Many of our clients wrestle with the decision to purchase term insurance or permanent insurance. The premiums for term insurance are cheap, particularly when you’re young, while permanent insurance generally provides a level premium with more certainty that a death benefit will be paid.
Term insurance seldom pays a death benefit. The reasons for this are simple. Most people live to, or close to their life expectancy. By the time they have reached their life expectancy, the premiums on term insurance have increased to the point where the insurance is dropped, or the individual has reached an age or health condition that is deemed uninsurable by the insurance company.
For this reason, term life insurance is best for temporary needs such as support for a surviving family (particularly when you are young), funding a buy/sell arrangement for a closely held business, providing cash (key man insurance) for transition of business, and for the repayment of debts.
I often tell clients to load up on term insurance when they are young, partly because it’s so cheap, and partly because their financial “security” needs are so great when their families are young. Of course, the premiums for term insurance are lower because it seldom pays a death benefit. The only usual financial “winners” for term insurance are the insurance agent and the insurance company.
As we get older, financial obligations (except retirement) tend to decrease. Many of us begin to look at permanent insurance as a permanent feature or category of assets that we are accumulating during our lifetime. Most of us want to have a certain portion of our insurance that is ongoing. The insurance can provide liquidity to our heirs, cash to pay estate taxes, a fund to provide for the maintenance of a second home, or a mechanism to equalize the estate where certain hard assets (such as farm, business or vacation home) is necessarily directed to one particular heir, while the other child receives cash.
Permanent insurance generally falls into three categories: whole life, universal life (including universal blends and indexed products) and variable life. Whole life is the most expensive, while universal life is generally the most inexpensive permanent insurance policy. Variable life has more stock market investment features inside an insurance policy wrapper.
Universal life is popular among our clients as it provides guaranteed lifetime coverage at the lowest level of permanent insurance premiums, and generally level premiums can be pre-paid or lowered by lump-sum or higher premiums in early years. Generally, with universal life policies, guaranteed cash accumulation for retirement income or other purposes is not a significant objective. The goal is to lock in a death benefit while keeping premiums as low as possible.
By far, our estate planning clients buy mostly universal life products. While there are many varieties, studies show that the internal rate of return on universal life products is generally positive, where as the internal rate return on any term policy, if clients live to or close to their life expectancy, is significantly negative. In other words, with term insurance, we have thrown our money away unless we die prematurely.
Most term insurance lapses before death. This is fine if the reason for the insurance no longer exists. However, many policy owners want to extend the coverage of their insurance while their health is still good, because they know that the risk of their health changing increases with age and health changes can happen suddenly.
Be aware that term policies can carry a conversion right. This is important, even though it might marginally increase the premium cost, because a client might otherwise become higher risk or uninsurable prior to the expiration of the term policy and be unable to get other insurance.
Generally, our clients are rarely content to allow their insurance policies to lapse when they reach the end of the coverage period. The older we get, the more we see the value of “investing” in insurance as one of our many buckets of asset categories that we are accumulating and tending to during life.