of the first considerations when
investigating life insurance is the
question of term versus whole or
variable coverage. We first
need to understand how they are
different and take a look at the pro's
and con's (loosely translated as cost!)
of term life insurance.
Comparing the types of life insurance
including term comes down to a simple
point. Term life insurance is for
a fixed period of time. Whole and
variable life can usually be carried out
for a person's entire life. This
means there will be some payout at some
point as long as the policy is kept in
force (generally meaning that premiums
are paid). This is
counter-intuitive to the world of
insurance and the very principle of how
insurance works. Insurance is to
protect against an unlikely but
catastrophic risk across many people and
thereby reducing the risk to any one
given person. Whole life
insurance is providing coverage for a
very likely (like taxes, inevitable)
risk to all.
take an example. If 100,000 people
buy life insurance ($100,000K) for a 10
year period and 15 people actually
trigger the benefit, the total payout is
$1.5M (15 people times $100,000).
But this total amount is spread among
the total risk pool of 100,000 people.
The baseline premium that each person
need to pay for this protection is $15.
in inflation and investment returns
(plus administration costs and profit)
to this and you have the basis for your
term life premium. The carriers
have statistics to essentially guess
what percentage of people will trigger
the benefit according age, health
status, and length of term. It's
higher than the 15 above but you get the
idea of how term life insurance, and
more importantly insurance in general
should work. This is also true for
medical and property/casualty. The
whole basis of insurance is that a
catastrophic expense would wipe out one
individual but if spread among a large
enough pool of people, the group can
handle it because only a percentage will
trigger the benefit. It spreads
life insurance (and variable) is
something entirely different. The
risk of you triggering the benefit is
100% (assuming policy kept in force).
How can that be? Well, the premium
has to be significantly more (usually
around 10 times more) than term life
insurance for smaller amounts.
Here, the carrier is estimating that
they can take the 10 times premium
(let's say $150 per person for our above
example) and make enough money investing
that amount to pay out for everyone in
the group at a lesser amount. They
are essentially investing with your
money hoping to earn off this "float"
before needing to payout death benefits.
They also plan to pay your death
benefits with future money which is
worth much less (due to inflation, $1
today might be worth 60 cents 10 years
from now and 20 cents 20 years from
now). You're not
insurance to have money invested.
You are buying life insurance to protect
against a risk.
equivalent to purchasing health
insurance to cover 100% of all expenses
(no copays, no deductibles, and no
co-insurance). The cost for such a
plan would be so high that it would
quickly price itself out of the market.
This is why we have the constant
movement towards higher deductible and
more cost sharing. Covering 100%
of the risk of death just isn't cost
effective which leads us to our next
Premium premium premium
Premium is the amount you will pay to
keep a life insurance plan in effect
and this is where the tire meets the
comparing term and whole life
insurance. Term is so much less
expensive than whole life that it's hard
to make the case for whole life.
If you have enough money to afford large
amounts of whole life insurance than the
question begs whether you need life
insurance to begin with. It takes
a great deal of premium to buy large
amounts of whole life. Some
(usually insurance brokers selling whole
life) would argue that you build up cash
values with whole life which means that
after a period of time, you start to
have a portion of the whole life policy
that is essentially your asset (to
borrow against for example). Why
would you pay your own money in premium
to have a life insurance company hold it
(and invest with it) as your own money
for you to borrow against.
Why not keep 9/10ths of your premium to
yourself and buy term with the other
1/10th (difference in premium) of the
whole life premium. In our view,
this is a gimmick for people who do not
understand how money works. You're
essentially giving the life carrier
money to invest for themselves, and they
will give you back a smaller amount at
the time the benefit is triggered.
Keep your own money and spend a fraction
of it to protect against the real
insurance risk. That's term life
insurance in a nutshell.