Life Insurance for Parents! It's a snazzy tagline used by a certain insurance industry periodical that I won't publicly shame for such a terrible grab at attention. The idea is straight forward and lacks any real creativity or nuance.
Here's the basic premise…
Your parents are older than you, you likely haven't saved enough money, so why not buy a life insurance policy on them and wait for your parents to die. When that day comes, your weak retirement savings will benefit from the windfall death benefit (insert raising eyebrows emoji…if we had emoji's back then…).
This was an idea actually published in an industry publication years ago and the idea came back around to me recently. I thought, surely this horrible idea met an appropriate death years ago and long since disappeared from the face of the earth. Nope.
Turns out some people are still talking about it like it's a newly minted idea. To be fair, I'm certain the first time I read about it wasn't the first iteration of the idea either.
But let's get serious for a minute. Can you really buy life insurance on your parents to guarantee a stronger retirement account position for yourself in the future?
Maybe. Should you?
Probably not. Let's talk about why.
Why Would You Buy Life Insurance on Your Parents?
Your aging parents might face financial challenges as they reach ever higher ages. What money they've saved could one day evaporate due to a major health issue or some other catastrophe and this will turn a coveted inheritance into a little more than a love note and a five dollar bill form mom and dad. So you can ensure you don't become disinherited by bad luck by using the wonderful power of life insurance as a means to lock in some value from your parents' eventual demise.
All you do is purchase life insurance on one or both of them. Given their age, probably best to go with something permanent. My recalling of the idea isn't as tongue-in-cheek as you might anticipate. This is, more or less, the presentation of the idea.
Mind you this…”sales strategy”…hit the presses following the 2008 market collapse that left a lot of American's deeply worried about their retirement viability and everyone jockeyed for a position that sought a solution to lost retirement account balances. This one at least offers some degree of likelihood.
There are three distinct issues that can make this idea run into problems. I'm going to present them here from most to least important.
1. Insurable Interest
In order to buy insurance on something, you must have an insurable interest in it. This is universal insurance law spanning all areas of insurance in the United States. I cannot, for example, purchase car insurance on your car hoping that your terrible driving record will net me some cash the next time you drive the car into a telephone pole.
I do not own the car. You wrecking your car has no adverse financial impact on me. Therefore, I do not have an insurable interest in your car.
Life insurance works in the same fashion. In order to buy life insurance on someone else's life, you must have an insurable interest in that person's life. The general policy to follow is that you must identify some loss, you'd actually incur should the person die.
In matters of spouses purchasing life insurance on each other, the potential loss is pretty evident. In the case of partners of a business purchasing life insurance on each other, the insurable interest is also pretty easy to identify. Even if a business wishes to purchase life insurance on an employee, the business must prove that it has an insurable interest in that employee before it's allowed to purchase life insurance on said employee and maintain the tax-free elements of the death benefit.
The only circumstance with some wiggle room is a parent buying life insurance on a child. And I stress the term some wiggle room. Sure most parents are not dependent on their children for income or any other living needs. But, there's certainly a case one can make for the loss a parent might suffer while processing the immense grief that follows the loss of a child.
But even in cases where a legitimate insurable interest exists, when buying life insurance on someone else's life almost always involves significant scrutiny from the life insurance company. Your parents do not receive any special leeway.
In order to purchase life insurance on your parents, you'll need to justify the need for you to own life insurance on them, and I didn't save enough money for retirement isn't an acceptable justification. Bonus tip, I will detail the only justification I can think of later in this blog post.
2. Health Underwriting
Purchasing life insurance for parents requires medical underwriting in most situations. This means that your parent(s) will undergo a full health screening to ensure they are healthy enough to present an acceptable risk to the life insurer.
While I know there are plenty of healthy American's who are quite advanced in age, I also know they represent a minority exception.
Most parents of adult aged children have some medical background that could lead to unfavorable evaluation results and that alone could put this idea to bed permanently for you.
3. Rate of Return isn't Always Great
Most of us think of life insurance in terms of a small premium for a large death benefit. And truthfully, all life insurance policies look like this in the first couple of years. But as people age, the return on premiums paid given the death benefit of the policy declines. For people who buy life insurance later in life, this effective return on premiums paid becomes even less attractive.
Looking at an example of a life insurance policy purchased on a “healthy” 70-year-old female, the return on premiums given the projected death benefit of a standard whole life policy drops below 4% at age 92. If the adult child is a healthy 40-year-old woman, she'd achieve a better return on cash value with the exact same premiums paid over the same 22 year period.
When Life Insurance for Parents Might Work
Long term care type benefits appear to be the fastest growing improvement to life insurance contracts over the past decade. As the market for traditional long term care insurance products continues to dwindle, life insurance stepped in to cover a big need gap.
While there is a lot of variation, the basic principles are something like the insured can access a certain percentage of the death benefit should they not be able to perform two of the five activities of daily living (ADL). Or, the policy has a specific rider that builds a cash pool available to the insured if they are unable to complete two of the ADL's.
While most of these products still pale in comparison to a bonafide individual long term care insurance policy, they are a great leg up in the preparedness efforts many make every day for failing health and lesser independence.
The use of these long term care features on a life insurance policy can justify an adult child's purchasing life insurance on their parent(s).
They might buy life insurance for their parents because they worry about possible financial obligations they might face should mom or dad need long term care. It's also possible that buying life insurance on your parents could protect certain assets because the life insurance long term care benefit provides the cash needed to pay for the care instead of needing to liquidate assets. For example, perhaps your parents still live in your childhood home and you have an attachment to that home. Life insurance might prevent an inopportune sale of the home should your parents end up in a nursing home.
You might also do this for dignities sake. While it's harder to qualify for long term care benefits when the insured's afflictions still allow them to remain at home, it's possible that such a circumstance could pay for at home nursing needs with some life insurance policies. At the very least, it opens the door to options rather than being forced into an unpleasant Medicaid facility.
Bottom Line: Do it for Their Benefit…Not Yours
Life insurance for parents is more about providing mom, dad, or both some financial security against long term care costs. While this might have mutually beneficial aspects, your interests should be secondary.
Trying to buy life insurance because you'd like the death benefit when your parents die is a difficult idea to sell to any reputable life insurance company. Trying to recoup investment losses or make up for the lost time is both a bad idea and a likely express lane to the rejection file.