Insurance

Premiums vary among insurance companies so it’s a good idea to comparison shop in order to get the best premium. It’s also helpful to understand how premiums are calculated by insurers. Here’s a quick look at how this works.

Insurance companies place individuals into four risk groups: preferred, standard, substandard, or uninsurable. A terminal illness at the time you apply for insurance will render you uninsurable. Having some type of chronic illness will place you in the substandard category. People with conditions such as diabetes or heart disease can be insured, but will pay higher premiums.

If you have a high-risk job or hobby, you will be considered substandard, a high risk.

The premiums charged will be commensurate with the category you are placed in. Thus, a standard risk will pay an average premium for similarly situated insurers.

Tip: One company’s category for you may not be the same as another company’s category, so it still pays to shop for insurance with other companies even though one may have labeled you “substandard.”

Tip: Once an insurance company approves you for coverage, you cannot be dropped unless you stop paying your premium.

Here are some questions to ask about policies:

• How do cash values accumulate? An early, rapid build-up is generally preferable.

• How has the policy’s cash value performed in the past? You can get this information from a publication called Best’s Review, Life-Health Insurance Edition. Determine how the policy performed in comparison with the company’s projection and with other insurers.

• Are any special features merely bells and whistles, or do they add value for you?

• What is the company’s rating with A.M. Best, Standard & Poor’s, and Moody’s? You can find these publications in public libraries or online. The rankings should be in the top three to ensure that a company has financial stability.

Policy provisions that are hard to understand and compare. Many insurance company products contain investment features as well as insurance elements. Because these insurance products are very complex and have many variations, most clients cannot understand them. As a result, rates cannot easily be compared.

Pushing inappropriate policies. Make sure your agent carefully identifies your needs and explains why the policy is suitable for you. You may want to have your accountant or financial planner review any recommended policies before you make any purchases.

High commissions. Make sure you review the costs of any recommended policy carefully. As much as 80 percent of your first-year premium might go into the pocket of the insurance agent.

Tip: Due to administrative costs and commissions paid to agents the expected rate of return on insurance policies is generally low. If you want both insurance and investment returns, unbundle your needs. Get your life insurance from the insurance company (at the lower premium for pure, term insurance) and put the premium savings (the investment element) into a more profitable investment vehicle, where your return at age 65 will be substantially higher than through the insurance company’s annuity.

Safety of investment. Check an insurer’s rating before purchasing a policy. Even venerable companies such as Lloyd’s of London can be wiped out by unexpectedly high claims and the insured’s investment (as well as life insurance proceeds) can be lost.

In most states, there are rules, set by a group of state insurance regulators, requiring the agent to calculate two types of cost indexes that can help you to shop for a policy. You can use these indexes to compare policy costs.

One type of index, the net payment index, gauges the cost of carrying your policy for the next ten or twenty years. The lower the number is, the less expensive the policy will be. This index is useful if you are most interested in the death benefit aspect of a policy, as opposed to the investment aspect.

The other type of index, surrender cost index, is useful to those who have a high level of concern about the cash value. This index may be a negative number. The lower the number is the less expensive the policy will be.

These two indexes apply to term and whole life policies; however, with universal life policies, you’ll need to focus on the cash value growth and the cash surrender value to make comparisons. “Cash surrender value” is the amount you receive if you cancel the policy. It is not the same as “cash accumulation value.

If you are shown two universal life policies, and they have the same premium, death benefit, and interest rate, then in most cases, the one with the higher cash surrender value is generally the better policy.

The purpose of life insurance is to provide a source of income for your children, dependents, or whoever you choose as a beneficiary, in case, of your death. Life insurance can also serve other estate planning purposes, such as giving money to charity on your death, paying for estate taxes, or providing for a buy-out of a business interest.

Whether you need to buy life insurance depends on whether anyone is depending on your income. If you have a spouse, child, parent, or some other individual who depends on your income, then you probably need life insurance. Here are some typical families and a summary of their need for life insurance:

1. Families or single parents with young children or other dependents. The younger your children, the more insurance you need. If both spouses earn income, then both spouses should be insured, with insurance amounts proportionate to salary amounts.

2. Adults with no children or other dependents. If your spouse could live comfortably without your income, then you will need less insurance than the people in Situation (1). However, you will still need some life insurance. At a minimum, you will want to provide for burial expenses, for paying off whatever debts you have incurred, and for providing an orderly transition for the surviving spouse.

3. Adults with no children or other dependents. If your spouse could live comfortably without your income, then you will need less insurance than the people in Situation (1). However, you will still need some life insurance. At a minimum, you will want to provide for burial expenses, for paying off whatever debts you have incurred, and for providing an orderly transition for the surviving spouse.

4. Single adults with no dependents. You will need only enough insurance to cover burial expenses and debts unless you want to use insurance for estate planning purposes.

5. Children. Children generally need only enough life insurance to pay burial expenses and medical debts. Many advisors recommend self-insuring for children rather than buying an insurance policy.

6. Retirees. There is less of a need for life insurance after retirement unless it is to be used for estate planning purposes. You may need to provide an income for the second spouse to die if your retirement assets are not large enough. Further, you will need some insurance to pay burial expenses, final medical costs, and debts.

Determining how much insurance to buy requires you to calculate your current annual household expenses, followed by your assets, debts, and other sources of income. Your financial advisor can assist you in this computation.

The ideal amount of coverage is the amount that would allow your dependents to invest it after your death and maintain their desired standard of living without touching the principal. Although the old rule of thumb–to buy five, six or seven times your annual salary–may serve as a starting point, it is no substitute for making the calculations to find out how much you really need.

It’s important to be as accurate as possible in estimating your family’s needs since an underestimation could lead to your being underinsured, and an overestimation will lead to money wasted on unnecessary coverage.

Tip: To accurately estimate your family’s annual income needs, it’s helpful to have the following documents with you: A checkbook register for one year, a year’s worth of credit card statements, and last year’s tax return.

Once you have an idea of how much coverage you need, you can decide which type of insurance product would be best to fill those needs. Although the array of insurance products may seem confusing, there are really just two types of insurance.

• Term, whereby you pay for coverage for a specified amount of time, and if you die during that time the insurer pays your survivors the death benefit specified; and

• Cash value, usually referred to as whole life, universal life, or permanent life insurance, where, in addition to paying a death benefit, it also provides you with some other redeemable value.

For individuals age 40 or less, a term policy will almost always be less costly than a whole life policy. Although term policies do not build cash values, many are convertible to whole life policies without a physical exam. Thus, a term convertible policy may be a good option for someone who is under 40. There are various types of term insurance, which we will discuss briefly here.

• Renewable. A renewable term policy is the most common type of life insurance where the policy renews automatically on a renewable term, e.g. every year, every 5 years, every 10 years, or every 20 years–the most popular renewal term. You do not need to take a physical or verify the fact that you are employed. The premium goes up at the beginning of each new term to reflect the fact that you are older. Most renewable term policies can be renewable until you reach age 70 or so.

• Re-entry. With this type of policy, you must undergo a physical exam after a certain period, or pay an extra premium.

• Level. With level term policies, the premium is guaranteed to stay the same over a certain period. This period may be shorter than the term of the policy. Nearly all life insurance bought today is level term insurance.

• Decreasing. With a decreasing term policy, a good option for insuring mortgage payments the face amount of the policy decreases over time while the premium payments remain the same.
• Return of Premium. Some insurers offer term life with “return of premium.” Typically, premiums are significantly higher and they require keeping the policy in force to its term.

There are four types of cash value life insurance: (1) whole life, (2) universal life, (3) variable universal life and (4) variable whole life. The first two types are the most common and have a guaranteed cash surrender value; in the last two types, the cash surrender value is not guaranteed.

Whole Life. This is the traditional life insurance policy. It provides a death benefit, has a cash value build-up, and sometimes pays dividends. You do not need to renew a whole life policy. As long as you pay your premiums, you will have coverage, usually until your death. The premium for a whole life policy remains the same for the amount of time you own the policy; the premium is “level” in insurance parlance. Thus, when you are younger, the premium you pay for whole life will be greater than what you would pay for term insurance but when you are older, the premium will be much less than a term premium. Part of each premium goes into the cash value of your policy. Your cash value, which is actually an investment, is guaranteed to grow at a fixed rate. You do not have to pay current income taxes on the growth in the cash value-it is tax-deferred.

Tip: You can borrow against your cash value at a rate that is usually better than the prevailing consumer lending rates. If you die with an outstanding loan amount, the loan amount, plus interest, will be subtracted from your death benefit.

Dividend-paying whole life policies-termed “participating” policies are usually offered by mutual life insurance companies. Mutual life insurance companies are generally owned by policyholders while other insurance companies are owned by shareholders. The dividends are refunds of insurance premiums that exceed a certain level. They are paid when the insurance company does well during a quarter or a year. Of course, premiums for participating policies are usually higher than those paid for non-participating policies.

Note: Term policies can also be participating, but the dividends paid are usually minimal.

Universal Life. Universal life, also known as “flexible premium adjustable life,” is similar to whole life, but offers more flexibility in terms of payment of premiums and cash value growth. With a universal life policy, your monthly premium amount is first credited to your cash value. The company then deducts the cost of your death benefit and the expenses of the policy. These costs are about equal to what it would cost to buy term coverage. As with whole life, your cash value grows at a fixed minimum rate of interest. The growth of the cash value is tax-deferred, and you can borrow against it or make partial withdrawals.

Caution: A special feature of universal life is that you can vary the premium paid from month to month. You can pay more or less-within certain limits-without jeopardizing your coverage. You can even let the cash value absorb the premium. However, the danger here is that if the premium payments fall too low, your policy may lapse. While some states require the insurer to tell you when your cash value is at a dangerously low point, you will, if you live in another state, have to maintain a careful watch on the amount of cash value if premiums are skipped.

Variable Universal Life. Variable universal life allows you to choose the investment for your cash value. You have a potentially greater cash value growth, but you also have added risk, depending on the type of investment you choose.

Variable Whole Life. With variable whole life, the death benefit and cash value will depend on the performance of an investment fund that you choose. Again, you have potentially greater reward, with its accompanying risks.

Since the purpose of life insurance is to provide for dependent survivors, children generally need only enough life insurance to pay burial expenses and medical debts. Yet, 25 percent of cash-value life insurance policies sold covers the life of a child under 18. Note: Cash value life insurance; either whole life or universal life combines a death benefit with a savings or investment element.

Alternatives to covering the costs of a child’s death include (1) using funds already set aside for college and (2) taking out a rider on a parent’s policy (if available).