How To Buy Life Insurance Without Getting Screwed
- May 8, 2008 by Fox | Comments: 25
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 and thousands of dollars. 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 in that you pay a simple annual premium to receive a decided amount of life insurance coverage. Think of term life insurance as similar to how home or car insurance works. If the insured person perishes then the beneficiaries collect, otherwise the premium is gone.
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 and you don’t have to re-qualify by showing evidence of good health each year.
Cash Value: All other policies (whole, universal, variable) combine life insurance with a sneaky so called investment portion that builds a cash value. Basically, your premiums pay for the life insurance and some of the money is invested in various high priced vehicles, touted to grow over time.These investments are managed by the insurance company so they benefit from the fees charged to the account. If you miss paying a premium, then you pay penalties outlined within the policy terms. Most people think this sounds perfect - the notion of investing insurance dollars and not wasting premium dollars. But think again.
For the same amount of coverage (say $250,000), cash value polices cost up to 10 times more than similar 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 lucrative for agents and brokers as they pay commissions and bonuses. 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 leave home 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 canceled 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 comparison 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 baby food policy providing $5,000 of life insurance for kids. This is contrary to the logic of owning life insurance since you are NOT financially dependent on your children but rather 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!
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Comments:
Increasing interesting insurance post!
One thing to note - when I had my mortgage with TD they had life insurance on the mortgage but it was based on how much was owed, so the premiums did decrease as the mortgage was paid off. Of course, it still cost about three times as much as regular term insurance for the initial mortgage amount so still a ripoff.
Mike
Great article! Life Insurance is something I haven’t had to tackle yet, as I’m single and supporting only myself and my cat. But this is a very helpful guide.
I don’t have (and never have had) any sort of life insurance. I try my best not to give people an incentive to want me dead. Plus, as you point out, I have no dependents so I don’t really need it…
Definitely good tips. We used AccuQuote to get ours.
I admit it, I was baffled into a whole life insurance policy a few years back, but have realized the woes in my ways. It really is ridiculous to see what an agent will try to sell you. I can assure you the next thing on the list they’ll try to peddle is an annuity. When they do that, you know you need to run away, fast. I like your writing style, you’re officially RSS”d!
Excellent Post! Very informative.
Coincidently, I have an appointment at my bank this afternoon to cancel my insurance on my mortgage. When I set up my first mortgage last year, one of the conditions was that I had to sign up for the term insurance (this was in part because I managed to bargain my bank down to a ridiculously low rate after bringing in quotes from an independent broker). My plan was to cancel the insurance after a few months (a loop hole my mortgage broker told me about) and continue on with my payments as normal. Unfortunately I had forgotten about canceling the insurance until earlier this week.
Down the road, when I have dependents my plan is to purchase term insurance. Does anyone have more recommendations of places to shop for insurance?
thanks! came here through nancy zimmerman’s twittering. question. i have a cash value life insurance, back from the times when i didn’t know what i was doing. that was 10 years ago. i’m in my early 50s. i guess buying a new life insurance is not such a great idea now bec of my age but would it be best then to take the cash contribution as far down as possible?
Great post!
One tip, even if you already have life insurance that you have bought 5-10 years ago, it doesn’t hurt to check out the new rate even if you are a bit older. I just did and find a new insurance with same coverage and same lenght of coverage but 50% cheaper. So I’m switching to a new company as soon as I drop the letter in the mail.
@isabella mori: Before changing anything with your current Cash Value policy, I think it’s important to do the following:
1. Evaluate how much life insurance your dependents need. Life insurance is about dependents, so unless you still have children or a spouse that depends on your income, you may not need life insurance as much as you did 10 years ago.
2. Evaluate your investments: Since your policy has an investment portion, it makes sense to evaluate your current investments. Do you have an RRSP? (or 401k for USA residents) What will your CPP (pension plan) entail at retirement? Do you have other sources of retirement income? Does it make sense to invest the cash value elsewhere? These are questions you may need a fee-only financial planner to help you with. For me, I took my Child’s Whole Life Policy and invested the cash portion in index funds (my RRSP is maxed out)(401K for USA). Again, only you can really answer these questions given your particular situation.
3. If life Insurance is needed: Get Term Life Quotes: You never know what a premium will be unless you ask. Term life premiums have dropped significantly over the past years, you may be surprised. Besides, 50ish is the new 40.
@Amy @ The Q Family: You are very correct, THANK YOU for mentioning this. I forgot about how significantly term life rates have dropped as I got my insurance last year.
thanks for this thorough reply and great article! i’ve stumbled it
and congrats on having your RRSP maxed out!
Great post! I have a whole-life insurance with an investment component and I am just appalled at the fees charged in these funds! I invest the proceeds into index funds, and even these funds charge anywhere from 3-4% in MER!
Unfortunately, I’m not sure I would be able to switch to term life, due my being diagnosed with Type 2 Diabetes. Even though I have completely turned by health around (normal blood sugars, no longer overweight and now running marathons), most of the insurance companies no longer want to insure me or they want to charge me outrageous prices!
I wish I had known about all this 10 years ago!
I’m a single mom. I have a daughter. I have life insurance on her. If she were to die, I’d be devastated and suspect I’d need a lot of time off work. I’d have no income so the insurance I have on her would help cover off my income while I was off as well as any funeral expenses. I also have critical illness insurance on her for the same reason. If she were to get really sick, I’d have to be off work to be with her and again, I’d have no income. Lord knows I hope none of this happens but I feel better knowing I could take as long as I need to manage through these difficult situations.
An excellent article on life insurance. A couple of clarifications though.
First, not everyone needs term. Most need term - but there are instances where permanent insurance is needed. Ask yourself ‘do I need this insurance when I’m 80?’. If yes, then term insurance will not work for you. However, for most people the answer to that question would be expected to be ‘no, I don’t need this insurance when I’m 80′. And that makes term a better fit.
Secondly, I think your term categories may not be well matched with the Canadian marketplace today. 5 and 15 year term are not price ocmpetitive. If you’re looking at either of those, you will be better served looking at 10 or 20 year term. For competitive reasons those two types of term insurance will be the same price or less expensive than 5 or 15 year term. Doesn’t make any sense conceptually, but that’s the current marketplace.
The guaranteed renewable thing IMO means little (more on the real alternative in just a sec). Life insurance has two pricing tables; select which means you’re proven healthy, and ultimate which means we don’t know how healthy you are anymore because it’s been so long since you took a medical. Take a 10 year term - the first 10 years you’re going to get the select/cheap rates. Year 11+ you’re going to get the crazy expensive ‘ultimate’ rates. You’re not going to want to pay those rates. Which means if you still need the insurance at that point you’re going to have to take a medical exam to buy a new policy to get back to the select rates. By making that assumption (which it seems you have squawkfox) you have taken on the risk of being able to take a medical exam in 10 years. If you don’t want to incur that risk and would prefer to lay that risk back on the insurance company you should go with a long term to cover you as long as you need the insurance. In other words, if you need the insurance for 20 years, buy a 20 year term so that you’re not looking at a medical exam in 10 years when we don’t know what your health is. Certainly for most of us our health isn’t getting better as we get older.
Back years ago the ‘renewable’ part meant more for term policies because Canadian term products had renewal premiums based on the cheaper select prices. So year 11 pricing was sane. Not so anymore.
The real fallback position is not the renewability - it’s conversion. I always recommend that people ensure their term policy has a conversion priviledge. This allows you to switch to permanent insurance without a medical exam - and is also a good example of why term isn’t perfect for absolutely everyone. If you’re going along with your 10 year term policy and become uninsurable, there’ll be no more buying a new term policy in 10 years. If your current policy has a conversion priviledge, you can trade it in for a permanent policy and get the same rates as someone who just qualified medically. And if you’re uninsurable you’re going to ‘want’ permanent insurance (it’s a different perspective you get when you realize you can’t get insurance anymore). So rather than being overly concerned with a product being ‘renewable’ because while most term plans are in fact renewable, few will want to actually take advantage of it, you should be very concerned that your product has a conversion priviledge. Do not buy a term policy that is not convertible!
And my one last clarification on the post; the ‘cash value insurance’ moniker has been used a bit too broadly. It seems you’re comparing ‘cash value insurance’ against term. In fact there are two types of insurance; term and permanent. Permanent life insurance has three types; whole life insurance (this is the ‘cash value insurance’ that many object to and I think you’re referring to), term to 100 (no cash values), and Universal life - that may or may not have cash values.
Both term to 100 and Universal Life insurance can be set up to be straight up or pure life insurance almost like term - no cash values or investments, just guaranteed level premiums for life. Great IF you need life insurance permanently (and again, I appreciate that most folks don’t). Universal life insurance can develop ‘cash’ values or an account value under certain conditions and it is commonly sold that way - but it doesn’t have to be.
I love you article and always said to my friends buy term insurance and invest the different,if you have other article mail me because like help other to know about life insurance is very important.
What would Warren Buffett buy?
The debate between term and permanent life insurance never ceases. Each product satisfies different needs. Untimately, you get what you get pay for. If you think insurance companies are minting money, buy shares.
Term is great for estate creation. It’s cheap because it expires before normal life expectancy. Much like a warranty that runs out before the big repair bills start. In comparison, permanent insurance is expensive because it lasts until you die.
You’ll find that wealthy Canadians (especially small business owners) buy permanent insurance for tax planning. They’re smart and prudent. They usually have proposals reviewed by their impartial accountant before acting. The cases I see typically have deposits of at least $100,000/yr for 3-5 years. The same principles apply for smaller cases too.
Does Warren Buffett “Buy Term and Invest The Difference”? You can get answers and dozens of comments (mainly from Americans) at http://blog.riscario.com/2007/10/does-warren-buffett-buy-term-and-invest.html. You will see a lack of consensus.
Wow Ricarsio Insider sums it all up in one comment WHAT WOULD WARREN BUFFET BUY! Warren Buffet is worth more money than obviously Ricarsio thinks because to think for one second you would sell life insurance to him only means you must be a cash value crook. What do you think Warren Buffet would do with a life insurance policy. he is worth some 40+BILLION dollars. But i guess in your way of selling life insurance he is the Big Fish you are looking for. Let me guess you would have him put 20 million in a whole life policy that would give him a great rate of return of 2.2% after the 5th year, don’t forget to tell Mr. Buffet that he would lose all 20 million for the first 5 years, but no worries he would get it back after that! while you spent your next 4 years living it up in cabo on his 20 million. so let me ask what good did that 20 million dollar investment do for him. except pay for a vacation for your family?
Once again a cash value agent that tries to explain to someone that is completely financially independant to buy a life insurance policy……. thats just sad!!!
Brett, Riscario Insider isn’t a life insurance agent, he’s an actuary. So I suspect you’re going to look a bit foolish trying to simplify the numbers for him.
Secondly, your view is simplistic. Trying to save the day by rescuing poor consumers from the horrible perils of whole life insurance is wonderful. But the fact is, very affluent people have different needs - yes even when they become self insured. These people frequently have large tax issues upon death that they can either liquidate assets at that time to pay the taxes, or buy life insurance. For those that run the numbers it turns out that buying life insurance is actually less expensive. That’s because permanent insurance is lapse supported. Lots of people buy insurance,most cancel before dieing. That means the insurance company doesn’t have to price life insurance strictly as
PV of future premiums=PV of death benefit+profit+claims.
It’s actually more like
PV of future premiums= PV of death benefit+profit+claims-premiums from other people’s lapsed policies.
And you’ll notice that Riscario prefaced this comment with the word ‘wealthy’.
The fact is, while you might imagine that wealthy people will self insure and sell their assets or use their cash upon death to pay their tax liabilities, in reality these people don’t listen to what you’re saying. They decide that using life insurance is cheaper than self-insuring AND means they don’t have to liquidate assets at death (which means at firesale prices) and screw up everything they’ve built during their lives.
If you run the numbers the PV of the future premiums turns out to be substantially less than the PV of the death claim. And in plain English, that means that if you know you have a large liability like taxes to pay out on death, in many cases the cheapest way to do that is with a permanent life insurance product.
The other big problem with Brett’s post is that Riscario Insider talked about permanent insurance. Fanatics hear permanent insurance and they put on their ‘whole life insurance’ blinders. If you read his link, it’s clear that Riscario is discussing Universal Life, not whole life. People look start to look foolish when they use about the 30 year old whole life arguments against Universal Life. In most cases the arguments - and for that matter the basic objection - just don’t hold true.
Of course if you start reading general VUL information on the web, you’re going to be reading the same vitrol as you do about whole life. That’s because you’ll be reading American stuff. Canadian Universal Life insurance is far better than most American universal life insurance. AND American universal life insurance products are actively in the process of moving towards a model that looks much more like Canadian Universal Life insurance. And you won’t find that on the web in most places either. Unless you read something like Riscario’s blog who is an actuary, Canadian, and knows what he’s talking about.
In short, your entire rant against Riscario is misplaced since he’s not even talking about whole life, and your basic premise that wealthy people who can self insure don’t need life insurance is actually wrong.
The comments from Brett S are interesting to read but show the difficulties in having a dialogue. In contrast, The Term Guy makes perceptive observations that help readers. I’ll comment on three.
1. I was referring to the wealthy and they are indeed different. I was reading today’s Toronto Star while waiting for a haircut and saw lots of ads for cars touting high gas mileage. That may be a deciding factor if you’re looking for a $20,000 car, but not if you’ve got a $70,000 BMW M3 in mind.
2. There are different forms of permanent insurance. Canadian sales figures show that very little whole life is sold in Canada — only 8% of premium last year (see http://blog.riscario.com/2008/03/canadian-life-insurance-sales-in-2007.html). The predominant form of permanent coverage is universal life which is effectively lets you “buy term and invest the difference in a tax-sheltered vehicle”. That’s not to say that UL is ideal for everyone.
3. Most of what you find online is about whole life and American products.
Unfortunately, there’s limited online content to help Canadians understand their options for life insurance. Thanks to Squawkfox for sharing her thoughts.
coming from an insider: typical comission on whole life is 100% of the first year’s premium. This is not rip off, this is murder (no pun).
Never, EVER buy term life insurance if you’re middle-aged. My mother did that, and now that she’s in her 70’s, it’s going to be impossible for her to get life insurance for a decent rate, when her term expires.
The result? She’s paid into a useless life insurance policy, because she’d have to die soon in order for it to be worthwhile. She and I would both like her to stick around a while longer.
Term life is useless for anyone except the young. Once you hit the big 4-0, don’t fall for this scam.
I’m ALWAYS suspisious those who advocate one and only one position when it comes to life insurance. Ask yourself a question… Will it be important to have a death benefit when you die? The chances of death are 100%. To make a blanket statement that term is the only way to go is extremely irresponsible. Term is great for specific periods of time but for the average person who will live past the age of 65 term is a great way to guarantee you will not die with an in-force life policy. If you have convinced yourself that there is no possible way you will need or want a death benefit if you live an average life span then just keep your term policy. This may be the best course of action for you but I would argue a fair percentage of your readers have multiple reasons why they should consider a permanent life policy.
SCOTT,
To make a blanket statement is pretty easy when it comes to life insurance! Your telling me it is going to be in your best interest to buy a cash value life insurance policy at 65? why is it that you think you can’t just buy another term policy for 15 years at 65 which would give you coverage to your 81st birthday. That would still be far less expensive and far more rewarding than any other cash value product. Did you know Scott that when the market averages 12% a whole life policy averages 2.6%,Universal life averages 4.2% And A V.U.L averages 7.6%WHO GETS THE DIFFERENCE??? i just don’t understand!Do you truly know how a cash value life insurance policy is broken down with fees and Cost of insurance? if you do then how is it ever in the best interest of the individual. Scott answer me an honest question… Are you a life insurance salesman. I’m not asking because I’m some narcissistic term insurance guru. I’m just a guy that took a little bit of time to break down my policy and six of my friends policies all ranging from 25-40 and ran the same numbers that they were all quoted and it came to pass that we were all getting taken for a ride. let me restate my previous comment… Cash Value life insurance should only be sold to maybe 1% of the population. all others should buy a term insurance policy and invest the difference. so i guess your right my new comment is going to read: 99% of the time you should buy a term life insurance policy over a cash value product!
the comments are very nice but why some people are not showing interest to buy life insurance?