Life insurance is a complex financial instrument, but it is not a complicated one. A life insurance policy can serve many functions, but it is, fundamentally, a tool to reduce risk for you or your family. A policy can cover funeral expenses or the costs of a child’s education, provide for a surviving spouse, children, grandchildren, children with special needs, or other loved ones, support a charity, leave a legacy, or provide for estate liquidity.
The complexity of life insurance is daunting to some and the lack of knowledge about life insurance products stops some people from purchasing it. Basically, it is a tool that transfers risk from the individual to the life insurance company. They balance that risk by pooling the risk (or mortality) of many people so they can predict expenses and match them with the premiums they collect from policy owners.
It is an age-based, health-based product so premiums are lower for younger people in good health. Your lifestyle can contribute to the cost of insurance, e.g., smoking or obesity.
You cannot plan on getting life insurance any time you want. You can have, or develop, health issues that make you uninsurable.
Some applicants are less forthcoming about their true health or lifestyle habits when they recognize these facts. Omitting or falsifying information on an application can result in the policy being terminated. That being said, most individuals overestimate the cost of insurance, with younger people overestimating insurance at three times its actual cost (LIMRA 2024 Life Insurance Barometer).
Almost all types of deaths are covered, with the most common exception being suicide within the first two years of the policy. The insurance company does have the right to contest claims in the first two years if it was determined the applicant had not been forthcoming on their application.
Should the insured pass once the policy is in effect, the beneficiaries would be provided the full death benefit amount, which, as mentioned above, can be spent as needed or desired to replace income, cover funeral, education, or medical expenses, or pay bills.
Just over half of Americans report owning life insurance and women trail men in life insurance ownership.
The easiest type of life insurance to obtain is group insurance from your employer. It is usually limited to some portion or multiple of your salary and it is only valid when you are a member of the ‘group’.
Term policies are typically the most affordable because they provide coverage for a limited amount of time, typically when the individual is younger so there is not a high mortality rate associated with term policies.
Whole life insurance is more expensive because it is permanent and provides a guaranteed death benefit from the time of coverage begins to end of life. Whole life policies develop cash values that pay dividends, and you can take a loan against the policy cash value.
A policy has different features (built-in) or riders (options added to the policy) that can make it useful for different phases of life. It can be used to cover a mortgage or a child’s education early in life, be used for medical expenses near the end of life, or create a legacy after life.
Since life insurance is purchased infrequently, it is worth the time to shop for the company that best suits your needs.
Here are 9 things to consider:
- Compare similar policies and features (i.e., compare a term policy to a term policy and a permanent policy to a permanent policy).
- Shop around and get quotes from different insurers.
- Compare premiums and ask if they can change in the future.
- Be aware of any commissions, surrender fees, or loads.
- Understand the guaranteed features, if any, of the policy.
- Ask for the crediting rate and crediting rate history
- For new permanent policies, ask for and compare net payment and surrender cost indices.
- Compare cash surrender values and future death benefits using a realistic crediting rate.
- Ask about the financial security of the insurance company.
Some intangibles would be empathy and responsiveness. Life insurance is a product that takes effect after the insured has passed. You will want to understand how the company treats and responds to your beneficiaries.
Do they answer the phone, ask questions, or only communicate by letter or email? It will be a difficult time. Are their processes simple and easy to follow? If not, the beneficiaries could take a long time to be paid.
How long does it take the company to pay a claim? You trust that company to take care of your loved ones. They should honor that trust in you while you live and in them after you pass.
