Consumer Life Insurance Buying Guide
FCAN tells you things about life insurance
you didn’t know.
And Money Magazine "Ten Things Life Insurers Won't Tell You"
Click here for Money Magazine article (PDF 132k)
Life insurance is a complex product. Most people don’t understand it and that makes them vulnerable to being ripped off. FCAN gives you the scoop:
Why do I need life insurance?
There are two reasons to buy life insurance: you have a family that you want to provide for when you die or you want a tax advantaged investment vehicle. By dollar volume, most life insurance is used for investments. If you have a family, by all means get some term insurance – it’s a straight up deal. You pay a set premium, and the insurance pays if you die. If you don’t pay them, they don’t pay you. Term insurance is exactly what you think it is.
Other types of life insurance (or just “life”) are variously called whole life or universal life or are some kind of annuity. These types of insurance have a value that depends on the amount you have paid into the plan. You can borrow against that value or even sell it. In an annuity, you’ve usually paid in the entire amount and the value varies according to how its invested and may even be guaranteed, but it still pays off if you die.
Why not just put the money in a savings account?
The government thinks it is a good idea for you to have life insurance, so there are tax advantages. This is a major marketing point for insurers, and for some people with higher incomes, this tax savings can help. Your insurance policy accumulates value tax free, and the payout is tax free, but there’s a catch. The insurance company is investing your money in order to create the payout. Guess what? They have to make a profit. So you are sharing your tax savings and profits with the insurance company, but if you need the policy its all there unlike savings. Life insurance has a different role in providing financial security than savings. Once you have enough savings, you might not feel you need insurance.
How does the insurance company make money?
How do the insurers pay for those big buildings downtown, all those employees, and very healthy profits if all they have is a share of the earnings? It doesn’t seem like it would be enough. Insurers say that they are investing your money as you pay it in and they are good at that and it adds up. At least that’s what they’d like you to believe.
The “dirty secret” of life insurance is that a high proportion of people let their policies “lapse.” Some estimates put life insurance lapse rates as high as 75%, but others say 30 or 35%. Either way, that’s a hell of a lot higher profit than the tax savings and investment earnings. So that’s where the money comes from and they’re really not giving you that great of a deal. In fact, this is such a rotten deal that another group of businesses have organized to offer you a better deal on your policy. Instead of lapsing your policy, you can sell it to a life settlement company. This is setting off widespread panic in the life community.
How much insurance can I buy?
You can only buy so much insurance and that amount is called your insurance “capacity” and is based on a number of factors including your age and finances. It is determined not by some public authority or formula you can see, like a credit score, but by individual insurers when they decide whether you insure you or not.
Your insurance capacity has a value, whether you choose to use your capacity or not. Let’s say you want to use your insurance capacity and buy an insurance policy on yourself for $500,000. When you die, it is worth $500k. An actuarial table determines how much you would have to pay either in advance or in installments for that amount of insurance. Essentially, they are predicting your life span and using the figuring out how much to invest at what percent return to produce the payoff when it is needed. By issuing lots of policies and averaging out the times people die early and the time people live longer, these estimates become fairly accurate.
Your insurance capacity is an asset that you can use. You can use it to assure your family of security by buying insurance, or you can cash it in. However, insurance companies frown on you just selling your insurance capacity, although that seems a strangely anti-capitalist attitude for an industry that deals in money. You must buy your insurance on your own without making any deals in advance to sell your policy. That would be unfair, according to insurance companies.
Should I take out a loan to buy insurance?
Borrowing money to buy insurance could be a good deal in some circumstances because of tax and pricing advantages. You can do it, but when you get into transactions like this, FCAN hopes you trust your financial advisors, because you’re well beyond any advice we can give you.
How can I get ripped off buying life insurance?
Unless you buy term insurance, the company is hoping you will pay into your policy for a while and then just forget about it, leaving them the proceeds. It happens a lot, so don’t let that happen to you. If you don’t need your policy, find a life settlement company and get your money back. Your life insurance company will offer to refund some of your money, but you can usually get a better deal from a life settlement company. These are companies that buy insurance policies and hold them until they pay off.
Make sure you really need the insurance you are buying. Insurance companies profit on worry and they profit on selling a product that’s needlessly complex. Don’t fall for complicated insurance programs unless you’re absolutely sure they’re right for you. The agent makes a commission on the sale, and there’s no requirement that they make sure the policy is right for you and your family. Its buyer beware! For most people a simple term policy is the best solution. If you have enough money to consider an annuity to shelter your income, you can probably afford a financial advisor, or you know the ins and outs on your own. Be sure to look at alternatives including IRAs and mutual funds or just plain buying a house.