Do you know the quickest way to silence the chattiest neighbor on a plane?
Tell him you sell life insurance. You’re guaranteed to be left alone for the rest of the flight. Is it fair that life insurance salespeople have such a bad reputation? Sure, there are a lot of bad apples that have tainted the industry, but there are also a lot of honest and caring individuals that want nothing but the best for their clients.
How can you protect yourself and not be scammed by the bad apples in the business? After you read this section, it won’t matter because you are going to walk in the door and tell the insurance agent exactly how much life insurance you need, the type of insurance you want, and how long you want it. Get ready to be in the driver’s seat!
All of the other types of insurance we’ve discussed so far are pretty easy to understand. Once you know the basics, you can easily compare one auto insurance policy with another or one disability insurance policy with another. When you start talking about life insurance, people’s eyes tend to glaze over.
Just what is life insurance?
At its very basic, life insurance is a simple agreement. It’s an agreement between you and a life insurance company. The agreement says that if you die, the life insurance company pays money to your beneficiaries. It’s that simple.
In fact, life insurance is even simpler than auto or disability insurance because there is no ambiguity. If you become disabled, your disability has to be examined and approved by the insurance company before they will pay you. If you get in an auto accident, you usually have to prove who was at fault before the policy will pay to fix your car. With life insurance, there is no guesswork. If you die, the insurance company pays—it’s a simple situation.
As straightforward as it sounds, life insurance can be one of the most complicated and confusing forms of insurance available—even for those selling it. Truckloads of books have been written about life insurance. If you think Hollywood is creative, you haven’t seen anything. The insurance industry has some of the most ingenious and creative people in the world who continuously create a dizzying array of new types of life insurance.
Before I discuss the various types of life insurance, it’s important to get a handle on a few definitions:
Owner (or Policy Owner) – The owner is a person who owns a life insurance policy and who is responsible for paying for the life insurance. The owner is in the driver’s seat. They determine who is insured and who is the beneficiary. The owner and the insured are usually the same person, but they don’t have to be.
Insured – The insured is the person whose life is covered by the life insurance policy. Stated another way, the insured is the “life” in the life insurance policy agreement. As soon as the insured passes away, the insurance company is required to pay the death benefit to the beneficiary.
Beneficiary – The person named in the policy to receive the life insurance proceeds upon the death of the insured. The beneficiary can be a spouse, child, or business partner. The proceeds can also be split between several people.
Contingent Beneficiary – If all of the named beneficiaries are deceased, those listed as contingent beneficiary receive the death benefit. When would this occur? If the insured and the beneficiary die together, the contingent beneficiary becomes very important.
Death Benefit (or Face Amount) – This is the amount of money paid by the life insurance company at the death of the insured to the beneficiary.
Premium – The premium is the cost of owing life insurance. When you send a check to the life insurance company after getting a bill, you are paying the premium. Why is it called a premium? It’s a marketing trick. Premium sounds good and positive—a lot better than bill or expense.
Rider (or Endorsement) – Legally speaking a rider is an amendment to a life insurance policy that becomes part of the insurance contract. In other words, a rider is an option or feature for which you are willing to pay extra. When you’re buying a car and the salesperson is discussing car undercoating, premium sound system, and satellite navigation, he is trying to sell you “riders.” Some riders are worth their cost, and you should avoid others.
In force – When you hear that a life insurance policy is “in force,” it simply means that the policy is active and you are insured.
Life insurance broker/agent – A life insurance agent is a salesperson that sells life insurance for one company. When you go into a Toyota dealership, the salesperson will try to sell you a Toyota. Don’t expect her to recommend a Honda. On the other hand, a life insurance broker represents multiple insurance companies and can sell you policies from more than one company.
Types of Life Insurance
There are two basic types of life insurance: (1) Term and (2) Permanent. It’s very important to know the differences between these two types of life insurance.
(1) Term Life Insurance
Term life insurance is easy to understand. It provides protection for a set amount of time—usually between one and 30 years (10, 20, and 30 years are common). At the end of the term, the agreement ends and your insurance ends. If you still want or need life insurance, you have to enter into a new agreement by purchasing a new insurance policy.
If you have a term life insurance policy, you don’t really own it. Instead, you’re renting it. Just like you would rent an apartment or lease a car. During the time of the lease, it is yours to use, but once the lease expires, it’s no longer yours. If you want to keep living in the apartment, you have to enter a new contract.
If the insured dies during the “lease” period, the insurance company is obligated to pay. On the other hand, if the insured survives the term of the policy, the insurance company isn’t obligated to pay anything.
(2) Permanent Insurance
If term insurance is like renting an apartment, permanent life insurance is like buying a home. Instead of being protected for a limited number of years, permanent insurance provides protection for as long as you live—that’s why they call it “permanent.”
There are several different types of permanent life insurance including whole life, universal life, and variable. Then there’s variable universal life. Of course, with permanent insurance, you have cash value, guaranteed and projected interest rates, in-force illustrations, maybe even investment options. Long story short, permanent insurance can get pretty complicated. It can also get pretty expensive.
I don’t like rules of thumb, but for most people most of the time, term insurance is what you want, and permanent is what you want to avoid. Permanent life insurance does have a purpose, but it is a very narrow purpose that I will discuss later in the chapter.
How much does life insurance cost?
Life insurance can be affordable or downright expensive. It all depends on the following five factors:
1) Policy. Different life insurance policies will cost different amounts. Just as a Cadillac is going to cost you more than a Honda, you can get relatively cheap life insurance or you can get more expensive policies. The type of life insurance—term versus permanent, the amount of death benefit, how long you want coverage, and the type of riders you select are all factors that affect the cost.
2) Age. A lot of things come with age—maturity, confidence, wisdom, and character. You can also add “higher life insurance costs” to that list. The older you are, the more expensive life insurance will cost. This should make sense. Life insurance companies live and die (pun intended!) by averages and statistics—mainly life expectancy numbers. The older you are, the greater the chance the life insurance company will have to cut a check to your beneficiaries. Someone who’s 30 has a longer life expectancy than someone who is 70. If the insurance company thinks they will have to pay a death benefit sooner rather than later, they’ll want to charge you more to cover the risk.
3) Health. It pays to be in good health. Life insurance companies will go to great lengths to determine your health. Insurance companies require you to complete a long medical application that includes questions about past surgeries, the health of your parents or their cause and age of death, medications you’re currently taking or have taken in the past, and a list of all doctors you’ve seen in the past ten years and the purpose for the visit. They won’t just take your word for it either. They’ll go through all of your medical records to verify your application and to make sure you didn’t “forget” anything important. In addition to a comprehensive application, they will also perform a medical evaluation. The medical evaluation normally doesn’t take more than 30 minutes, during which time they will take your blood pressure, height, weight, blood sample, and urine sample. If you’re in good health, the life insurance company won’t charge you as much since a healthy person has less of a chance of dying sooner.
4) Smoker/Non-Smoker. Life insurance companies read the warning labels on cigarette packages. They know all of the problems smoking can cause, and aren’t thrilled about insuring a smoker unless they charge the smoker a lot more in premiums. Bottom line, if you smoke, expect to pay more for life insurance.
5) Insurance Company. Remember, a life insurance policy is a contract. You pay premiums today and the life insurance company pays a death benefit at some point in the future. The assumption is that the life insurance company will (1) be around when it is time to pay the death benefit and (2) have enough money to pay the death benefit. You’re betting that the life insurance company will be able to honor their end of the agreement in the future. Better, more financially stable life insurance companies can charge a little more.
Do you or you spouse need life insurance?
The answer to this question has several important consequences that can affect your financial health while you are living and the financial health of those you love after you’ve passed away. Don’t waste your time wondering, if you need term or permanent, coverage for ten years or twenty, or $500,000 or $1 million. The first thing you should do is evaluate whether you need any life insurance.
Unlike auto insurance where consumers look through their phone book and proactively buy it, life insurance tends to be sold by salespeople. Don’t buy life insurance just because you’ve heard it is the right thing to do or because an aggressive salesperson tells you that you’re neglecting your family if you don’t have a policy.
Sometimes life insurance is not necessary. For example, if you are financially independent, retired, or have no family or dependents to support, you may not need life insurance. Owning a policy you don’t need or having too much life insurance can mean paying hundreds or thousands of dollars a year in needless insurance premiums. Every dollar that you spend on life insurance is one less dollar you can use to improve the quality of your life and loved ones while you are alive. The money keeping your policies in force could be used to buy groceries, fund a vacation, go to a baseball game with your kids, give to a charity, or save for retirement.
But what would happen if you passed away tomorrow? If you die without life insurance and you don’t have enough money in the bank or in your investment accounts, your family may experience financial hardship at a time when they are trying to deal with the emotional hardship of losing you. Would your family be able to recover financially? Would your spouse have to sell the house? Go back to work? Work two jobs? Take the kids out of piano lessons? If you have life insurance when you pass away, your loved ones can use the proceeds to help them fulfill their goals.
The proceeding blog post is an excerpt from The Six-Day Financial Makeover: Transform Your Financial Life in Less Than a Week!, available now on Amazon.
About the Independent Financial Advisor
Robert Pagliarini, PhD, CFP®, EA has helped clients across the United States manage, grow, and preserve their wealth for the past 25 years. His goal is to provide comprehensive financial, investment, and tax advice in a way that was honest and ethical. In addition, he is a CFP® Board Ambassador, one of only 50 in the country, and a real fiduciary. In his spare time, he writes personal finance books, finance articles for Forbes and develops email and video financial courses to help educate others. With decades of experience as a financial advisor, the media often calls on him for his expertise. Contact Robert today to learn more about his financial planning services.