There is a saying that ‘life insurance is sold, not bought’. Compare, for example, shopping for life insurance with shopping for a car. When most of us shop for a car there is a little bit of excitement. You ‘want’ a new car and shop around to find out what kind of car you want to buy. In comparison, few people actually ‘want’ life insurance. Rather, it is something that we are told we should own. Few shop for the type of insurance they want to buy. More often, an insurance salesman sells us on a specific policy. Thus, the saying, ‘life insurance is sold, not bought’. The result, however, is that many of us do not understand what type of insurance we own even though they are often paying hundreds of dollars each month - about the price of a car payment! - to the insurance company. If you are in the market for life insurance, or have a policy that you do not understand, here are some life insurance basics so you can make more informed decisions.
Types of Life Insurance
Life Insurance can be broken down into a few categories. “Group” or “Individual” and “Term” or “Permanent” At the most basic level, understanding these categories can help you determine what life insurance policy is best for you.
Group or Individual
As the name implies, Group life insurance is offered through a group, your employer or some type of union or trade organization for example. Group insurance has some pros and cons. First, because of group buying power, group insurance can be very cost effective. It can also provide at least a basic level of guaranteed coverage without the need for medical disclosures and exams. As a result, obtaining life insurance coverage through your employer, union, or trade organization can be a cost-effective way to obtain coverage even if you have some medical issues.
Be aware, however, that group life insurance coverage often ends when your association with the group ends, which means if you lose your job you can also lose your life insurance coverage. And if you have a medical issue or a medical issue arises, you may have a difficult time obtaining coverage as an individual.
Individual Life Insurance is purchased by you as an individual or married couple. It is your policy, and therefore can be tailored to your specific needs. Unlike group insurance, individual insurance is not tied to your employer, and stays with you when you change jobs. Of course, individual insurance can also be more expensive, and can be more difficult to obtain, often requiring a medical exam and extensive medical disclosures.
When weighing whether group coverage or individual coverage is right for you, consider your job security or likelihood of continuing with the group. For example, those in the tech industry will often switch jobs every few years. If so, it may be better to not rely on your company for life insurance. In comparison, if you have been with the same company for 30 years, have strong job security, and will likely finish out your career at that company, then buying group coverage may be a great option. Similarly, are part of a union or trade organization where you are likely to remain a member, group insurance through that organization may be advantageous.
Term or Permanent
Term life insurance provides coverage for a specific period of time or ‘term’. For example, 20 years or until the insured reaches a certain age. Term policies will often have level premiums for the term, though after the initial term they may also switch to annually renewable premiums at ever higher cost. Term life insurance is somewhat like auto insurance. You will be paid a benefit if there is an incident (death) during the coverage period (term). Term insurance is the most straightforward way to buy life insurance and is often the most cost effective.
Permanent insurance in contrast is intended to last for your lifetime, and often builds a ‘cash value’ that can be cashed-in or borrowed against. Permanent insurance comes in several different flavors: whole life, universal life, variable universal life, and index universal life. The key differences among permanent insurance center around how the policy builds cash value, but the fundamentals are similar. Whole life insurance builds value based on a stated dividend, universal life based on a stated interest rate, variable universal life based on market performance, and index universal life based on index performance. The details can get complex, but the fundamental concept is that the insurance policy will last your lifetime and will build value.
One of the biggest differences between term insurance and permanent insurance is cost. Term insurance will typically have much lower premiums. As a result, term insurance is the best choice for most people, allowing you to obtain the highest insurance coverage for the period of time when your family needs it most, such as when you have young kids at home. For most people life insurance needs decline later in life as their assets increase, so permanent insurance may not be necessary. Permanent insurance can have its place, when there is a taxable estate for example, but those situations are rare.
Since life insurance is sold and not bought, insurance agents will often push clients to the highest cost insurance coverage: individual whole life policies, rather than exploring other lower cost insurance options, such as group insurance through an employer, or individual term insurance for the time most relevant. It pays to be well informed and consider whether you are getting the coverage that is the best fit for you at the lowest cost.