If you ask me, life insurance is too often sold as a product.
You hear people throwing around statements like “Hey, buy this term policy” or “Here, purchase permanent insurance.”
Agents are telling you (yes, telling you) to buy a product without actually reviewing your needs. It’s like someone telling you to purchase a minivan without asking whether you have children.
In reality, some financial plans need life insurance. When making the decision to purchase life insurance, you should work with someone who accurately identifies if you need life insurance as well as what life insurance is the right choice for you.
In a perfect world, all financial advisors would think this way, but we don’t live in a perfect world. Life insurance isn’t, and shouldn’t, be a one size-fits-all system. Policies can be very complicated, but they can also be designed to meet a specific need (just like a minivan meets the need of a family with a lot of children). In other words, don’t buy a van if all you need is a four-door sedan.
Here are some steps you can follow to determine if you need life insurance, and what type of life insurance may be best for you.
1 – Identify a Reason to Need Life Insurance
This is a no-brainer, right? Yet, I see life insurance purchased all the time by people who don’t even need it.
Before you buy life insurance, you should identify a particular reason that you need insurance. For many, the first need for life insurance presents itself when you start a family. Other reasons you may need to purchase life insurance include the following:
- You are seeking to replace the lost income of a wage earner due to death
- You have a special needs child
- You are seeking to fund an estate planning need
- You are trying to support a charitable intention
- You are funding a corporate buy/sell agreement
- You are funding an executive compensation need
- You are intent on passing assets to the next generation
STOP here if you realize that you don’t have a clear need for life insurance. Tell the guys interrupting your family dinner to go bother someone else. Save your money and move on.
2 – Okay, so you do need it…now choose term or permanent
Now that you have identified a reason to buy life insurance, the next question is – what type of life insurance do you need? Do you need term life insurance or permanent life insurance?
Do you remember when I said that insurance could be designed to fit a particular need? Each need mentioned above should have a “best” protection strategy. For some, term will be better, while for others permanent will make more sense.
Let’s review the reasons from above. While there is no one-size-fits-all answer, my personal bias suggests the following (each case should be independently evaluated).
- You are seeking to replace the lost income of a wage earner due to death – TERM
- You have a special needs child – PERMANENT
- You are seeking to fund an estate planning need – PERMANENT
- You are funding a charitable intention – PERMANENT
- You are funding a corporate buy/sell agreement – TERM or PERMANENT
- You are funding an executive compensation need – TERM or PERMANENT
- You are intent on passing assets to the next generation – PERMANENT
Funding insurance is not a universally applicable model. Sometimes, term insurance works best and other times permanent is the answer. To take it one step further, once you decide on permanent insurance, you need to consider what type of permanent insurance policy is better. Your options include universal life, variable life, indexed life, and whole life.
3 – Determine how much coverage you need
Now that you have identified a need and picked the type, you need to ask yourself “How much life insurance should I buy?”
The answer will differ depending on the need.
A young family may need to replace lost income, college funding, and debt payoff.
A business owner may need to purchase enough insurance to cover 100% of a buyout of a deceased partner.
A person with an estate planning need may want to fund the estate or income tax liability that they will incur.
Each situation is different and each person is different. Determining the amount of insurance purchased is a combination of art, science, and affordability.
4 – Shop insurance companies for underwriting
“Shopping” is a critical, yet often overlooked, step in the insurance process (consider it the secret sauce).
When you apply for insurance, the insurers are going to scan your medical records to determine just how healthy you are. Based on their determination of your health, they will assign you a rating.
This rating affects your annual premium more than anything else (a good rating means a smaller premium, while a bad rating means a higher premium).
What’s important to know is this: insurance companies, looking at the same medical records, will offer different ratings to the exact same client. I have seen rating decisions range from “uninsurable” all the way to “super preferred” for the same client.
It often makes sense to pick the insurer that offers the best rating, as the cost of the policy will likely be the lowest.
5 – Complete the application
FINALLY! The heavy lifting is complete. Now it’s time to complete the application.
6 – Review the policy
Insurance policies need to be reviewed at least every few years to determine if they are still suitable. Spoiler Alert – your life changes and your needs change, so your policies should change. Over time, your policy may or may not meet the needs for which it was initially established. It’s important to monitor and to update your policy to be sure it’s still in line with its stated objectives.
The ability for an insurance company to meet the general account obligations and guarantees to policyholders are subject to sufficient capital, liquidity, cash flow and other resources of the insurance company. The guarantees do not apply to investment return or principal value of the separate account found in variable insurance policies.
Image courtesy of Stuart Miles at FreeDigitalPhotos.net