The life insurance industry has developed many products making it difficult to shop and
compare policies and other products.
This is no accident.
The bottom line on life insurance is that it is expensive. Life insurance is a major investment
and unless you have much more money than you will ever know what to do with, you need to
treat it as such. Even if you have more money than you will ever know what to with, you should
still treat it as a major investment.
Do not rely entirely on your insurance sales person. We will not please our insurance
friends with that statement, but as much as we like these people we do not represent them. We
represent you, our clients. At the end of the day, as much as you too might like these people
you need to know that they do not represent you. They are not your agent. They are called
"agents" not because they represent you, but rather because they represent the insurance
company. While some may strive to do what is right for you, because that is the right thing to
do, you have to assume that the products they offer are the products of their company. They
may actually be prohibited from showing you competing products unless you approach them
about those products first.
Of course, without casting aspersions, can you afford to simply dismiss the role of the
relative commission structures on each product? If a sales person could sell you two similar
products, do you suppose they will prefer to sell you the one that yields them the lower
You, the consumer, have only one real defense: do your own homework. If you aren't up to
this, retain the service of other, more independent professionals in addition to your
commissioned sales person. There is nothing wrong with compensating anyone on a
commission, as long as the consumer understands that anyone compensated in that manner
cannot possibly be independent. It is an old maxim in equity that a servant cannot serve two
masters, and if the commission is paid by someone else, and the commission depends on how
much the person gets you to buy, the person earning that commission is not your agent. Shop
and compare. Ask questions. Do your homework, and do not hesitate to seek out independent
How do you do your homework? As discussed above, the diversity of available products
renders the process confusing and difficult.
Understand first and foremost that regardless what policy you consider, a life insurance
product is an actuarial arrangement that guarantees a profit for the company providing the
product. When you consider that your commissioned sales person may earn up to 90% of the
first year's premium just for getting you to sign the policy, the bigger picture comes more into
focus. Now this profitable arrangement should come as no surprise. This is America. This is
what we do. The life insurance industry is just that: an industry. Without profit this industry
would cease to exist.
What else happens when you buy a product? The company takes your premiums and the
company pays out the commissions. Obviously the rest of the costs of running the company
are paid, including marketing and administrative costs and claims that have to be paid from
time to time. The company then invests the difference. In exchange for your premiums, the
company generally guarantees to pay out benefits to your designated beneficiaries upon your
death. As with any other business, the company must take in more income from the premiums
and its investment returns on those premiums than it pays out in benefits and other costs.
Such a deal. Right? You "win" on this “investment” if you die an untimely death. If you live to
a ripe old age, any way you look at it you have paid for insurance that you didn't need. If there
is an investment component to the product, you have netted the return on that investment less
whatever costs the insurance company has charged you for the privilege of letting them use
your money. Those costs are usually high relative to other investments you could have made.
The return on the investment component, whether it is a fixed return or whether it depends on
the market, may or may not be a good return, like any other investment.
In this respect, while you have a choice of either pure term or a “cash value” (or
“permanent”) insurance policy, in reality you really always buy term insurance. The company
knows, actuarially, that a certain percentage of its customers will die at various intervals. The
premiums for the insurance are established. The premium paid will either be paid out of current
premiums paid by the customer or accumulated funds from prior premiums paid in excess of
the amount paid for the insurance component.
The "cash value" or "permanent" part is really some sort of investment or annuity.
Pure term insurance is just that: an insurance policy purchased for a certain term. Term
insurance can generally be renewed annually, subject to annual premium increases. A
product known as “level premium term insurance” may also be offered, which commits the
insurance company to accepting the same annual premium, usually for some time between 5
and 30 years, depending on the contract. Generally the initial premium for the level premium
policy will be higher than a policy that is not a level premium policy. Again, the same actuarial
calculations are applied.
Many term policies permit the insured to convert the policy to a cash value policy without
evidence of insurability. Since one never knows whether one will be able to get insurance in
the future, if one needs insurance in the future, there is a value to having this right.
There are three types of "cash value" or "permanent" insurance: whole life, universal life,
and variable life. Since all policies are term policies at their core, you would expect correctly
that the distinction between these three types of insurance would lie in the investment
Whole life policies feature fixed annual premiums, guaranteed cash value, and dividends
that may provide additional investment returns. Universal life policies have flexible premium
payments and face amount. The owner of a variable life policy can direct investment of
premium deposited to a variety of mutual type funds.
Term insurance is generally a simple, straight-forward product wherein premiums are paid
for some set payout to your designated beneficiaries if you die. Cash value policies are more
complicated and the key to understanding what you are buying lies mostly in the true cost of
the policy, often hidden by the provider. Of course unless you purchase whole life you cannot
predict the performance of the product, and the risk in a whole life "investment" is that you
could get a better return elsewhere.
No evaluation is complete without considering the strategy of buying term insurance and
investing the difference. It is not universally true that this is always the best overall strategy,
but when you compare apples to apples the argument is almost invariably difficult to overcome,
from a true investment perspective.
Life insurance policies also vary according to who is insured:" individual " policies insure
one person; first to die policies insure two or more people and pay a death benefit upon the
first death (they are sometimes used to fund buy sell agreements); and second to die policies
insure two people (usually spouses) and pay a death benefit upon the second death.
To select a policy, consider:
1. Why do you need the insurance? Is it income replacement, estate liquidity, payment off
some debt in the event of your death, or to replace the loss of the potential value in the event
of an untimely death?
2. How much insurance do you need?
3. Who should be insured?
4. How long is the coverage needed, whether for a fixed term or a lifetime? Term insurance
is appropriate for a fixed term, such as until your children reach majority, but may not work for
certain lifetime needs.
5. How much can you afford to spend on premiums? It makes no sense to make yourself
6. Is flexibility required to pay premiums? For example, a business may need to ensure a
key employee but it's revenue stream may be volatile. The premium flexibility of a universal life-
insurance policy prove helpful to the business so that it can pay more when the cash flow is
7. Do you want to not have to pay premiums when you reach a certain age? A whole life
policy can be " funded” in a short period when the client's income is high and predictable, but
you also have to think carefully about whether you will really want to have that policy.
8. Is a guaranteed, fixed premium important?
9. Do you need level or increasing death benefit?
10. Do you wants control over the investment of the premium deposits (variable life)?
11. Consider an insurance company based on at least five factors:
A. Financial strength ratings;
B. Product line strength;
C. Underwriting considerations (an insurance company may not choose to insure you);
D. Customer service (you should be able to obtain enforced illustrations after you buy
your policy); and
E. Treatment of policy holders in terms of such things as passing along to existing
policy holders any benefit of any improvement of mortality rates.
12. Visit these sites for useful information to evaluate insurance companies:
13. Develop a sound funding plan based on five premises and steps:
A. Illustrate the product to age 100; paragraph
B. Understand that the illustration is not a contract, as many illustrated values are not
C. Understand that price variation among different products is often a function of
product design rather than a real difference and expenses;
D. Find out if the underlying interest rates and mortality assumptions are reasonable
and illustrate to the product an interest rate 2% below the current projected rate; and
E. Consider using more than one insurer to diversify your portfolio.
Usually in life there isn't a "better" or a "worse", per se. We are comfortable taking the
position that a blend of insurance products is probably a good idea for most people, with the
bulk of the insurance being a relatively inexpensive term policy.
ADVANTAGES OF TERM
1. Smaller premiums because you are not funding an investment.
2. You will probably be able to get a better deal, in reality, on the insurance component
since it is not rolled into and hidden within any investment.
3. You buy the insurance for only the time you need it to cover a specific risk.
4. Over the long run if you buy term and invest the difference you will probably do better
than if you bought a "cash value" policy.
5. If you buy term and invest the difference you may accumulate an investment wherein
you no longer need the insurance to cover any risk.
DISADVANTAGES OF TERM
1. Premiums will go up significantly either every year or after the period where premiums
2. If you become uninsurable, you may not be able to get a "permanent" policy and you
may not be able to afford the premiums on your existing policies.
3. If you buy term and invest the difference, the income and gain from the investment is
taxable as it is realized.
ADVANTAGES OF "CASH VALUE" OR PERMANENT
1. It is a forced savings account. It is nice to think about buying term and investing the
difference, but will you invest the difference?
2. The cash value of the policy is exempt from creditors and it is an effective asset
3. The income and gains on the policy can be tax free.
4. At some point you may be able to have your insurance without having to pay any more
premiums, depending on the policy.