Income protection should be a part of everyone's financial plan. There are ways to protect your income from loss by accident, disability or death. Many see insurance as an expense rather than an investment.
Life insurance is confusing to many people, but should not be. I know that no one enjoys contemplating their own death, but a prudent provider makes plans to care for his loved ones if he or she is no longer there to provide the comfort and financial resources to live a good life. So, let's take a look at the three basic types of life insurance.
TERM LIFE, as its name suggests, is a life insurance policy that provides a death benefit over a defined period of years such as 10, 20, or 30 years. Some older term policies have gone as long as 40 years.
Because the term is defined, these policies generally have a lower premium, especially if you take out the policy at a young age. In this case you are "renting" the policy for the specified period, but you build up no cash value or equity in the policy–much like renting an apartment. One reason the insurance industry markets term insurance aggressively is that the exposure is less than 10%. Most policy holders will outlive the policy or drop the coverage before the end of the term—a very profitable contract for the company.
Permanent life insurance comes in three primary varieties. Each has the potential of building cash value inside the policy that can be used to return some of the premiums paid, taken out as a loan, or used to increase the death benefit. All of these policies split the premiums to pay the cost of insurance and to invest the excess premium in accounts that may increase in value. As the insured gets older, the cost of annual insurance increases. In order to keep the premiums at a level amount, the increased cash values are tapped to pay the difference. They are "permanent" because the policies cannot be cancelled by the insurance company as long as the premiums cover the cost of insurance for the insured at his current age.
WHOLE LIFE insurance policies are designed to guarantee a level premium for life. The set premium is split between insurance costs and an interest bearing account that grows over time. The death benefit remains constant, so the company's exposure decreases as the cash value grows. The owner of the policy can cancel the contract and take the cash value at any time–subject to penalties.
UNIVERSAL LIFE insurance allows for both a flexible premium payment and a flexible death benefit. As long as the owner pays premiums sufficient to cover the cost of insurance the policy will stay in effect. Cash value build-up can be drawn out as a loan that is not paid until after death out of the death benefit. This feature is so powerful for building tax-free income for individuals that the IRS now limits the amount of premium you can put into such a policy, but the opportunity is still considerable.
VARIABLE UNIVERSAL LIFE insurance allows for flexibility in the death benefit as well as the premiums paid. In addition, the excess premium can be invested in a guaranteed fixed account or a securities account similar to a mutual fund. There is greater potential for gain, but there is also the potential for loss in value due to market fluctuations. These losses can be so large that the premiums required to cover the cost of insurance may have to significantly increase in order to keep the policy in force.
As the insurance market changes to address the changing financial landscape, new products are appearing in the market place. Lincoln Benefit Life has as universal life policy that ties the growth of the cash value to the S & P 500 index. The value growth is similar to an indexed annuity in that there is a guaranteed floor and a maximum interest that will be credited each year. Currently, the policies are guaranteed never to go below zero (you can't lose value), and the interest is capped at 12%. So if the index goes up 24% this year, your account can only increase by 12%. But, if the index goes down by 24% your account will simply be credited with 0% and you will not lose past gains.
So, you decide. Look short term and rent your coverage, but realize that this may not be a good long term choice. Choose a permanent policy that may build cash value you can tap later if you outlive your need for coverage, or if you want to take advantage of the tax-free elements of cash build-up and access. Always have your insurance representative run an illustration that shows the risk the policy will "blow up" if you don't pay enough in or are overly aggressive in your investment allocations. The insurance industry requires that you be given a copy of a realistic illustration demonstrating the guaranteed values in the policy as well as the upside and downside risk in the non-guaranteed portion.
It does not have to be confusing. Ask questions until you are comfortable with your choice. If you can't get the answers from the insurance representative you're talking to–find another representative. It's your future–your choice.
Bill Morris is a healthcare financial advisor and management consultant. Comments & questions may be sent to firstname.lastname@example.org