Life Insurance: Where, What Kind, and How Much to Buy

The Ins and Outs of the Life Insurance Purchase Process  - By Scott Whittemore, CFP® 

Why life insurance? 

Life insurance is a very useful both to individuals and businesses, but also to our overall society.  When would cash be more needed than after the premature death of the main bread winner of the family?  The family with life insurance will not suffer financially or be a burden on other people or the government. 

When I picked up the Marin Independent Journal Monday morning, November 30, at my Mill Valley, CA home, a front page headline,” Family of 4 Killed on Hwy 37” caught my attention.  With a sinking feeling in my stomach, the article contained a familiar last name.  While I did not know them well, I knew who this father, mother and boy of 8 and girl of 5 were. The family had been on their way to visit the father’s older daughter from a previous marriage, a college freshman who was back on her Thanksgiving vacation.  I kept asking myself, “Why did this have to happen to such nice people?”  The highway patrol officer was quote on the accident, "It's a tragic situation.  These people had no idea what was coming at them. Wrong place, wrong time."  The suddenness and randomness of terrible events is awesome and humbling.  Knowing someone impacted by a horrific tragedy, if only remotely, just makes that tragedy hit home with more force 

As sad and tragic as the death of the family was, I was more worried for the surviving daughter.  She was very close to her father, brother and sister. Starting college out of state, she was already going through important life changes.  To now have to bear the loss of loved ones would be profound. As a CERTIFIED FINANCIAL PLANNER™, I was also thinking I hope there is life insurance and the daughter is beneficiary so financial issues would not be another impact of her loss.  I did not want to see her college education disrupted.  Latter I notice an article in the paper about a fund being started to help the girl with her college expenses.  Maybe there was not adequate life insurance? Protecting loved ones is the most basic reason to buy life insurance. 

Life insurance can be a complicated purchase.  There are many different companies offering many variations of life insurance.  Even the simplest of life insurance policies, term insurance, offer a wide variety of different options.  It is a purchase you will be using for 10, 20 or 30 or more years. Also, figuring out the right amount of insurance can be a complex calculation.  Because of the nature of the product, protection from an event we would rather not think about – death, life insurance is sold, not bought.  The image of an agent and family meeting over the kitchen table to be sold a life insurance is not one of comfort and satisfaction.  The purpose of this article is to give you direction on how to find help to make the process less complex and more comfortable and get a successful result.  It is good to understand the options available before you make your decision.  

Does it matter from which insurance company you buy your policy?

There are thousands of insurance companies in the marketplace and some are better than others in terms of value and claims-paying ability (financial strength). Premiums for similar amounts of coverage vary widely among companies.  They also specialize in certain types of life insurance such as term, return of premium, universal or whole life Insurance.  They also have different underwriting standards (or health rating standards).  If you have particular health issues, some companies are better at evaluating and taking the risks on those conditions than others.  A condition as common as asthma can be evaluated very differently among companies. Some companies are better for insuring people who do a lot of foreign travel.

Ratings

Many individuals will maintain life insurance for quite some time before there is a benefit payout. It is necessary to have a company with a strong financial position and track record. The claims-paying ability rating is an indicator of the company's financial strength and how well prepared it is to pay on policy claims. The best insurance companies are those that have strong financial reserves (to pay claims) and have a history of paying claims promptly.

There are five major ratings services that monitor insurance companies: A. M. Best, Standard & Poor's, Fitch (formerly Duff & Phelps), Moody's, and The Street.com (formerly Weiss). Each company has a different rating system. Rating information is available in most public libraries (check the business reference section) as well as through various published sources, some of which may be found on the Internet.

Service is an important factor in determining customer satisfaction. Check with the consumer division of the department of insurance in your state to find out about complaints (and how they were resolved) or about disciplinary action against a particular agent, broker, or insurance company. And finally, ask friends and family members who they use and how they found out about the company

Independent agents

If you use a professional, independent life insurance agent, they can provide a number of benefits to you in your insurance search.  First, they are not limited to any one particular insurance company.  They represent a wide variety of companies.  Given all the differences in value, types, financial strength, an independent agent is best positioned to sort through the difference and match you up with the best policy for your needs.  Second, they can educate on the difference in life insurance types.  Third, they are familiar with the financial ratings of the companies and help you interpret them.  Fourth, they know which companies are better with certain types of health issues and can get an evaluation of what the decision maybe before formally submitting an application.  Once an application has been turned down with one company, it can slow down and complicate any future application.  Finally, they can provide the same pricing as the Internet.  Life Insurance companies are regulated by the states and discounts are illegal.  The really low prices seen on the Internet are also available from an independent agent.  The difference is you can get advice tailored to your situation and needs with an independent agent.  Don't be afraid to ask questions. It's your money and your policy. 

How do you know how much to buy and what kind of life insurance to buy? 

Needs analysis

The first step in determining what type or amount of insurance to buy is a "needs analysis." A financial professional, such as a CERTIFIED FINANCIAL PLANNER™, can conduct a needs analysis to assess the financial impact on the family or business if the breadwinner or a key person in the business should die. The analysis will look at income-generating capability, current assets, debts, and ongoing expenses. Another consideration is your overall financial picture. This may include your goals for retirement, estate and tax planning, and education funding for any dependents, as well as your overall feelings about investments and risk. The results will indicate whether you have a need for insurance and how much insurance is appropriate. This picture will also direct you toward a specific life insurance policy type. 

Different types of life Insurance

A unique feature of life insurance is it is insuring against an event that is certain to happen:  death. The uncertainty is when it will happen.  Because of this unique characteristic of life insurance, there are two different types of life Insurance that are sold.  Term, which is similar to auto or homeowners insurance, provides coverage for a limited period time (the term).  Permanent life insurance is permanent and, as long as premiums are paid, will be paid out when the insured dies.  Since the insurance company knows they will have to pay on a permanent policy, they reserve against that certainty by setting aside cash to fund death benefit.  This “cash value” is accessible to the policy owner if they decide to terminate the policy before they die or borrow against it while they are living.  This feature adds a savings element.  Permanent life insurance is often called cash value insurance.  The two basic types, term and permanent, can be combined or blended together to provide the features and benefits of both types of policies in one policy.  Examples are products such as a return of premium (a term policy that returns cash at the end of the term) and universal life that allows flexible premium payments, but fewer guarantees.  With all the variations, it is possible to create a much customized policy solution to your particular type of needs.

 

Permanent policies have been have been compared to owning a home, and term is compared to renting one.  Owning requires more upfront cost (higher annual premiums), but you can get your money back.  Renting means lower premiums, especially initially, but if you do not use it, the money you paid in premiums is gone.  Which is best?  This question elicits very strong opinions on both sides, with advocates on both sides voicing their views of what is bad about the other type with a religious fervor.  Proponents of term point to the high cost from high commissions on the permanent products.  Proponents of permanent point to the high future cost of term as people age and that most term policies never pay any benefits because the expire before the insured actually dies.  The way to take the emotion out of the debate is to let the needs analysis drive the decision.  Carefully identifying the need with an independent insurance professional will lead to picking the right type of insurance.  Frequently a combination of the two types can be the best solution. 

Affordability

As important as it is to know how much insurance you need, consideration must be given to what you can afford. If you are in a situation where you have a high insurance need but low cash flow, there may still be a policy type available for you (e.g., term insurance), and you may have more options than you think. 

Again, an independent insurance professional can help sort out all the different products and companies, analyze the trade offs in costs and benefits, and come up with the life insurance solution that best suits your requirements. 

Other Buying Tips

Age is an important factor in the cost of insurance.  The younger you are, the lower the cost. Buying when younger saves money. 

Health is an even bigger factor than age.  Getting life insurance before health issues develop will save substantial money. 

What to expect when you decide to buy? 

The application

The first step to obtaining life insurance is completing the written application. Insurance companies typically inquire about a proposed insured's age, place of birth, home and business addresses, Social Security -number, occupation, salary, tobacco, drugs and alcohol usage, bankruptcy, driving record, dangerous hobbies, travel outside the United States, other life insurance owned, and personal and immediate family medical history.

Today, insurers pool life insurance application and claims information in a database maintained by the Medical Information Bureau (MIB), a nonprofit membership organization of life insurance companies that operates an information clearinghouse on behalf of its members. When an application is submitted to a member life insurance company, the information on the application is compared to the MIB records from other companies' applications and claims information that the MIB has on the proposed insured. Insurance companies use this information to verify the information provided on the life insurance application as a means of preventing fraud.

Omitting a pre-existing medical condition or making any type of material misstatement may be grounds for denial of coverage. Be carefully to truthfully and completely answer all questions.  Even if the omission or misstatement does not appear to be substantial to the applicant, for the insurer the credibility of all the information on the application is in question and raises concerns there are known risks that are being hidden.  If the omission is discovered after the policy is issued, the insurer may be able to revoke the policy or increase the policyholder's premiums, depending on the amount of time that has passed since the issue of the policy and the discovery of the misstatement.

 

The medical exam

Depending on the proposed insured's age, the amount of insurance the insured is buying, or other factors, a medical exam may be required after the application has been completed. The exam may include a physical exam, blood work, and EKG. Typically, the exam is performed by a licensed health professional that works for the insurance company. The insurance company usually pays for the exam and any lab work. The results are sent directly to the underwriter for review along with the proposed insured's application, although the proposed insured may request a copy lab work results.  If something surprises you, you should review it with your doctor. 

The underwriting process

The job of an underwriter is to analyze the information provided by a proposed insured and the records and reports obtained regarding the proposed insured, decide whether the company should assume the risk of insuring that person, and if so, at what price. If an applicant is deemed a favorable risk, the application will be approved, the premiums will be set, and the policy will be issued.  The applicant has 30 days to accept the insurance companies offer.  Even after accepting the policy and paying the first premium, which puts the policy in force, the policy owner has an additional 30 days, called the free look policy, to change their mind and return the policy and get the premiums refunded. 

The premium pool

When an insurance company collects premiums from its policyholders, fees, expenses, mortality costs, and taxes are deducted and the balance of the money is pooled and invested in an account to pay future claims. 

When an insured person dies, a claim is filed with the insurance company that issued the policy. The insurance company pays the death benefit to the policy's beneficiary (there can be more than one), using money from the cash reserve of paid premiums and investment earnings. 

Conclusion 

This article has discussed why buy life insurance, where to buy life insurance, how to determine what kind of and how much life insurance to buy and reviewed the process of applying for life insurance.  An independent financial professional, such as a CERTIFIED FINANCIAL PLANNER™, can be your best guide through this decision making process.