Life insurance may be one of the most uncomfortable topics in financial services. Death isn’t fun to think about and people can have strong opinions about insuring it. Then there are the pesky sales agents (and “friends”) that turn every conversation into the wonders of life insurance. Rest assured, this is not a life insurance pitch.
This is what’s increasingly difficult to find, an honest and objective opinion about life insurance that’s not tainted by conflicts of interest. Everyone is different, and what’s best depends on individual needs and goals. This isn’t personal advice, but important points to consider when evaluating life insurance.
Understand the purpose of insurance
The purpose of insurance is to protect against potential risk and liability. We buy auto insurance in case we get into an accident and health insurance in case we get sick. Insurance has a cost, which we pay for as premiums.
It is possible to receive more benefits than paid in premiums, but that’s not the expectation. We don’t buy auto insurance and hope to get into a terrible car crash. On the contrary, we want to avoid such accidents. We buy insurance for protection against things that we don’t want to happen, but could happen anyway.
Insurance companies (ICs) have a different perspective. ICs are in the business of selling financial products. Like any business, an IC operates for profit and it seeks to bring in more money than it pays out. In fact, it must do so in aggregate and over time, otherwise the business goes broke!
ICs are skilled at profiting from their activities and insurance is a lucrative business. That doesn’t mean ICs are bad, we just need to understand that we should not expect to profit from buying insurance, and protection does not come cheap.
Understand the reason for life insurance
Let’s apply this understanding to life insurance. We buy life insurance to protect others against our death. Maybe we have children or other dependents who rely on us for financial support. What happens if we die tomorrow? What if we have a big mortgage and outstanding bills to pay? How will they house, feed, and clothe themselves?
Those are unpleasant questions, but also real-life risks. Life insurance can protect our beneficiaries against the loss of our financial support. There are other use cases too, key man policies for businesses, estate planning, and others. But in all cases, the core purpose of insurance should be to protect against some risk or liability.
What if there is nothing we need to protect? Maybe we don’t have dependents, or we don’t have any liabilities. Perhaps when we pass away we will only leave cash and assets for our heirs. That doesn’t seem like a situation where life insurance is necessary. There may be special use cases for taxes and estate planning, but the basic need for insurance is not there.
Despite what some agents may insist, it’s perfectly fine to not have life insurance when there is simply no need for it. At this point agents may twist the conservation into other wonders of life insurance like tax benefits, cash value, and growing your money. The reality is there are typically better ways to accomplish those things outside of an insurance policy.
What is the right amount of life insurance?
Assuming you identify a legitimate need for life insurance, the next questions is how much is enough? Instead of agreeing to some arbitrary value, like round millions or 10 x income, use a needs-based analysis to ask, what do we want and need to protect? Maybe we need to pay off debts, fund college education, or provide 20 years of living expenses. There are no right or wrong answers, but we should be clear, honest, and realistic about what we want and need to protect.
From there, it’s just a matter of quantifying the needs and working backward to estimate how much benefit value is required. Be sure to consider how factors like inflation, taxes, fees, and others may affect potential needs and the benefit value.
Although we don’t know what the future brings, thinking carefully about our expected wants and needs will yield a more appropriate estimate than an arbitrary value or buying the biggest and fanciest policy we can afford (which unscrupulous agents may encourage).
What about the fancy policy “riders”?
Speaking of big, fancy policies, life insurance can offer many add-on “riders” (special features) for additional costs. Some riders are simple, like adjustments for inflation. Others can get complicated like the ability to use the insurance policy as an investment vehicle with guaranteed growth.
Agents may laud these features as sophisticated investment tools with special tax advantages used by the rich to build wealth. They may present a hypothetical illustration whereby after making certain premium payments the policy is worth millions of dollars! It almost looks too good to be true. Just remember, if it looks too good to be true, it’s too good not to be very expensive!
It’s generally not a good idea to mix insurance and investments into a single financial product because the two have opposing objectives. Insurance is for protecting, whereas investments are for growing.
We can usually achieve better results by using separate products designed for their distinct purposes. Forcing two (or more) opposing objectives into a single product can result in a financial Frankenstein with unnecessary complications, high costs, and sub-par performance.
But what about all those rich people putting money into fancy life insurance policies? The reality is their needs are probably different. The wealthy are not using life insurance policies to build or grow wealth, they already did that through other more effective means. It’s likely the insurance is part of a larger financial planning strategy for taxes, risk management, philanthropy, etc. (as opposed to a “growth” strategy).
Buyer beware with life insurance
Don’t be fooled into believing a fancy life insurance policy is a special tool for creating riches. That is not the purpose of life insurance. Also, remember the more ICs and agents collect from you, the more profit they will make at your expense.
Life insurance is a lucrative financial product. Sellers can collect over 100% of the first year’s premium as an upfront commission as well as a recurring percentage of future premiums. ICs expect to profit much more than that over the life of the policy.
That is not to say all life insurance, companies, or agents are bad. There are many good people who work in insurance and life insurance can be very helpful in the right circumstances. This article communicates we should understand how life insurance works and we should use it for its intended purpose.
Unfortunately, life insurance is often used and sold incorrectly. The lucrative nature of the life insurance business encourages the pushing of oversized, overcomplicated, and overpriced products that even selling agents may not fully understand.
All too often, the most complex and expensive products are sold by agents, not bought by customers. The bottom line is to beware out there, be clear about what you need, and don’t be fooled by slick marketing materials or aggressive sales practices into buying more life insurance than you want or need.
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HWL
Happy Wealthy Living 
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