By Jason Van Steenwyk
Term life insurance is a simple and beautiful thing. It’s easy to understand and explain: Pay your premiums each month or each year to keep the policy in force. Premiums go up over time, as you get older. If you die while the policy is in force, the life insurance company pays a tax-free death benefit to whoever you told them should be your beneficiary.
It is the only financial product out there that allows you to leverage such a small amount of money into such a large one – if the unthinkable happens. And the unthinkable happens to many families every day.
Term life insurance isn’t just easy to explain: It’s easy for almost anyone in good health who loves their family to afford. It should be a no-brainer, for anyone with a family dependent on them: A 25 year old new parent in good health can easily obtain a $500,000 death benefit for less than the cost of a dinner out for two every month.
But not all life insurance companies are the same. The basics are very simple, but some companies work in a number of additional benefits or features into their policies, called riders. And these riders can be vitally important. Also, some life insurance companies are more financially sound than others.
Here is a look at some of the issues that differentiate one life insurance company from another, and which is best for you.
Term insurance buys a temporary death benefit. The thing to remember with term insurance is that it is actuarially designed not to pay claims. Underwriters set term life insurance premiums to be very affordable when you are young, but to gradually get so expensive you’re forced to drop the policy before the policy is likely to pay a claim. For this reason, only a tiny percentage of term policies ever pay a claim. Which is obvious, when you think about it – there’s a reason it’s so affordable!
But often times, your need for life insurance is permanent, not temporary. As you get older, you may need a large tax free death benefit to handle final medical expenses, see your heirs through probate delays, pay taxes, allow one of your children to buy out your heirs’ share of an interest in your family business from others, or to continue providing an income for a spouse if your pension dies when you do. For these kinds of needs, term insurance doesn’t do the trick. You need a death benefit that will pay out no matter when you die.
It’s very tough to predict what your life insurance needs will be many decades into the future. If you’re not sure now, consider a life insurance policy that is guaranteed convertible. That means, you have the right to convert the policy to a permanent “cash value” policy – a whole life or term policy – regardless of your medical condition, for a period of time.
There are four major life insurance ratings organizations that pour through insurers’ books, and provide letter grades ranking insurance companies for their financial stability and liquidity. This is crucial, because if a life insurance company went out of business, you might not be able to just run out and find a new policy. If your health has deteriorated over the years, you might not be able to get insured at all.
Look for nothing less than A+, Aa, or AA ratings, depending on the ratings company. These ratings mean that an independent body has examined the insurance company’s assets, liabilities, cash flows, and capital structures, and determined that these companies can withstand nearly any economic hardship, a war, a nuclear disaster, a plague or epidemic on the devastating scale of the influenza epidemic of 1918, and still be in a position to pay claims. Lower-rated companies may drop premiums in a desperate attempt to attract assets in the short-term, but this is bad in the long run, because premiums have to be higher than long-term mortality risks. Also, life insurance agents’ errors and omissions insurance policies may not protect you if the agent places a poorly-rated life insurance policy.
Don’t take risks you can’t afford to lose. Buy a policy from a company that has been responsible in managing its own affairs and setting aside adequate reserves – even if it costs a few dollars more.
Note: The highest rating you can get from Standard & Poor’s is AAA. But nobody’s rated AAA anymore these days, because life insurance companies have to buy a lot of U.S. treasuries for their own portfolios, and Standard and Poor’s downgraded Treasury debt from AAA to AA in the summer of 2011. It doesn’t make sense for insurance companies to have higher ratings than their capital pools, and so life insurance companies got downgraded immediately after the Treasury did.
A mutual life insurance company is simply a company that is owned, collectively, by its policyholders, rather than by stockholders on Wall Street. When the company earns a profit, the company either shores up reserves (which earn interest for policy holders) or issue a dividend. Mutual companies issue dividends to policyholders. Other companies issue dividends to stockholders.
When a mutual life insurance company issues a dividend to term policy holders, it usually either sends them a check (taxable), or simply discounts their next life insurance premium due. In the short run, stock companies may show lower premiums. But in the long run, when dividends are taken into account, the lifetime cost of owning a mutual life insurance policy is frequently much less than owning a stock-owned life insurance policy. Dividends are usually reliable – companies like New York Life and Northwestern Mutual Life have issued dividends every year without exception for more than 150 years. But dividends are not guaranteed.
If you get sick or disabled, you may lose your ability to earn a living. If that happens, you may lose the ability to pay your life insurance premiums. If this happens, you may lose your life insurance – just before your family desperately needs the coverage you may have paid premiums for for years.
Not even the life insurance company wants this to happen. You can guard against it by paying a few extra dollars for a “waiver of premium” rider. This rider is the insurance company’s contractual guarantee that if you become disabled, they will pay your life insurance premiums on your behalf. Specific provisions vary, so be sure to check the fine print on your policy when you receive yours for delivery.