premiums for a short time while he was paying down credit card debt. After the credit card debt is paid off, the insured can increase his premium payments (universal life offers flexible payments).
Another problem I have with the analysis is the assumption that sufficient funds will be available after a term policy expires, therefore a new life insurance policy won’t be needed. Even with careful financial planning, there’s still a chance of not having enough money. At the very least, people should fund their final expenses with a permanent life insurance policy. I’m not talking about a large policy; just something large enough to cover end of life expenses. If you don’t like the idea of paying premiums for the rest of your life, there is a special type of policy called limited pay whole life that allows you to pay off a policy in 10 years. After 10 years there are no more payments to make, and the policy stays in force forever.
Life insurance ads often take a one-size-fits-all approach, emphasizing the use of one type of life insurance over any other. Since certain age groups typically only see ads for one type of life insurance, those products become more popular within their respective age groups. For instance, people under 50 will never see ads for whole life unless they see an ad intended for an older age group.
Life insurance solutions are often more complicated than the one-size-fits-all strategy shown in advertisements. I use a two policy approach for people under 50. For final expenses I recommend whole life, and for all other expenses I recommend term life (affluent consumers should look at universal life). The problem with term life is that it terminates at a designated point in time, and some expenses, such as the cost of a burial or cremation, never go away during a person’s lifetime. Therefore, it’s inappropriate to use term life for everything.
Here is the takeaway: popular is not always better. Insurance products are only popular because ads make them that way, and ads make them that way because they only have enough time to discuss one product. Insurance agents, on the other hand, have plenty of time to discuss multiple products, and how those products compliment each other.
Depending on which agent you talk to, insurance riders are either fundamentally important or a waste of money. I say it depends on which type of policy you’re talking about. For sophisticated products like universal life, a long term care rider can alleviate the need for a separate long term care policy. Some riders are both cheap and critically important, like the “waiver of premium for disability” rider. As the name implies, your premiums are paid by the insurance company if you become disabled. Some term life policies have riders that provide living benefits for severe illness, and those are good as well.
Perhaps the most controversial use of riders is with small whole life policies. The most common riders on these polices are accidental death and grandchild riders. Accidental death is a relatively rare occurrence, and dishonest agents can use certain language to suggest that they are doubling or tripling the amount of coverage with this rider, conflating the death benefit with the rider benefit. Grandchild riders provide a small amount of convertible term insurance for grandchildren. The problem with this rider is that almost nobody converts the term insurance into a permanent policy. You would be much better off buying a “limited pay whole life” policy for your grandchildren. Be weary of agents trying to push these two riders because they might be using them to justify an overpriced policy.
How often should you or your agent review a policy? Some policies such as universal life are high maintenance. Other policies such as whole life are low maintenance. Universal life allows flexible premium payments, which is too much freedom for some consumers. Not paying enough over an extended period of time can cause a universal life policy to cancel. Annual reviews of universal life help to make sure the premiums paid are not too low. Whole life only needs to be reviewed when there is a life event: marriage, birth, divorce, etc. Life events sometimes warrant a beneficiary change.