Life insurance policies provide cash relief and financial support for the loved ones that you leave behind. Insurance agent, Anthony Steuer, explains: "Life insurance is designed to replace income for someone or something that is dependent upon the insured."
Types of Life Insurance Policies
Life insurance policies can protect your family from financial hardships in the event of your death. The proceeds received from life insurance can help your beneficiaries pay for funeral costs, medical bills, and other debts that you may have left behind. This money also ensures that the household, mortgage costs, and other bills can be maintained in your absence.
If you are interested in acquiring life insurance coverage, there are two basic types of life insurance policies to choose from:
Whole Life Insurance
Whole Life Insurance gives you coverage for as long as you live providing you make your premium payments. The best part about this type of life insurance is the fact that you can accrue additional money based on investments the you make. Investments may be in bonds, money market instruments, or stocks. After the policy has built cash value, you can borrow against it if you need to. However, you should keep in mind that borrowing against the policy lessens the amount of money paid out to your beneficiaries in the event of your death.The amount that you pay in premiums for whole life insurance coverage depends on your age and health at the time that you purchase the policy. In general, whole life insurance premiums do not fluctuate and may be quite reasonable if you purchase the policy when you are young.
The type of whole life insurance coverage that you choose also affects policy rates. Common types of whole life coverage include:
- Traditional Whole Life which provides a guaranteed rate of return on cash value.
- Single Premium which allows you to purchase a policy upfront with no monthly premiums.
- Variable policies give you a variable rate of return on the cash portion of your policy.
Term Life Insurance
Term Life Insurance is exactly what the name implies: life insurance for a specific term or amount of time. With term life insurance, you can purchase insurance coverage for a specific term or number of years.
The premium for term life insurance policies is based on your age and health at the time of purchase, as well as the length of the term. Because term coverage is often much cheaper than whole life insurance, it is the preferred type of life insurance for most people. However, there is no investment potential. You cannot increase the cash value of your term life insurance policy by making investments, nor can you borrow against it.
Shopping for Life Insurance Policies
When purchasing a life insurance policy, it is very important to shop around prior to making any decisions. The cost of a policy can vary significantly depending upon the policy terms and where it was purchased.
If you are looking for low cost life insurance, you may want to check with your employer to see what type of life insurance benefits you are eligible for. You can also speak to some of the associations and organizations that you belong to. Many of these groups offer low cost life insurance plans to their members.
You can contact various insurance agents and groups to see what your options are. If you decide to go this route, make sure you get at least three quotes, so you can make comparisons properly.
How Do You Choose a Life Insurance Company?
Consider Anthony's advice in choosing a life insurance company: While determining your life insurance needs and the type of life insurance coverage are the first steps, it is critical to choose the life insurance company wisely. Life insurance, even a ten-year term policy, is a long-term proposition. You have to take into consideration whether your life insurance company will be around to pay the claim. This can quite a challenge as there over 1,600 life insurance companies offering thousands of life insurance products to residents of the United States.
Fortunately, there are some common sense guidelines that will help you narrow the field to a more manageable selection of companies and products. Let's cover briefly how to evaluate a life insurance company from a financial perspective.
Many "net-savvy" consumers are pros when it comes to looking up and analyzing financial data on stocks, bonds, and mutual funds. Performing insurance company due diligence, however, presents a new challenge. Fortunately, many of the leading sources of information make their ratings and "analysis" available to the online public and almost all of it is free. Most likely this will change as the rating services will view this as an income stream.
Don't get caught in the trap of simply comparing two companies and choosing the better one. Instead, hold each company up to a pre-determined set of benchmarks. If an insurance agent wants to sell a particular company or product, it is not uncommon for the agent to offer two or three alternatives that look worse than the one the agent wants to sell.
Finally, don't assume that it costs more to purchase insurance from a top-rated company. Remember, product illustrations are poor indicators of how a policy will perform. Since insurance companies generally have comparable expenses, reserve requirements, and overall investment strategies, buying from the best does not necessarily result in higher premiums.
When selecting or evaluating a life insurance company, a logical place to begin is by reviewing the ratings given by the five major insurance company rating services. In a rating, the rating company or agency expresses its opinion of the life insurance company's financial soundness and creditworthiness. In some cases, the life insurance company will ask one or more rating companies for an evaluation and rating, and the company will then pay a fee ($25,000 to $30,000 is common) to the rating agency. Generally speaking, this fee does not compromise the rating because rating companies are extremely protective of their reputation for objectivity. Without public credibility, a rating is useless, so rating companies strive to maintain their credibility.
Five firms currently rate insurance companies. They are:
- A.M. Best Company
- Standard and Poor's Corporation
- Moody's Investors Service
- Weiss Research
Each firm employs its own rating system, and some rating agencies are considered to be more stringent than others.
Not all insurance companies are rated by each agency. Each agency employs its own techniques for determining a given insurance company's rating. Areas of consideration may vary and these include financial leverage, management stability, recent performance, and the rated company's overall financial situation. External factors such as competition, diversification, and market presence may also be considered.
Each rating agency provides a description of its analysis and defines the meaning of each rating from the highest to the lowest. Since there are differences between rating agencies, this can make a fair comparison between different ratings somewhat confusing. Information on how to contact each rating service will be found below (including some useful links). The chart at the end of this report compares the ratings given by each agency. To obtain the latest ratings, please check with the appropriate rating service.
The following summary describes each rating service and the rating criteria used, along with a brief explanation of how insurance companies initiate the rating process. It is important to keep in mind that these criteria may change.
- AM Best Company - Simply enter the name of your company under the "Search Ratings" category and in addition to providing you with an up-to-date rating, under the various folder tabs you will find the following: 1) the age of the company (a minimum of 50 years' experience is recommended); 2) the corporate address; 3) the company ownership structure (stock or mutual); 4) the Financial Size Category (recommended minimum is IX); 5) the business overview, and 6) the history of the company including any mergers and acquisitions. In addition to this free data, AM Best also offers a complete company report for $19.95 which provides financial statistics for the past five years. But unless you're proficient at interpreting insurance company financials, this report may prove rather overwhelming. (Web site is: www.ambest.com).
- Standard & Poor's - To access the Insurer Financial Strength Ratings, click on the Ratings Lists link, and then choose the Insurance category. When you have located your company, the resulting report is quite detailed. In particular, pay attention to the following data:
- Total assets for five years (goal is moderate growth over this period with a recommended minimum of $2 billion in assets)
- Total liabilities (should experience roughly the same growth rate as total assets)
- Net income (should remain relatively stable)
- Business review and history
A pie chart indicating the company's product sales.
The last category is particularly important in times of change. If a company sells too much of any one product type (individual annuities, or permanent life insurance, for example) a sudden shock to the marketplace, such as a change in the economy or tax system, could result in a sharp decline in the company's business. Lack of product diversification was a leading factor behind the failure of Mid-Continent Life. The company primarily marketed one policy type and, when that product proved to be under priced, the entire company was at risk. (Web site is: www.standardandpoors.com).
- Fitch - The Financial Strength Ratings Reports can be found under the "Insurance" category. In addition to a letter rating, the Fitch website will provide you with a detailed business review and overall outlook for the company. In particular, you should pay attention to the following: 1) the product mix (life, annuities, group insurance); 2) the company's marketing focus (upscale and advanced marketing is usually a sign that much of the company's business is tax-oriented; 3) the primary states where the company sells insurance (diversification between several states is advised); 4) the company's reinsurance practices, and 5) the quality of the assets in which the company invests. High-risk investments (junk bonds and defaulted mortgages, for example) have caused the downfall of several large insurance companies such as Executive Life, First Capital Life, and Monarch Life, and a company's exposure to such investments should be very limited. (Web Site is at www.fitchratings.com).
- Moody's - Insurance Financial Strength Ratings can be found under the "Insurance" category. (Web Site is: www.moodys.com).
- Weiss - Weiss is the only major rating service that charges for its current ratings. The cost is currently $7.95 per company and the only information you will receive for that price is the letter rating. To purchase a rating, click on the "Ratings Online" button. (Web Site is: www.weissratings.com).
The web site addresses given here are the main home page for each rating service. The page where the ratings can be found changes so you may have to look for it on the web site. It also can be a challenge to find the page; however they are there. At the time of the writing of this book, you do need to establish a free account for some of these services. A high rating is not a guarantee that a company will meet its projected earnings or that it will survive. Similarly a low rating does not mean that a company will not meet its projected earnings or that it will fail. A rating is simply an expression of opinion about selected aspects of the current financial condition of an insurance company. Each rating service also has extensive information on their philosophy and the criteria on their website.
How Much Do You Need?
In Anthony's agency, he provides a simple worksheet with the following advice: If you know the amount of income that needs to be replaced (assuming that this a permanent level income), you can perform a reverse calculation by dividing the income stream needed by a conservative, reasonable rate of return if you were to invest the entire proceeds and leave the principal intact (such as a 5% annual rate of return). For example, if your need is for an annual before tax income stream of $50,000 then divide by 5% ($50,000/.05) resulting in a death benefit of $1,000,000.
The following is a worksheet that you can use:
Life Insurance Worksheet
INCOME NEEDS:1.) Annual income your family would need if you die today (typically between 60%-80% of total income)- Consider any lifestyle changes, and include any current expenses such as mortgage/rent, groceries, clothing, utility bills, entertainment, travel, transportation, child care, etc: $______________
2.) Annual income available to your family from other sources - Include all salaries, dividends, interest, current (or estimated) social security benefits, along with all other sources of income: $______________
3.) Annual income to be replaced (Subtract line 2 from line 1.) : $______________
4.) Funds (Capital) needed to provide income for your required number of years? $______________
Multiply line 3 by the appropriate factor below:
10 YEARS X 8.1
15 YEARS X 11.1
20 YEARS X 13.6
25 YEARS X 15.6
30 YEARS X 17.3
35 YEARS X 18.7
40 YEARS X 20.0
5.) Funeral expenses - average cost of an adult funeral is about $10,000: $______________
6.) Administrative Expenses (also referred to as an Emergency Fund and/or Final Expenses (approximately six months - 50% of the higher wage earner's salary); - can vary for cleaning up the affairs of the deceased, e.g., advisor fees, filing taxes: $______________
7.) Mortgage and other outstanding debts (credit card debt, car loans, home equity loans, etc). It may make sense to pay off these debts, considered if the survivor will have a substantial income: $______________
8.) College costs: 2002-2003 cost of a four-year education: public college-$51,346; private college $109,412. Multiply by number of children and keep in mind that costs are increasing more rapidly than inflation $______________
9.) Capital needed for college - Multiply line 8 by the appropriate Years before college Factor: 5 years X .82; 10 years X .68; 15 years X .56 and 20 years X .46: $_____________
10.) Total capital required Add lines 4, 5, 6 and 9: $_______________
Keep in mind that current asset value may be considerately different at time of liquidation as well as the value may be significantly discounted due to forced sale such as real estate, family business or other investments:
11.) Bank accounts, money market accounts, CDs, stocks, bonds, mutual funds, real estate: $_______________
12.) Retirement savings IRAs, 401(k)s, Keoghs, pension and profit sharing plans: $_______________
13.) Present amount of life insurance (including group life insurance assumes that it will continue): $_______________
14.) Total income producing assets - Add lines 11, 12 and 13: $_______________
15.) Life insurance needed - Subtract line 14 from line 10: $_______________
Consider this advice from Anthony as you contemplate the decision to buy a life insurance policy, "Keep in mind that as you go through this process that life insurance is not for you, it is for your survivors. Therefore, you typically will only have a need for life insurance when you are leaving behind someone or some entity that is dependent on your income."