By Robert O. Weagley, Ph.D., CFP®, thanks to Jacob XXX (BSHES ’14)
Our Personal Financial Planning emphasis students are required to do an internship. In the summer of 2014, Jacob XXX had the opportunity to intern at a large life insurance company, which provided him with valuable knowledge in financial planning. He was also taught aspects of risks that exist, if one does not plan correctly and the consequences that follow. I will take his work and try to provide some commentary to add to the reader’s understanding and will note my comments with a (rw) at the end of my editorial additions.
The goal of his Financial Tip is to enlighten people about the topic of life insurance in general. More specifically, his goal is to tout the benefits of getting insured early, regardless of your relationship status (single, engaged, married, etc.). This, of course, is nonsense (rw). For, if you are single with no economic dependents, you do not need life insurance (rw). Life insurance is designed to provide income to those that would otherwise be without income, should you die. If you don’t need it, don’t buy it (rw).
Age and Health Sensitive
Life insurance prices are sensitive to your age and health. This means that the cost of the insurance gets greater, the greater the likelihood of your death. You pay more when you are old and not in good health (rw). Therefore, it is held out by insurance companies that the earlier you obtain coverage, the less expensive the cost of the insurance. Still, however, if you don’t need the life insurance, why should you buy it (rw)? The counterargument is that your health is a variable that you have no control over and that you do not always wait to die until you are old. Factors such as family history, medical history, unsafe habits, and tobacco/ non- tobacco use coming into play to name a few. As a result, the purchase of insurance when you are young, is often set up with a case that rests on the potential lack of insurability.
Insurability is exactly as it sounds it is the ability to be insured. When the ability to become insured is lost there are few options for people (in regards to life insurance), and regaining the status of insurability is virtually impossible. We know events that can lead to becoming uninsurable. A terminal illness, certain types of diseases like cancer, and various other physical conditions can reduce one’s ability to be insured. Of course, if this happens and you need insurance, it can have a devastating effect on your dependents’ lives. That is, if you have dependents and have a need for life insurance (rw).
Tying It Together
So what does all of this mean? As with everything, we weigh options and assess risks to make decisions. When it comes to life insurance, the risk of waiting and not getting insured until one has a spouse or family is a decision that many people make. People are answering the question, “Why do I need insurance as a single person? I have nobody to give money to if I die”. Or the less savvy simply say, “I don’t need any insurance yet, I’ll be fine, nothing’s going to happen to me.” Both are points Jacob XXX would have agreed with last year and he still understands why people say them. However, few realize the benefits of getting insured young and even fewer understand the fact that if they don’t have anyone who needs money, should they die, they do not need life insurance (rw). We know that insurance is age and health sensitive, and the insurance industry rightfully points this out to young purchasers (rw). They are, after all, in the business of providing life insurance to the public (rw). If, however, you purchase an inexpensive term life Insurance policy with guaranteed insurability as a single, 20-something year old, and the next day you find out you have cancer, you have locked in your insurability for that policy. You would not, however, be able to purchase additional insurance if you were deemed uninsurable. Of course, if you need more life insurance following the diagnosis, you should have purchased more life insurance in the first place (rw)!
Being married and having kids obviously changes people’s views. They see that they need something in place in case something happens that limits their ability to economically provide for their family. In fact, the moment of greatest need for life insurance is at the conception of one’s last child and it, generally, decreases each day you live after that event (rw). Insurance and risk management are definitely a large piece to a financial plan for families. At the end, if you can insure that your dependents will not have to suffer financially, you have definitely made a good decision.
The following is mostly all (rw):
For the majority of the public, term life insurance allows families to have adequate insurance coverage at a price they can afford. Insurance companies, however, compare term insurance to renting an apartment. When you rent an apartment, you have a specific period of time that you are allowed to live in it (a lease). Once the lease is over, you move out and have nothing to show for it (no equity)… besides months of rent paid and maybe a memory of your weird neighbor from 4A. Term insurance, they say, works the same way. You have coverage for a certain period of time (could be 5, 10, 20, or 30 or more years). If you do not pass away in that designated time, then your coverage must be renewed (if it is guaranteed renewable) at a greater premium, since you are older and more likely to die. You do this until you reach the point where you no longer need life insurance – when you no longer have dependents. However, if you do pass away during the term, then your beneficiaries receive the amount of insurance you purchased and it is often the case that term insurance is the only affordable option for a family with a substantial insurable interest.
The agents will tell you that you are technically taking the risk of paying into the policy for years to protect loved ones if you die, but if you don’t die then you have nothing to show for the payments for all those years. That is true but it is only true if you do not take the difference in your premium dollars (lower cost term insurance premium subtracted from the alternative, whole-life policy premium) and deposit them into your retirement or other savings vehicle. Typically, younger people with little discretionary income and people who need large amounts of insurance purchase term life insurance, as it is inexpensive coverage (e.g., 23 year old male could pay $10-$20 per month for as much as $100,000 to $200,000 of coverage).
That said, there are instances where whole life (permanent life) is the best choice. Sometimes, we have a permanent need for life insurance, such as a disabled child that needs lifetime care. Some people make sufficient income that they are able to invest the maximum in their tax-favored accounts and still seek additional tax favored investments. If so, a savings type of life insurance policy can provide added tax protection.
The majority of people, however, who purchase permanent, whole-life products do not fit these criteria. We do not need life insurance if we have no economic dependents. We do not need a death benefit once our children are independent. Most of us do not have sufficient assets to make the need for life insurance as a source to pay estate taxes. For us, there are many reasons why whole life products are not the best cornerstone policies for a beginning family’s risk management plan.
To determine your need for life insurance, answer the following.
- Do you need life insurance to protect the economic livelihoods of your dependents?
- NO – Stop, you are finished with this exercise.
- YES – Continue to 2
- How much life insurance do you need?
- What kind of life insurance do you purchase?
- The answer to 2), if large, will often dictate that you purchase term-insurance.
- If you’ve sufficient income, the need for permanent protection for a dependent, for the payment of estate taxes, or you are motivated to bequest money to MIZZOU when you die, you should then consider a permanent policy.