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When shopping for life insurance, the best strategy is first to understand your objective in buying life insurance and then focus on the products best suited to meet that goal.
This statement might sound a bit underwhelming or generic, but it has considerable nuanced implications that I want to spend time building out a bit. I think you'll find that effort both insightful and helpful in your pursuits when in the market for life insurance, be it the first time or the umpteenth time.
Define your Need AND Define your Focus
Life insurance is an extremely versatile product. It's actually a collection of products all uniquely designed to help you meet a goal. If you understand what exactly you seek to accomplish by purchasing life insurance, that will allow you to cut through the confusion of what type of life insurance you want to buy. Instead, you can more quickly match your objective to the kind of life insurance aligned with it and move forward soon.
The majority of people looking to buy life insurance seek death benefit protection. This means they want to cover the lost income loved ones face should they pass away while still working or while still having significant financial obligations–the two are often inextricably tied, but not always.
I'm not going to spend a great deal of time discussing how one arrives at a targeted death benefit amount today. You can find helpful tips on that elsewhere, and honestly, that's a task often best tackled with the personal assistance of a financial or insurance professional.
I do want to stress one crucial consideration loosely tied to the amount of death benefit you seek. That's the amount of time you need that death benefit to exist.
The Death Benefit Term
Lots of financial gurus stress the importance of understanding how much life insurance you might need, but few spend much time guiding you on just how long you might need life insurance coverage. Some make vague references to financial independence and how that is kind-a sort-a a point when you might be able to drop your life insurance coverage. No real argument here on that idea. However, misunderstanding precisely what that means from the outset leaves a lot of people susceptible to financial pain later in life.
I want to suggest that knowing both how much life insurance you need and how long you'll need it to hold equal weight in terms of importance. In other words, you need to figure out not just how much you need, but how long…realistically…you'll need it.
The length of the death benefit need question is often trickier to calculate than the exact amount. But let's use a for-instance or two to help build out an understanding.
Perhaps you're in a situation where you have minimal financial obligations beyond a mortgage. A 15-year mortgage for a new home you just bought with a $350,000 total balance. This one is easy. You should buy $350,000 of 15-year term life insurance. Assuming you never refinance the mortgage and reset the term of it, your life insurance policy will last exactly the same amount of time that you plan to have a mortgage outstanding.
Now let's move to a more complicated situation. Let's say your currently 35 with a wife, kids, mortgage, and all that middle American lifestyle stuff we all know and love. You compute your death benefit need to be $2,500,000. Your current plan is to retire by age 65.
Traditionally, we might tell you to buy $2.5 million of 30-year term life insurance. This should cover you for your entire working years. Assuming you retire at 65 as planned, you should have all the money you need to cover your expenses and have no need for life insurance.
But what happens if your plan doesn't work out as planned? I'm not saying it won't, but I can speak from experience when I say it doesn't for a lot of people. Life is messy, and a lot of people end up in situations where the linear path to financial independence looks more like a doodle done by a drunkard. Those blessed to have never dealt with a significant financial set back will have a hard time relating to this statement, but the majority of Americans out there will know what I'm talking about.
Term insurance might be the weapon of choice in the above example, but you have to understand that it has a lot of failure points that could lead to stress and significant sacrifice. Term insurance isn't necessarily the wrong answer. If your capable of savings substantial sums of money, keeping liabilities low, work in a low risk/turnover occupation, and have reasonable expectations for good health term insurance becomes a much more viable option.
The one thing you should never do is simply choose term life insurance because it appears cheap and it allows you to move one with all the other things you want to buy instead.
So if you can easily define your need for life insurance over a few decades or less with reasonable certainty that it completely goes away after that, term life insurance is your answer. With that being said, let's dive into best practices for buying it.
Buying Term Life Insurance Best Practices
Term life insurance quoting is straight forward 99% of the time. You can easily acquire several quotes from an agent and review the cost of a given amount of death benefit and length of death benefit quickly. Most of the time, you'll simply go with the insurer that offers the coverage for the lowest premium. There are a few times, this might not work out best, and you might opt for the insurer with slightly more expensive premiums. These situations are:
- Access to the Product – Not all life insurers distribute life insurance products the same way, and you might discover that buying the absolutely cheapest term life product requires you to go on the hunt for an agent with an exclusive contract. This individual may or may not be much of a life insurance expert, and you might find you receive better service from an agent with access to the next cheapest option.
- Bad customer service – You've likely seen us stress this point elsewhere on the subject of insurance. Not all life insurers approach customer service in the same way. Some are great, while others leave us underwhelmed. You'll need some guidance from your agent on this one, but any good agent can quickly speak to the customer service aspect of a life insurance company.
- Underwriting speed – the underwriting process for life insurance is under a dramatic reformation. The old practice of collecting lots of bio-samples, asking lots of questions, and taking a few months to underwrite an application are rapidly fading away (thankfully). But some life insurers adopt new procedures slowly, and you might discover some insurers are still underwriting like it's 1999. This, too, is an area where your agent should help provide guidance on who can process your application quickly and won't most likely will not.
- Underwriting Practices/Trickery – Some life insurers love to boast incredibly lot term life insurance rates for risk class assumptions they approve a couple times a year. It's akin to a bait and switch tactic where the insurer appears to be very competitive but has a very low probability of approving you at the rates published. Instead, you'll come to a different underwriting offer, and the premium goes up. The hope is that you'll still take the policy because you don't want to start the process over with someone else. It's an annoying practice and again, an area where any good agent should be more than capable of offering guidance to help you avoid.
Armed with this information, let's also cover four tips on things you'll want to avoid when purchasing term life insurance:
- Blindly accepting quotes from your car insurance agent. Car/home and auto insurance agents tend to sell a decent amount of life insurance. Not because they have some sort of rare specialized knowledge or fantastic life insurance rates, but because no one really knows where to go looking for life insurance, so they ask the one person in their life who they associate with insurance in general. The problem with this for you is the likelihood that you're reviewing a limited market of life insurance. Often times, the quote for life insurance is from the agent's career company. You'll likely pay more for life insurance doing it this way. You'll also probably buy life insurance from someone who doesn't have much expertise in life insurance.
- Blindly accepting quotes from the bank. This one is closely tied to the one above. The next place people sometimes associate with insurance is the bank. It's a financial institution with which a lot of people have regular contact. Sometimes this works out just fine. But a lot of times the guy or gal at the bank has a very different focus than life insurance and can unintentionally steer you down the wrong path.
- Neglecting the term premium period. Some agents will quote shorter term paying periods to appear cheap. There are huge insurance brokerage companies that advertise on television and radio that continually advertise 10-year term insurance rates while commenting on how affordable life insurance is. You should take a lot of care to ensure that whatever price you receive matches the timeline you'll need the coverage.
- Assuming your work benefits are all you need. Many people, fortunately, have some form of life insurance coverage as an employee benefit. That's great. But most of this coverage is very basic and likely not nearly enough to truly cover your need for life insurance. Additionally, this coverage often doesn't stay with you if you leave your current job and if you do have that option, you'll usually pay a lot for the amount of coverage you do get to keep.
Permanent Life Insurance
What happens if you discover that your life insurance need goes beyond the years that term life insurance offers? You'll need permanent life insurance. Permanent life insurance is a broad term that encompasses life insurance products like whole life insurance and universal life insurance. The key feature is that these life insurance products can provide a death benefit for your entire lifetime. You can also think of permanent life insurance as a backup plan for when things don't go as planned.
Some people discover that they end up not needing the death benefit offered by permanent life insurance for their entire lifetime. At this point, they might choose to cancel the policy to stop paying the premium. The good news for them is that most permanent life insurance policies build cash value that the policyholder gets to keep if he/she decides to cancel the policy. So while the life insurance policy will not end up paying a death benefit, the policy owner still gets value from the policy in the form of cash upon cancelation.
Some people also focus in on that cash building aspect of life insurance to build a nest egg with life insurance as a complement to other savings strategies. That subject is a tad more complex than the topic I wish to discuss today, but you'll find a plethora of information on that idea elsewhere on this blog.
Evaluating permanent life insurance is a tad more complicated than term life insurance. Because of its cash value component and ability to create more death benefit than the original amount purchased, you have to take more care than merely comparing premiums for a given amount of death benefit. This is an area where an agent well versed in the subject can come in extremely handy.
You'll also want to spend more time looking at insurance company specific financial data since you'll likely be choosing a relationship for a company over several decades. You want to ensure that they have the finances to remain in business for a long time (pro tip: most of them do).
There are a few pitfalls I want to call to your attention so you can avoid them:
- Don't waste your time with company-sponsored brochures on financial data. Sure, a glossy brochure exclaiming superiority because company A has a higher surplus ratio than the other companies included on the list in the brochure might appear impressive. You have to keep in mind, however, that the company wants you to focus on this because there could be something else they'd rather you ignore. Independent financial data exists, and your life insurance agent should be able to provide you with such information.
- Take care to understand product focus. Permanent life insurance contracts can have different primary objectives between the death benefit and cash value performance. Some products exist to build a lot of cash value, while others exist to provide death benefit at a lower cost. If you cross this, you'll end up with a product that doesn't do what you are seeking very well. Your agent can help identify what products are built to accomplish which goal.
- Understand that some products aren't guaranteeing the premium. Some products don't guarantee the premium you need to pay to keep your life insurance. These products are certain types of universal life insurance. This doesn't make them wrong, you just need to understand this aspect of the policy. Your agent can help guide you here. Also, the ledger that depicts policy values can also help you. If you see a guaranteed ledger that reports your policy values going to zero and the policy lapses, it means the premiums aren't guaranteeing the death benefit.
- Don't Assume that all policies are the same across companies. You might gain familiarity with the features of a specific company's whole life product (for example). You should not assume then that all whole life products will work the same way at other companies. Permanent life insurance products can and do vary quite a bit from one company to another, so you'll need to take time to learn about the nuances from one company to another.
