 Preparing for Rainy Days
If you are like me, you dread having to think about any type of insurance.
Whether it's life insurance, auto insurance, or health insurance, the decision making process requires you to actively think and plan for rather macabre scenarios. But like it or not, it's a critical part of personal financial planning and estate planning so it's important to make sure you are making smart decisions especially given the overwhelming plethora of choices available today. For life insurance in particular, the wide range of options available can often be bewildering for most people so I would like to offer a few thoughts based on my own experiences on this topic: Start with Your Needs To me, the whole point of insurance is to ensure you have adequate protection in the "worst case scenario". So with life insurance, while you may no longer need anything in the event of your death, the goal is to ensure that your loved ones or dependents are properly cared for and not be left in a worse financial state than before your death. With this in mind, I tend to prefer the "Needs Approach" over the "Value of Human-Life Approach" (essentially a present value of your future expected earnings given your age and life expectancy) and would suggest that you consider the following factors in estimating how much insurance you may need: - the number of remaining years in which you may have to provide for your dependents (e.g. your children, spouse, and/or aging parents); for single wage earners in particular, you'll have to keep in mind that you may need to replace your income either through insurance or in combination with any savings you have - the amount of money required to sustain the desired lifestyle for your survivors; depending on your income, you may or may not need to replace the full amount of your annual income, even assuming no additional savings. For instance, if you were a high wage earner who generally had plenty of excess savings, the amount to insure for could be a percentage of your former income needed to maintain the same lifestyle, e.g. live in the same house, go to the same schools, enjoy the same activities, vacations, etc. - consider any future "big-ticket" costs that you would have provided for if you were still alive, such as college educations, weddings, bar/bat mitzvahs, and other special occasions; or future reductions in ongoing costs, such as a paid off mortgage - and lastly, factor in any funeral and death related expenses and any estate related costs such as taxes and probate that you may trigger through your death - I would also gross up the sum of the above with some additional percentage in case you've underestimated things or to account for unexpected factors such as high future inflation, potential future healthcare needs, etc. You may discover after this exercise (as I did), that the amount that you may need to insure for is more than what you originally anticipated. Depending on your financial situation and preferences, you could save on insurance premiums and insure for a lesser amount if you have other savings that can cover some of the above costs and not have to rely fully on insurance (so, essentially you would partially self-insure in this scenario). Keep it Simple Simple is always cheapest when it comes to insurance. There are two basic types of insurance. Term life insurance is the most straight forward and definitely cheapest. You pay a premium that will guarantee you a lump-sum payment to your beneficiary (or beneficiaries) upon your unfortunate demise. The cost for this insurance is calculated based on the the actuarial probability of your death given your health condition and age, as well as the amount you wish to insure, with some selling costs and a small profit margin built in for the insurer. Given the simplicity of this vehicle, and the resulting ease by which you can make apples-to-apples comparisons, the pricing for this tends to be fairly competitive since there are not a lot of ways for insurance companies to add any gimmicky profit-enhancing fees into this product. The second type of insurance is generally referred to as permanent insurance and comes in several flavors: whole life, variable life, and universal life, among other more exotic and gimmicky versions. I won't get into all the details of each of these types here since there are many resources online/offline where you can get this information. But essentially permanent insurance does not expire upon your death and provides you with some type of savings/investment component and the differences among the three main flavors are based on different combination of mortality costs, expense charges, and cash value. To net it out, I personally think permanent is a bad deal since it is more expensive than term and you can more cheaply replicate what a permanent life insurance policy would give you with your own combination of term life and investing the difference in a tax deferred investment vehicle, such as a 401K plan or IRA. Certainly, there's a bit more work involved to do this as opposed to simply outsourcing to a permanent insurance policy. However, the benefit of taking control over your own personal finances in this case is that you will have better control and greater options (ultimately potentially superior returns) if you handle the investment portion yourself. And you will also sidestep the many ways in which you could be "taken" by gimmicky plans and product offered by unscrupulous agents/companies that may be full of hidden fees. Use Common Sense Let your common sense prevail in buying your policy. Obviously, you should make sure you are dealing with reputable insurance companies that have the financial soundness to actually pay out the benefits upon your death. For this, I would definitely suggest checking out any company you are considering on A. M. Best. I would also look for deals in selecting the most economical benefit level given that insurance is typically sold in fixed increments and there are sometimes opportunities to benefit through the built-in price breaks that may be slightly over or under the exact amount you need. And lastly, I personally prefer a level premium policy to ensure that there are no surprises. You may pay a bit more in the short term, but over the long haul, it will likely be cheaper and certainly eliminate future increases that can throw a wrench into your plans!
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