Life insurance is an odd name. Every other kind of insurance tells you exactly what you’re being protected against. For fire insurance you’re protecting against the possibility of a fire or flood insurance against a flood. I think life insurance is called life insurance because “death insurance” wouldn’t be as attractive. It is death, not life, that is being insured against and unlike most insurances the probability of death is 100%. Since insurance is meant to be used in instances where probability is low but consequences high, life insurance should only be used when the probability of death low. Interestingly, it is often when the probability of death is low that consequences are costly. At Independent Financial Planning, I often recommend term policies for life insurance coverage because it covers the risk of premature death while saving can occur.
Term insurance is a form of life insurance that is active as long as you pay for it and is generally determined for a set number of years at a level cost. For example, a term life insured 40 year-old male classified as “preferred non-smoker” would pay $745 per year for 30 years for $500,000 of benefit. Like car insurance if that insured person decided after fifteen years of making payments that he didn’t like the policy anymore all he would have to do is stop paying it and the policy ceases.
“In general, I think it is smart for young people to buy 20 or 30-year term insurance. It takes care of the period where your family is most vulnerable. You get coverage when you are young and healthy, because you don’t know what tomorrow will bring. Then save and invest to build up assets to meet the needs you may have when the term policy runs out. If you still need insurance at that point, and are healthy, get underwritten again for a new policy.”
In general simpler concepts and policies in the insurance world are better. Insurance companies can hide costs or reduce your coverage by making complicated policies. Term insurance is straight forward and simple to understand. As a result of its simplicity, it has become commoditized and is significantly cheaper than other kinds of life insurance.
I did a quick study on the differences in costs for insurance policies. Whole life insurance is very different than term. With whole life insurance by the time you reach 100 years old the policy has as much cash value as the insurance is supposed to cover. So naturally the costs to whole life is going to be higher. I will explain whole life insurance in more detail in another post. For now, look at the chart below. The chart shows the comparison of cost between $50,000 of whole life coverage to $500,000 of term life coverage. No that’s not a typo. The chart shows the cost of term coverage 10x higher than whole life. Like I said, term life is MUCH cheaper.
Some consider life insurance to be an investment as well as insurance. While I think it is wise to have life insurance I often encourage clients to consider insurance as insurance and investments as investments. In general, returns and risk coverage alike suffer when you try to mix the two. Have any questions or comments? Don't hesitate to get in touch. Let Independent Financial Planning help you make wise decisions based on what's important to you.
