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My name is Tim, and welcome to the Financial LIFE Planning weekly!

10 Things You Absolutely Need To Know About Life Insurance

published2 months ago
11 min read

Life insurance is one of the pillars of personal finance, deserving of consideration by every household. I’d even go so far as to say it’s vital for most. Yet, despite its nearly universal applicability, there remains a great deal of confusion, and even skepticism, regarding life insurance. That's why we're outlining 10 Things You Absolutely Need To Know About Life Insurance in our continuing risk management series.

Speaking of risk, it was a somber close to the month and the quarter for the markets, and we're going to bring you up to speed on what you need to know there as well. And since he loves insurance companies (as an investment) and always has something helpful to say about the markets, we'll reserve our Quote O' the Week for the Oracle of Omaha himself.

Thanks for tuning into this edition of the Financial LIFE Planning weekly!


In this FLiP weekly you'll find:

  • Financial LIFE Planning:
    • 10 Things You Absolutely Need To Know About Life Insurance
  • Quote O' The Week:
    • Warren Buffett
  • Weekly Market Update:
    • The Perfect Storm


Financial LIFE Planning

10 Things You Need To Know About Life Insurance

Perhaps we avoid life insurance due to its complexity, the posture of those who sell it, or merely our preference for avoiding the topic of our own demise. But armed with the proper information, you can simplify the decision-making process and arrive at the right choice for you and your family.

To help, here are 10 things you absolutely need to know about life insurance:

1. If anyone relies on you financially, you need life insurance. It’s virtually obligatory if you are a spouse or the parent of dependent children. But you may also require life insurance if you are someone’s ex-spouse, life partner, a child of dependent parents, the sibling of a dependent adult, an employee, an employer, or a business partner. If you are stably retired or financially independent, and no one would suffer financially if you were to be no more, then you don’t need life insurance. You may, however, consider using life insurance as a strategic financial tool.

2. Life insurance does not simply apply a monetary value to someone’s life. Instead, it helps compensate for the inevitable financial consequences that accompany the loss of life. Strategically, it helps those left behind cover the costs of final expenses, outstanding debts and mortgages, planned educational expenses, and lost income. But most importantly, in the aftermath of an unexpected death, life insurance can lessen financial burdens at a time when surviving family members are dealing with the loss of a loved one. In addition, life insurance can provide valuable peace of mind for the policyholder. That is why life insurance is vital for the breadwinner of a single-income household but still important for a stay-at-home spouse.

3. Life insurance is a contract (called a policy). A policy is a contract between a life insurance company and someone(or occasionally something, like a trust) who has a financial interest in the life and livelihood of someone else. The insurance company pools the premiums of policyholders and pays out claims—called a death benefit—in the event of a death. The difference between the premiums taken in and the claims paid out is the insurance company’s profit.

4. There are four primary players, or roles, in a life insurance policy. These roles belong to the insurer, the owner, the insured and the beneficiary. The insurer is the insurance company, responsible for paying out claims in the case of a death. The owner of the policy is responsible for premium payments to the insurance company. The insured is the person upon whose life the policy is based. The beneficiary is the person, trust or other entity due to receive the life insurance claim—or death benefit—in the case of the insured’s passing.

5. Life insurance is a risk management tool, not an investment. While some life insurance policies have an investment feature that can offer a degree of tax privilege, insurance is rarely an optimal investment. There’s usually a better, more efficient tool for the financial task you’re trying to accomplish. If you haven’t yet filled up your emergency cash reserves, paid off all non-mortgage debt, maxed out your 401(k) and your Roth IRA, contributed to an education savings plan (where appropriate), and set money aside for large purchases you expect in the next decade, then you likely need not concern yourself with types of life insurance that contain an investment component. (You’ll see why in #7.)

6. There are two broad varieties of life insurance about which you should become aware—term and permanent. Term life is the simplest, the least expensive, and the most widely applicable. With term life, a life insurance company bases the policy premium on the probability that the insured will die within a stated term—typically 10, 20, or 30 years. The premiums are guaranteed for the length of the term, after which the policy becomes cost-prohibitive to maintain or you decide to let it lapse. Yes, this means that you may very well pay premiums for decades and “get nothing out of it.” But that’s good news, because it means you’re winning at the game of life.

Permanent life insurance includes this same probability-of-death calculus but also includes a savings mechanism. This mechanism, which is often referred to as “cash value,” is designed to help the policy exist into perpetuity. Whole life—the original—has an investment component much like bonds or CDs (but backed by the insurance company). Variable lifeoffers investment options more like mutual funds. Universal life was designed as a less expensive permanent life insurance alternative with added flexibility but increased interest rate risk for the owner.

Although they tend to be more complex and expensive, there are financial dilemmas—often related to business planning and/or high-net-worth estate planning—for which permanent life insurance may be the only solution. There are a few select instances where permanent policies are engineered to maximize the tax-privileged growth of cash value. They are, however, only appropriate for a small number of people and still dependent on numerous other factors to work the way they’re intended.

7. Life insurance can be extremely expensive, but it can also be surprisingly inexpensive. If you apply for a bells-and-whistles permanent policy, the size of the premiums alone might cause you to need a life insurance benefit right then and there. But most people are pleasantly surprised when they see the relatively low premiums of a plain-vanilla term policy.

A healthy, non-smoking, 30-something male, for example, might pay less than $500 per year for a 20-year term policy with a million-dollar death benefit. That same individual might be required to pay 10—or even 20—times as much for a variable or whole life insurance policy with a matching death benefit. No, a term/perm comparison is not apples-to-apples. I would hazard a guess, however, that a recent widower cares little for bells-and-whistles but a great deal for the death benefit. Of course, a smoker will likely pay twice as much for any of the above. Someone with health problems could pay triple or more (or simply be declined for coverage).

8. Determining the optimal life insurance policy for you doesn’t have to be complicated. While we could get really granular with a detailed life insurance needs analysis, it’s more important to get set up with something you can comprehend than it is to push off an important decision due to life insurance’s intimidating complexity. In the vast majority of situations, a household would be well cared for simply by buying enough life insurance to replicate all or most of the insured’s income for a term as long as the household expects to need that income.

Therefore, consider this simple but effective strategy for determining how much life insurance your household needs. Multiply a wage earner’s income by 15 and purchase a policy with an equivalent death benefit for a term that extends until the person insured would presumably retire. Why 15? Because it works. But it works because it results in a number that should re-create 75% of a wage earner’s income if the death benefit was conservatively invested to earn 5% (hopefully plus a bit more for inflation) annually. Here’s an example:

  • Dave makes $100,000.
  • $100,000 x 15 = $1,500,000 of death benefit
  • $1,500,000 earning 5% annually produces $75,000 of income.

9. Consider using a live person to help in your in-case-of-death planning. There are many online tools that can help give you an idea of how much money you should pay for the policy you need. But once you get to that point, I would recommend contacting a real, live insurance agent who can walk you through the application and underwriting process. The premiums at a given insurance company are identical whether you apply online, via a toll-free number or with a person. Indeed, a knowledgeable and dedicated insurance broker or agent may help you save money by choosing the best carrier for your particular situation. Underwriting, by the way, is the necessarily tedious process through which the insurance company classifies how much of a risk you are, based on your current health, past health, the health of your parents and siblings, and enough other questions to make anyone blush. Answer truthfully—but succinctly.

10. Know your options when cancelling an existing life insurance policy so you don’t leave money, or coverage, on the table. If you have a policy that isn’t appropriate for you—or you simply no longer need it—it’s important to proceed carefully. First, if you realize that you have overpaid for a policy that doesn’t meet your needs, but you still need life insurance, don’t cancel the wrong policy until the right policy is in place.

Who knows, you could learn of a health complication that is going to lead to you being declined for the new policy. Then you’d be left without any coverage. If you have an existing term policy you no longer need, you can simply cease premium payments and it will go away. If you have an unnecessary permanent policy with a cash value, however, you should analyze its present and expected future investment value, as well as any prospective tax complications, before cashing it in. You can do so by requesting an “in-force illustration” and a “cost basis report” from your agent.

I suspect we don’t love talking about life insurance because we don’t like talking about death. No shocker there. But open and honest discussions about planning for an unexpected death can be surprisingly life-giving. And even if you don’t buy that, the chances are good that purchasing life insurance is still an important part of your long-term and comprehensive financial plan.


Quote O' the Week

Warren Buffett

Turning our sites from insurance (one of Buffett's favorite types of investments for his firm, Berkshire Hathaway) to the markets, the topic for which he is most known, let's consider his wisdom as the market fear factor seems to have been active in recent weeks:

Be fearful when others are greedy. Be greedy when others are fearful.

Weekly Market Update

Here's a look at the past week...

  • - 2.91% .SPX (500 U.S. large companies)
  • - 3.09% IWD (U.S. large value companies)
  • - 1.43% IWM (U.S. small companies)
  • - 3.05% IWN (U.S. small value companies)
  • - 2.51% EFV (International value companies)
  • - 2.05% SCZ (International small companies)
  • - 0.43% VGIT (U.S. intermediate-term Treasury bonds)

Quarterly Market Update

...and the past quarter:

  • - 6.27% .SPX (500 U.S. large companies)
  • - 7.35% IWD (U.S. large value companies)
  • - 3.79% IWM (U.S. small companies)
  • - 6.65% IWN (U.S. small value companies)
  • - 11.51% EFV (International value companies)
  • - 10.59% SCZ (International small companies)
  • - 5.25% VGIT (U.S. intermediate-term Treasury bonds)

The Perfect Storm

Contributed by John Marske, CFP®, a Notre Dame grad and generally good guy.

The markets are turbulent enough these days, the last thing we needed was a major hurricane to hit Florida.

Unfortunately, this wasn’t the only storm we had to face this week. Events overseas are also causing more volatility in the markets. It all started on Monday following British Prime Minister, Liz Truss’s, announced plans for a series of tax cuts, not seen in Britain since 1972, funded by borrowing. The move was intended to drive economic growth in Britain.

Unfortunately, tax cuts are not a good idea when the country is already facing high inflation. The markets were quick to remind the Prime Minister of this fact. The British pound dropped to its lowest level against the U.S. dollar since 1985. Meanwhile yields on U.K. government bonds, known as “gilts,” experienced their sharpest monthly rise since 1957 as investors fled British fixed income markets. The ten-year gilt yield doubled from 2.10% in mid-August to almost 4.5%, before the Bank of England announced plans to temporarily purchase long-dated UK government bonds to keep a lid on rising rates.

We live in a global economy where events overseas affect U.S. markets and vice versa. The Fed’s efforts to fight inflation at home by raising rates has boosted the U.S. dollar versus other currencies. This has led countries, like England to take steps to defend their home currencies.

Ironically, as investors fled the UK market, they looked to the U.S. market as a “safe haven.” After experiencing losses in the U.S. market on Monday and Tuesday (resulting in new year-to-date lows for U.S. equities and a new high in Treasury yields), the U.S. market erased pre-market losses on Wednesday to open relatively flat. By mid-morning, the U.S. market was in full rally mode. Ten-year interest rates, which had hit 4% for the first time Tuesday evening, declined to 3.74%. Two-year yields fell from 4.30% to 4.11%. And stocks put on an impressive rally, with the Dow finishing the day 546 points higher, and the S&P 500 gaining 71 points to end at 3,718. Unfortunately, this was a one-day rally in reaction to international dislocations.

On Thursday, the Dow and S&P 500 index fell for the 7th time in 8-trading days, with Wednesday’s rebound all but a memory as Fed commentary and employment data suggested the Fed is nowhere near a pause in tightening. The Dow gave up 456 points of Wednesday’s gain, and the S&P 500 dropped 78 points to again hit a new year-to-date low of 3640.

And Friday was no better. US stocks closed out the day, month, and quarter lower. Thursday night alone, Nike noted margin compression and inventory build in its quarterly results, Carnival posted a larger quarterly loss and gloomy outlook, and Micron in tech was the latest chip maker to offer a somber outlook.

The events of the past week are a further reminder that in any policy endeavor, there are risks and rewards, coupled with both acceptable, unacceptable, and unanticipated trade-offs. For instance, while a stronger dollar might make U.S. imports more affordable, it will make our exports more expensive and it cuts into the repatriated profits of U.S. multi-national corporations, putting corporate earnings at even greater risk in an already weakening U.S. and global economy.

There’s obviously a lot to digest in this weekly update, but I want to end on a hopeful note. Pharma company Biogen (BIIB) saw its shares jump 35% on Wednesday, after announcing positive Phase 3 data for their Alzheimer's Disease (AD) treatment, lecanemab. The study met its primary endpoint by reducing cognitive and functional decline by 27% after 18 months of treatment. This is not only potentially great news for BIIB and for AD patients, it's also surprising news given the company's recent disappointment with Aduhelm, which received controversial approval from the FDA in 2021.

This is another reminder of the innovative advances being achieved within the walls of global corporations. Macroeconomic business cycles will have peaks and valleys based on policy, both good and bad. Over time, our corporations have learned to navigate the business cycle and typically come out stronger once the headwinds subside.

Stay strong!



As those of us in the Southeast are cleaning up in the wake of Hurricane Ian, and all of us send our prayers to those in Florida who bore the storm's brunt, I hope yours is a safe and peaceful weekend.

Best,

Tim


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Oh, and BTW, The information in this article is for educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. That should really come from your financial advisor. I'm thrilled to work for Triad Financial Advisors, but what I write is my opinion, and not necessarily theirs.