squawkfox

I’ve been thinking a lot about life insurance lately. I don’t have a death wish or anything, but I think life insurance is a neglected area of personal finance which requires some Squawkfox attention. Without a proper or adequate life insurance policy, you can leave your dependents in financial disarray if you happen to make an early departure.

Life insurance is a funny animal. This is a product which is more often sold than bought. Basically, the insurance industry is based on hefty commissions and perks which renders the policy peddlers biased towards their pocketbooks. This industry is a complex, weird, and wacky business. There are writers, underwriters, sales forces, brokers, and agents. When I started shopping around for my “better half’s” policy, I found myself wound in a tangled web of weirdness. I would call an “agent” and then get passed to brokers of brokers of agents of brokers.

Getting straight answers on what insurance to get and how much to buy was impossible. Everyone seemed to peddle the same policy s$it, and I trusted no one with this vital piece to my financial well-being. My “better half” and I spent weeks untangling the life insurance web, and I would like to share my findings with you.

Here’s how I bought life insurance without getting screwed:

1. Get Term Life Insurance

I’m about to save you billions of brain cells, hours of time, and thousands of dollars. Ready? Just buy term life insurance. The only exception is if you are an extremely high net worth individual, in which case you “have people” to discuss your privileged a$$ed-options and don’t need my blog anyways. Smile.

For the rest of us, there are two flavors in life insurance policies: Term Life and Cash Value.

Term Life: Is pure life insurance. You pay a simple annual premium to receive a predetermined amount of life insurance coverage. If the insured person perishes, the beneficiaries collect, otherwise the premium is gone. Term life is similar to the way home or auto insurance works.

Term insurance has no investment component. You’re buying life coverage that lasts for a set period of time provided you pay the monthly premium. An annual renewable term is purchased year-by-year, although you don’t have to re-qualify by showing evidence of good health each year.

Cash Value: All other policies (whole, universal, variable etc.) combine life insurance with a sneaky so-called investment option to build a cash value. Your premiums not only pay for the life insurance, but some of the money is placed in an investment account (operated by the insurance company) to grow in value over time (assuming you don’t miss your premium payments). This sounds really rosy, especially since people don’t like thinking their premium dollars are wasted.

So what’s the catch? For the same amount of coverage (say $250,000), cash value polices cost anywhere from 4 to 10 times more than comparable term life policies. There are also significant penalties to ending a cash value policy early or missing premium payments. Your cash value policy is also invested with the insurance company, so the fees you pay are likely high and not competitive. Lastly, cash value policies are the bread-and-butter of agents and brokers as they are lucrative with commissions and bonuses (remember, life insurance is sold, not bought). Buying a cash value policy lines the pockets of these people. Due to the expensive nature of this product, the sad scenario is most people end up being under insured.

By buying term life, you get more insurance for your beneficiaries for less bucks.

2. Do You Need Life Insurance?

You generally only need life insurance when other people depend on your income. If you have a spouse and/or children dependent on your income, then you should get life insurance. Those with mortgages and many years left to raising kids most certainly should get insurance. You are unlikely to need life insurance if you are single with no dependents, independently wealthy, retired and living off retirement investments, or a child (more on children later).

3. Calculate Coverage Needs

When buying life insurance make sure you’ve got enough. Deciding how much you need is both a subjective and quantitative decision. Since the main purpose of life insurance is to prove a lump-sum payment that replaces the deceased person’s income, the question you must consider is How much income do you need to replace? Also consider the following:

• Are there any outstanding debts to pay?
• Will the surviving partner have childcare expenses?
• Is there a mortgage to cover?
• Are there other assets on which to draw?
• Will your children be out of the nest soon?
• Will there be education costs for college or university?

The answers to these questions can influence the decision on how much coverage you need. Be sure to consider all variables before deciding on your coverage needs.

4. Determine The Term

Insurance agents and brokers are huge fans of selling cash value policies you can keep throughout your life. These cash value (whole life) policies fatten their wallets with juicy fees and commissions. What agents tend to gloss over is you probably don’t need life insurance throughout your life. You generally only need life insurance when you have dependents (see #2).

Since you’re a smarty now and are thinking about Term Life insurance, here’s how to determine your term:

How often do you want your premium to adjust?

The cost of insurance goes up as you get older and your risk of dying increases. Sorry to be a downer. On the upside, term life insurance can be purchased so your premium adjusts (increases) annually, or every 5, 10, 15, or 20 years. The less frequently your premium adjusts, the higher the initial premium will be.

Advantages to longer terms: The advantage to locking in to a longer term policy (15, or 20 years) is you know how much you will be paying over that time. You also require fewer medical evaluations to qualify for the lower rates.

Disadvantages to longer terms: The disadvantage to a longer term policy is you will be paying more in the earlier years than you would on a policy that adjusts more frequently. You may also want to change the amount of insurance you need as your situation changes, so you are throwing away money by ending a longer term policy with a premium guarantee.

A happy balance are policies of terms 5 or 10 years. My “better half’s” term life policy is nicely set at 10 years.

Guaranteed Renewability

The better term life policies have this feature which guarantees a policy cannot be cancelled because of poor health. Do not buy a life insurance policy without guaranteed renewability.

Guaranteed Renewal Rates

When comparing various policies, what really matters is the total overall amount you pay for your coverage for ALL the years you require life insurance. Be sure the premiums paid each time you renew are guaranteed and outlined term-by-term in your policy. To better evaluate various policies, have the agent do a present value comparision of the total. This figure represents the cost of a policy for all the years in a single payment, today.

5. Buy When You’re Healthy

The worst time to buy life insurance is when you need it. Older people and those not in the best of health pay steeply higher rates for life insurance, so buy as early as you can WHEN you have dependents.

6. Don’t Insure Children

I’ve seen this happen to many new parents. Some agent discovers you just had a baby, and sells you a Gerber “Grow-Up” policy, or some other policy providing $5,000 of life insurance for kids. This contradicts the entire logic of life insurance since you are NOT financially dependent on your children - your children are dependent on YOU. Don’t let these agents gain economically from your emotional attachment to your new baby. This is a lucrative cash value policy gone sour. Ohh, my dear mom bought one of these policies for me at four months old. I still shake my head about it. Rest assured I cashed that silly thing in years ago and bought myself a $250,000 Term Life policy for less than half the cost of the $5000 Cash Value baby policy premium. I’m no sucker.

7. Shop Around

Always invest some time in shopping around for the best term life policy at the best rate. It makes little sense to stop at the neighborhood insurance broker and expect the best rates without knowing more about what’s available. Here are some places to consider looking for low-cost term insurance:

• Are you a member of any Groups, Professional Associations, Business Organizations, or Alumni Associations? You can often find low-cost insurance by inquiring within your clubs and organizations.
• TermForSale: To get a sense of what your premiums will be with various companies, try this online quotation service.
• Blue Cross
• Automobile Associations
• RBC Insurance
• TD Insurance

8. Skip Mortgage Insurance

Do yourself a huge favor, avoid mortgage insurance policies. These policies only pay off the balance on your mortgage if you die. The problem with this insurance is you are paying the same premium for a steadily declining amount of coverage, as you pay down your mortgage. It’s best to skip this narrowly-focused policy and favor for a broader term life policy and include the mortgage payments in your calculations when determining how much coverage you need.

9. Tell The Truth

There is no sense in telling tales on your insurance application to get a lower rate. Be assured that insurance companies will investigate any claim made before paying out. Be sure to always tell the truth.

10. Getting Rid of Cash Value Insurance

So now you’ve gone though your paperwork and see you have an expensive cash value life insurance policy, now what? Do yourself a favor and don’t cancel it until you secure some affordable term life to replace it. The worse thing you could do is leave your dependents vulnerable while in between life insurance policies.

That’s my brain on life insurance. I hope you found this lengthly article helpful. I’m wondering how many of you have life insurance? Do you have cash value or term life? Have you ever felt screwed after buying a life insurance policy? Do tell!