Now that we’ve conquered the property and casualty part of your life, let’s move on to the exciting stuff…Life Insurance! One of the most criticized, scrutinized, misunderstood financial products ever invented…and probably one of the oldest!
This picture is of a book I have on my desk. Many years ago, when I represented this company, we moved to a new building. This was in the pile to throw away. Mr. Sentimental here kept it. I don’t know if you know what this is, but it is an agent’s life insurance manual to carry with them to quote life insurance policies when they used to go door to door. The date on the cover is January 1902. I just think this is pretty darn cool!
I have several biases, and not only do I not apologize for them, I’ll do my best to justify my logic. When I see an ad on a news channel that says “A 40-year-old man can get $500,000 of high quality life insurance for only $15,00 per month”. First, they show him with his kids, assume he’s qualified for the best underwriting classification, and what does “high quality” mean? Why would a 40-year father buy 10-year term in the first place? Red flags are flying big time when I see these ads.
Once again, the life insurance industry is playing the auto insurance game…selling strictly on price. Drives me insane. The other issue that drives me insane is the mentality of totally dismissing any life insurance products other than term insurance.
I’ve already made a few small references to whole life insurance in my introduction and when I was getting sued. The “financial entertainers” and many financial planners subscribe to this philosophy. I’ll talk more about this later in the chapter.
There are three ways to determine how much life insurance a person should own. The first way is how the life industry calculates that amount. They use a concept called HUMAN LIFE VALUE. Remember when you read about property insurance and how REPLACEMENT VALUE works? Same concept.
The insurance industry uses this method in their formula for how much life insurance a person can qualify and should purchase.
- Age 25-40 30 times Annual Income
- Age-40-50 20 times Annual Income
- Age 50-60 10 times Annual Income
- Age 60+ 1 times Net Worth
Do some quick math and I bet you lunch you are grossly underinsured using this industry method. You’re probably thinking that’s a big number. Yes, if you’re in your 20-40’s it might be. If your house burns to the ground, you’ve got enough coverage to rebuild it. If you die due to accident or sickness, shouldn’t you have the same coverage to rebuild your family’s life after you’re gone?
The court system uses the same HUMAN LIFE VALUE method, but they also build in the future values of what you would have earned had you lived. Remember that wreck I was involved in earlier? Let’s say that I died in the accident, and my family took that girl to court. I was still in my 40s at the time and let’s say my annual income was $100,000.
20 x $100,000 = $2,000,000 PLUS a 4-5% rate of return, now the court system has made a judgment that my family, in a court of law, deserves $2,500,000…which is higher than the insurance industry uses. If you were my wife and kids (which I don’t have by the way), wouldn’t you be suing for this amount?
The last way is the SWAG method. It’s the most prevalent method I see. I used this method in many classes when I was in college. It stands for Scientific Wild A__ Guess…meaning you pulled a nice round number out of the sky and that’s the economic decision you made for your family.
Fill in the blanks:
- I am currently age ____
- My annual income is $________
- I currently own $__________ in life insurance
- I am underinsured by $________
How do you feel right now? If you’re not disturbed, you should be. Just sayin’…
Obviously, this is my first bias. Hopefully you see my logic. I’m not trying to sell you more life insurance…I’m just using the same logic in my calculation that I did in insuring your house and maybe your car.
Chapter 6.1…Building your Moat…Life Insurance…
The second bias I have is regarding the type of life insurance company & their products. There are two types of life insurance companies: MUTUAL & STOCK.
The policyholders own MUTUAL companies. Profits from the company are paid to the policyholders in the form of dividends. Some of these companies are over 150 years old, and obviously very stable. Their products are varied. Term and whole life are their premier products.
STOCK companies are owned by the company shareholders as the company is publicly traded on the exchanges. Term insurance is their predominate product. The competing product that they offer in lieu of whole life is called Universal Life. It’s a similar concept to “buy term & invest the difference”, except the difference is invested in a fixed account with an annually declared rate of return.
Universal Life has a lot of moving parts that many agents don’t bother to tell their clients when they purchase it. STOCK companies include such names as AIG, John Hancock & TransAmerica. You can find these companies on the “doityourself.com” websites. As an industry friend always said
“Insurance companies can break a promise…as long as they put it in writing.”
So how does my bias come together? Simple…
Insure yourself to your full “replacement value” …AKA Human Life Value
Think about the day that your “level term” exhausts. What is your strategy?
When is the date you tell your family you either cancelled your life insurance policies or let them lapse? Think about that conversation…
There are a few optional benefits that I always build into my term policies…yes, I recommend a lot of term insurance! If you’re shopping on “cheap term.com” they will never mention them because they might cost a few dollars per month extra. They are: WAIVER OF PREMIUM RIDER, EXTENDED CONVERSION RIDER, and ACCELERATED BENEFIT RIDER.
Here’s’ how they work…and how they work together.
WAIVER OF PREMIUM says this: If you become disabled, and you have this rider on your life policy, depending on the definitions of disability in the policy, the premiums can be WAIVED and the company will make the payments on your behalf for the length of your disability or the length of the policy term.
Think of it this way, if you are sick or hurt and cannot work, what is one of the first expenses you’re going to eliminate? Yes, the life insurance premium is almost the first thing to go, but the protection you need to keep the most. With waiver, problem solved.
EXTENDED CONVERSION RIDER means that at the end of the policy term, or at any point before that, any or all the face amount can be CONVERTED to a permanent cash value building policy with no medical evidence whatsoever. This where my bias towards mutual companies comes into play.
Many term companies have a conversion rider that is only in effect for the first 5 policy years. Also, I’ve seen where the product they use for conversions is not their best in many occasions.
ACCELERATED BENEFIT RIDER came into play after the AIDS crisis in the 80s. Many men who had no health insurance but had life insurance were selling their death benefits for cash settlements to may for their medical care. This rider says that if you are deemed to have a terminal illness by a qualified medical professional, the death benefits can be paid to you while you are living to take care of medical expenses, family needs or wishes, or to have a higher quality of living while you’re still here to enjoy it.
HERE IS EXAMPLE OF HOW THESE WORK IN CONCERT:
I’m 35 years old. I own a guaranteed level 30-year term life policy with all three of these riders built into the policy. Face amount is my HUMAN LIFE VALUE of $3,000,000 (30 times annual income $100,000).
I am involved in the car crash from Chapter One, and at age 45, now I am permanently disabled. WAIVER OF PREMIUM keeps the term policy in force. My physician says the accident did not affect my life expectancy, so I’m probably going to live into my mid-80s.
However, my term premium is only paid until age 65 when the level term period ends. EXTENDED CONVERSION RIDER is on my policy. I have purchased a specific type of waiver that allows me the right to CONVERT the $3,000,000 of term coverage to a cash value building whole life policy with no medical evidence at the end of the 30-year term period. In addition, since the WAIVER OF PREMIUM benefit guarantees that the insurance company will pay the ongoing annual premium, they will pay the new whole life premium going forward for the length of my disability.
The policy will build cash values over time, I have access to them while I am living for additional needs, the full $3,000,000 face amount will remain in force for the rest of my life, and I because of these riders, I will have guaranteed that my wife, children, and hopefully grandchildren will have a “legacy of love” from me in perpetuity.
Lastly, if my physician deems me terminally ill, my family can access the death benefit while I’m living with the ACCELERATED BENEFIT RIDER.
…but they tell you on the TV ads that a 40- year old can buy 10-level term for $15.00 per month to protect his family. The “financial entertainers” and sadly, many financial planners tell many people the following statement:
“You should buy the cheapest term policy you can find because “You won’t need the coverage in your later years because you will have built enough assets through your retirement accounts and you will be “self-insured” so that you WONT NEED LIFE INSURANCE”
Remember earlier when I said I “stress tested” your auto, homeowners & umbrella policies to see if they performed to their optimum efficiency?
This is how I “stress test” your life insurance policies.
Building your Moat…Life Insurance Strategeries
Years ago, I was noodling around on a white board, and came up with this graph. I’ve found myself drawing it for almost every client I have when showing their life from a financial & insurance perspective. Remember, I’m a PROFESSIONAL EXPLAINER.
Let’s play out YOUR LIFE. There are four parts to a person’s financial life: ACCUMULATION, PRESERVATION, DISTRIBUTION, and LEGACY.
Starting either in your 20s or 30s, you will always be on the ACCUMULATION line…for your entire life…not only will you be growing assets in savings accounts, retirement accounts, and other investments, you should be fully invested in these accounts (based on period & risk tolerance) so that the rate of return will keep up with inflation, taxes, etc.
When you take your last breath, your assets will be doing all they can to still gain a reasonable rate of return…whatever that is.
About age 50 or so, and after a few market corrections, the Aggressive Growth investment style you had earlier stars to get a little more conservative…maybe to a Moderate Growth style allocation…focusing more on PRESERVATION…because even though you’re still concerned about ACCUMULATION, but now you’re thinking I should be just a little more conservative.
At age 70, the IRS comes into play and says “You’ve deferred these retirement accounts (IRA, 401(k), profit sharing) for a long time, but it’s our time to make you take DISTRIBUTIONS.” It’s called a Required Minimum Distribution, and every CPA and financial advisor knows about these. But here’s my point. Even though you’re now “semi, quasi, or fully retired, your assets are still on the ACCUMULATION/PRESERVATION Lines. You never leave them…but we’ve added a new layer…
So now you’re retired…have accumulated some assets…more than likely it’s not enough, but it is what it is. Social Security has kicked for you & your spouse, home is hopefully either paid for, or has a small mortgage balance, and you’re wanting to enjoy your “Golden Years”.”
However, you have a heart, and a soul, and a wonderful family of children, grand-children, and maybe even great-grandchildren. So now you’re thinking LEGACY. I’m not talking about putting your name on a building. I’m talking about leaving this world a little better than you found it.
However, you’ve painted yourself in a corner without knowing it. By using the strategies of the “financial entertainers” which is “buy term and invest the difference”, you’re possibly thinking the following:
- I’ve spent my lifetime accumulating assets for retirement and have outlived my term life insurance policies. No more life insurance for the wife!
- I’ve stayed the course through market corrections, financial disasters like 2008, and no telling how career and job changes.
- I’ve put two kids through school and gotten them both married off
- What happens if we get sick and need in-home or nursing care?
- Have I planned for the possibility of “outliving our $$$”?
- How am I going to make sure my wife is taken care of when I die?
- What happens to her after I’m gone and who is going to take care of her?
Welcome to the world of TRADITIONAL PLANNING! This is what the Internet is teaching you…and many financial planners too. So, let’s play this out using some of the strategies I believe & share with my clients.
The End Game…and where Permanent Insurance Makes Sense
Going back to my graph above. Buying term insurance with a face amount of your HUMAN LIFE VALUE, and investing the difference into retirement plans makes total sense during the ACCUMULATION & PRESERVATION phases of your life…but what happens during DISTRIBUTION & LEGACY?
So, from the day I purchase my GUARANTEED LEVEL 30-year term life insurance with WAIVER OF PREMIUM, EXTENDED CONVERSION RIDER, AND ACCELERATED DEATH BENEFIT, I am investing as well. I got the best class available and the lowest annual premium, even with the additional riders.
From ages 35-65, I’m optimally insured to protect my family against my premature death (…aren’t they all premature?) BUT…let’s say my strategy of asset growth is nowhere close to where the projections were when I started this plan. Life has kind of happened to my “best case scenario planning.”
- I’ve had a layoff or two…downsized once.
- Had to take care of Mom & Dad.
- Had to take a premature withdrawal from my IRA’s
- Suffered through the market correction in 2008, went to cash & missed the double-digit run up that came afterwards.
- My plan had an average annual return of 8-10%…it’s been a little more than 4% in the long haul.
- I’ve had a health scare of two…and I’m not the Ultra Preferred rating I once was.
All this to say, that targeted seven figure account balance your calculator gave you is coming up quite a bit short. I’m concerned with my wife and I not only having enough $$$ to live on in retirement, but what happens if I die or get sick?
What about that grandiose plan of living a comfortable retirement, having enough $$$ to do what we want to do, when we want to do it, not out live our $$$, and leaving a legacy of love to our heirs?
WHAT IF, in year 29 of my 30-year level term policy, knowing that I was entering the DISTRIBUTION AND LEGACY phases of my life, I exercised the EXTENDED CONVERSION RIDER of my term policy for a portion of that policy WITH NO MEDICAL EVIDENCE to one that I could keep for the rest of my life? What if I had that contingency plan in place in case “my plan” worked out exactly the way it did?
At that point, I’m not concerned with HUMAN LIFE VALUE anymore…I’m concerned with our lives in retirement. My chances of dying before my wife are higher, actuarily speaking. When I die, regardless of what is left in our DISTRIBUTION bucket, it gets replenished 100% TAX FREE with the life insurance proceeds…
All those term premiums I paid all those years will be recaptured, my wife, my kids, and grandkids will all remember the LEGACY of love from their Dad & Granddad. This is a simple strategy, and it all starts with purchasing the right type of term insurance with the right optional riders.
This is one of my biggest biases, by the way…and the reason I disagree with what the “financial entertainers” and a large majority of “financial planners” say about permanent life insurance.
Another big factor here is that everyone assumes that if it’s not term insurance, it’s Whole Life Insurance, which is not true. The financial entertainers detest whole life insurance…primarily because they don’t truly understand it. Most people don’t understand it because it can be complicated and oftentimes expensive.
The bottom line is that it’s expensive for a reason. The fundamental reason is that contractually, it’s got the strongest guarantees of any life insurance product available. It’s a true luxury product, and even though many of my clients see the value in owning it, their monthly cash flow prohibits it, and they need large death benefit amounts so we use term insurance.
Funny it worked amazingly well for all Americans up until the early 80s when these things called “mutual funds” came along with the opportunity for higher returns.
There aren’t many companies left that even sell Whole Life. I know of four: Guardian Life, Northwestern Mutual, New York Life, and Mass Mutual. These are Mutual companies where the policyholders are paid dividends in their cash value accounts.
There are no shareholders in a mutual company because the policyholders are the shareholders.
The other two types I see regularly are Universal Life and Variable Universal Life policies. In a nutshell, Universal Life is “buying death benefit and investing the difference” in a side fund that has a fixed interest rate adjusted annually by the company.
Variable Universal Life is the same concept, except “the difference” is invested into a grouping of mutual funds…very similar to the selection you see in your company 401(k) plan. These are great when we’re in a bull market. However, when it slows, and your cash values diminish with the stock market, you’ve got to remember it’s still life insurance, and premiums have to be paid.
You’ve also got to watch these types of policies as you age because the internal expenses (a.k.a. MORTALITY COSTS) increase annually and can eat away at your cash values if you’re not careful. Even worse with Variable life, because those values are tied to the market returns.
These types of policies are full of broken promises. As I’ve said before
“Insurance companies can break a promise, as long as they put it in writing.”
I’ve seen many of these types of policies through the years and know them all too well. Many times, the policy was sold with a proposal that showed a current interest rate of that year that hasn’t been sustainable for years. Back in the early 80s we saw interest rates proposed on life insurance policies in the 12-15% range, and people bought a gazillion of these based on those rates.
What the salesman didn’t say was that interest rate was only guaranteed for a year. After that, all the company was required to pay was the guaranteed interest rate which back then was in the 4-5% range. Today current rates are at 4%. See the problem here? Broken promises.