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Life Insurance

Posted on August 11th, 2010 | admin

The Life Insurance Labyrinth

Of all the different types of insurance being offered, life insurance is probably the most difficult to come to grips with. There are numerous types from which to choose and the pricing structures and options make the cockpit of a 747 look like child’s play. Most life insurance literature is long on pictures of smiling people and short on understandable facts. Life insurance salespeople have a well-deserved reputation for dazzling potential customers with numbers and burying them in paper. You might infer from these comments that I think this is an industry that tends to wrap itself in obfuscation.You’d be right. But let’s do the best we can to bring some clarity to the situation.

We’ll start by reviewing the various types of life insurance policies that are available.

Term Insurance

Term insurance gets its name from the fact that it does not cover you for life. Every policy has a “term,” which is effectively an expiration date based on your age. Once you attain that age, your coverage will lapse. In its pure form, term insurance is the most basic type of life insurance available, and is also the easiest to understand. As long as you don’t add on any bells and whistles (and there are lots of possibilities), term offers your best chance to do some meaningful comparison shopping. It is the cheapest form of life insurance, and the annual premiums may be hundreds of dollars less than you’d pay for a whole life or universal life policy.

If you only want basic protection for your family, this is the way to go. You pay a premium and the company provides coverage. The higher the coverage, the higher the premium. The younger you are, the less you pay. There are no dividends, no extras, no investment options, nothing but straightforward insurance. Simple, isn’t it? Unfortunately, even if basic term insurance is exactly what you want, you will almost certainly find yourself faced with a seemingly bewildering array of options when it comes time to make a decision. Here are a few.

Length of Term

The premium on your term insurance policy will be adjusted periodically. Think of it as a mortgage. The amortization period of your mortgage may be for 25 years, but the term (the period for which the interest rate is guaranteed) will be less. At each renewal date, your mortgage interest rate is adjusted to reflect current conditions.

A term life insurance policy works in a similar way, except that your premium always goes up at the end of each period. You can choose terms of anywhere from one to 30 years. The longer the term, the higher your premiums will be at the outset, but you’ll pay less later on. Alternatively, you can choose to make level payments until a certain age, usually 65, 70, 75, or 80, although some companies offer “Term to 100″ policies. Level-payment term policies provide payment stability and make budgeting easier, but are usually the most expensive approach.

Trying to figure out the best term to choose from a cost perspective can be a mathematician’s nightmare. You would have to do a projection of total premiums over the life of the policy using different terms, and for that you need the renewal rates for each term. This means you will want a guaranteed rate structure, as opposed to a flexible one that has a number of built-in variables. If you gather all that information, you then need to do a present value calculation. And of course, all this is predicated on living until the policy matures. If you die sooner, the calculations become meaningless.

My preferred solution is to pay as little as possible for as long as possible. This usually means selecting one-year or five-year terms. Ask your agent to provide projections. Choosing a short term also works better for most young families, because the insurance costs will rise along with total income. However, if fixed payments are more important to you (which is why people choose longer terms for their mortgages), then select a more extended term or a policy that runs to a specific age.

Conversion Privileges

Most term policies come with an option to convert to whole life without a medical. You may think at the outset that there would never be a reason to do this—after all, why convert and pay a higher premium for the same coverage? However, as you grow older your thinking may change. A few years ago, I went to the 70th birthday party of a close friend. Over a glass of wine, he remarked to me that he had been paying premiums on a term policy since he was in his 20s, and it expired on his 70th birthday. All that money wasted! I told him to consider the alternative, and that cheered him up somewhat.

At some point, he almost certainly could have converted to whole life but did not do so. There’s usually a cut-off point a few years before the policy expires you can’t wait until the last minute. Find out when the conversion privilege runs out and start thinking about whether you want to convert a few years before. You’ll face a big premium increase if you do and many people may simply not be able to afford it. But if you want to keep the coverage in place to provide income for your spouse or to leave a sizeable estate for your heirs, then you’ll need to plan ahead.

Decreasing Term

Decreasing terms used to be a popular variation on term insurance, although they’re not seen much any more. The concept is that your premium remains the same throughout the life of the policy but the amount of coverage declines as you grow older. The theory is that as children grow up and leave home, a family needs less protection. The downside is that your spouse or partner could be left in a financial bind. Mortgage insurance operates on this principle.

Inflation Protection

Some term policies offer a cost-of-living escalator, which increases coverage in line with inflation. This provides purchasing power protection. Naturally, you’ll pay more for this benefit.

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