The Life Insurance Problem

Life insurance is a difficult subject to figure out because it has lots of moving parts. Plus, most people don't like to think about their own mortality.

Someday, of course, all of us will die. But, since we don't know exactly when this will happen, we tend not to think too much about it. Sometimes we wait until it's too late before we get serious about the value of life insurance.

Only those who are reasonably healthy are permitted to buy life insurance. If you are seriously diseased, cancerous or diagnosed as terminal, it's unlikely that any company would knowingly issue you a policy. However, some "second to die" policies are available as long as one of the two applicants is insurable.

There are companies that specialize in limited value policies and market them aggressively in print and television, but these usually are for face amounts of less than $10,000. There are exceptions, but caution is advised before committing your money.

When a large number of comparatively healthy people are grouped into age related categories, it's possible to project with some accuracy how many of them will die within a span of time. This projection is for the large number only and not for the individual.

Indeed, if it were possible to predict with certainty the timing of your specific death, no company in the world would issue you an affordably price policy.

One major irritant to the purchase of life insurance is that you have to pay premiums for a long period of time without seeing any tangible benefit. There's nothing to hold in your hand... to watch... or to drive. It's an unselfish purchase.

It's the only asset you can own that will guarantee tax-free cash for your loved ones at the exact time they will most likely need it. Problem is, you won't be around when it pays off.

So, don't buy a policy unless you can guarantee it will be in effect at the time of your death.

But, since you don't know when your death will actually occur, how can you provide this guarantee? First, a brief overview.

The death benefit concept was originally developed over 200 years ago. Members of rural communities would each contribute small amounts of cash into a collection. When a member of the community died, a portion of the collection was given to the family of the deceased.

There are essentially two types of life insurance companies: mutual and stock. Mutual companies pay dividends to their policyholders and stock companies pay dividends to their stockholders.

The distinction between the two types has become blurred somewhat over the last few years as mergers and buyouts transformed the business into what is now called the financial services industry.

A major difference, however, continues to be in the net cost of a policy because mutual company annual dividends provide significant added value over time.

Companies like Mass Mutual, Northwestern Mutual and New York Life have excellent track records of increasing dividends; thereby significantly reducing the net cost of certain policy types.

An argument can be made that the mutual company policy premium is larger than necessary and, therefore, the annual dividend is nothing more than a method to reduce the premium to its more appropriate price.

While this point may have merit during the early years of a policy, it becomes invalid as the policy matures. Indeed, dividends paid over time by the above companies contradict any attempt to downplay their value.

There are two basic types of policies: term life and whole life (also referred to as permanent). The "term" is defined as that point in time when the death benefit will no longer be paid to the insured's beneficiary. If the insured party has not died prior to that point in time, there is no value.

The whole life death benefit is always available provided the premium has been paid when due.

Competition has forced life insurance companies to develop numerous other types of policies, but they are simply hybrid forms of term and permanent. These include universal life and variable universal life. The numerous and complicated features of these hybrids make many policies very difficult to understand.

The foundation of a life insurance policy is based on mortality or the expected time of death. Since the expectation of death increases each year, the cost increases as we age.

Life insurance is primarily state regulated, although this may change in the near future. State insurance commissioners determine the mortality age table that must be used in the pricing of a life insurance policy by each company wishing to do business in that state.

This means an insurance company must honor certain expectations in their pricing. If a company wishes to use a different mortality table to price their products they may do so as long as the mortality expectation meets state requirements.

Life companies consider their own experience with mortality when developing different products. Sometimes they count on having the mortality experience for all of their products to be good enough to over-compensate for one particular product that is intentionally under-priced.

For example, they might introduce a very low cost term life policy with unrealistic mortality expectations compared with the state requirements. This is done with the hope fewer deaths will occur with the under-priced product.

Even if a term premium seems inexpensive upon purchase and priced to stay level for a period of 20 to 30 years, under normal circumstances the price becomes unaffordable at the end of the level premium period.

Keep in mind that most term policyholders don't die before the level period expires; therefore, most term policies lapse without value. This doesn't negate the value of term insurance provided the parameters are understood prior to purchase.

The only reason to buy a life insurance policyis because you love someone so much that you want to guarantee they will have additional money in case you die prematurely.

Regrettably, an unscrupulous life agent can be a master of providing convincing evidence to the uninformed that life insurance would be a great supplemental retirement plan... or an education fund... or a forced savings plan... or even an investment.

There are much better ways to address all of those, so don't get conned into buying a life policy for anything other than what it is intended to be and that's a death benefit.

Your primary objective in the purchase of a life insurance policy is to secure the lowest net cost death benefit that will be guaranteed regardless of when you actually die.

Do yourself a favor and ignore those who advocate the buy term and invest the difference strategy. This is a foolish game and simply does not work!

The death benefit paid by a properly structured life insurance policy that has been issued by a financially healthy company will always always be better for your loved ones.

Why? Because it is guaranteed to perform at exactly the time when it is needed the most.

When you buy a policy you are usually given at least 10 days to review it. If you decide you don't want it, you can return it for a full return of premium.

Take advantage of this "free look" period to actually read your policy. Don't just put it away and believe everything is okay. If you have questions, make sure the life agent responds appropriately. Demand proof... if you have any doubts.