A Life Insurance Primer

There are two basic types of life insurance: term insurance and permanent insurance. Term life insurance is the purchase of a death benefit for a set premium and a set period of time, providing protection without a savings element built into the cost. There is only a premium to pay for a set period of time. Since there is generally no savings involved, term insurance is the most inexpensive form of insurance available. For most families, protection is needed for a set number of years to protect the income earning ability of an individual. Once retirement has been reached, earnings stop and are replaced by retirement income. Thus, if adequate savings have been accumulated, then the need for protection no longer exists. Permanent insurance, on the other hand, is the purchase of a death benefit and has both a set premium and accumulates savings.

It provides protection for families when the need will cover the life of the individual. As the savings increases, the protection value
decreases both because of inflation and because the savings is building.

Situations requiring this type of protection include a family whose primary wage earner owns a closely held business or has assets that are generally considered illiquid.

The reason for liquidity is that money is needed to pay for estate taxes. The current threshold is $5 million. With proper estate planning, that threshold can be expanded to $10 million. It is important to know this threshold may go back to $1 million. With this permanent form of protection, the savings element increases in the life insurance policy during the lifetime of the individual. When the policy is fully mature, the savings equals the original death benefit. Because of fees, higher mortality costs, and other administrative costs, this form of coverage tends to be more expensive. Few people have estates large enough to make this type of coverage necessary. I also have found that the savings element in the policy has not performed well historically.

There are, of course, a myriad of investment choices with life insurance policies; but, I have found consistently higher fees associated with permanent coverage. These same high mortality rates and administrative expenses do not exist as much with term insurance. With universal or variable policies it is important to track whether there is a point in time where your policy may implode. When the concept of universal and variable life was introduced interest rates were high and expenses could be more easily hidden from the consumer. Now, rates are low and many universal and variable policies are at risk of terminating prematurely. Whole life does not typically carry the same risk of imploding, but returns are lower and premium higher.

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