How to Buy Life Insurance

It’s natural to want to avoid thinking about your demise. But life insurance can be an important part of your family’s financial planning, and it’s important to educate yourself when you begin shopping for a life insurance policy.

Life insurance terms, conditions, and definitions

How to Buy Life Insurance

Here are some quick definitions of terms you might encounter when shopping for life insurance. For a more complete list, the National Association of Insurance Commissioners has a good glossary of insurance terms.

Beneficiary: The person who may become eligible for payment under a life insurance policy.

Claim: A request by the insured for the insurer to make payment.

Incontestability provision: A clause in a life insurance contract that limits the amount of time the insurer has to void the contract in case of false statements made in the application.

Insurable interest: A right or relationship such that the insured suffers a loss in the case of the death of a person.

Insured: The person covered by an insurance policy.

Insurer: The insurance company that issues the policy.

Key-person insurance: An insurance policy covering a business for the loss of a person integral to the business.

Lapse: Termination of a policy due to failure to pay the premium.

Living benefits rider: An addition to a life insurance policy providing long-term care for a terminally ill person.

Policy period: The time period in which the insurance is in effect. Also called the “term.”

Premium: The money charged for insurance coverage.

Whole Life Insurance: A life insurance policy that can be kept in force for a person’s entire life.

Is life insurance worth getting?

The first question you need to consider is whether you need to buy life insurance. Forbes magazine offers this rule of thumb: You need life insurance if anyone relies on you financially. The most obvious people who rely on you are your spouse and children. But as the magazine points out, there might be others who depend on you. For example, if your aged parents would suffer financially if you died, you should consider their needs.

The magazine also points out that life insurance is not an “investment” per se. Instead, it’s a risk-management tool. Your family probably counts on you to pay the mortgage and other debts, household expenses, educational expenses, and many other needs. These are normally paid from your salary or wages, and this income will cease if you die. Life insurance is designed to make up for the income your family would no longer enjoy. As the magazine points out, life insurance does not place a value on your life. Instead, it shifts the risk of needing to meet these expenses from your family to an insurance company that is better able to meet them.

Financial expert Dave Ramsey puts it this way: Almost everyone needs life insurance. For example, he notes that even young professionals might have debts that would need to be paid on their death. He reminds newlyweds and new parents that these are important life events that should prompt planning to get life insurance. He even points out the situations where retirees should consider life insurance.

Stay-at-home parents might think they don’t need life insurance since they have no income to replace. But according to consumer expert Clark Howard, this would be a big mistake. Even though they aren’t bringing in income, their services would need to be replaced if they died. That would mean either that the surviving spouse would need to stay home rather than work or someone would need to be hired to replace the lost services. In either case, it’s a financial loss that life insurance could cover.

When is Life Insurance Worth It?

When is life insurance not worth it? Are there reasons not to buy life insurance?

There are some times when life insurance is not a good idea. The website Investopedia.com, for example, points out that life insurance isn’t really “insurance” in the sense that the insurance company can’t prevent you from dying. They point out that you’re really just hedging your bets and making sure your family won’t suffer a financial catastrophe when you die.

So unless you can point to how your family would suffer financially, life insurance might not be a good idea. Two examples they give are young children and the elderly. No matter how emotionally devastating a death of a child would be, the child’s family would most likely suffer little financial loss. And in the case of an elderly person, the cost of the premiums might be very high compared to the financial loss that would be suffered.

U.S. News & World Report specifies four specific kinds of policies that probably make little sense financially.

The first type of insurance they advise avoiding is “guaranteed issue” life insurance, often peddled on late-night television. Often, such policies don’t pay anything if the person dies within two years, and the premium is often very expensive.

The magazine also advises not to buy life insurance for children calling it a huge waste of money since children generally don’t have any income to replace.

Similarly, it advises against buying travel accident insurance. The magazine points out that there’s no need for more insurance if you die while traveling.

Finally, the magazine advises against “whole life” policies, which combine investment features with an insurance policy. It points out that this insurance is expensive and the investment value is often minimal.

What age should you get life insurance?

As Dave Ramsey points out, age is a relatively minor consideration when it comes to planning your life insurance needs. The more important thing to consider is whether others depend on you financially. For example, he spells out the ways that even young professionals starting out can have others who depend on them.

Clark Howard also points out a number of ways in which even young people might have others depending on them. For example, student loans often involve a cosigner such as a parent. If the borrower dies, the cosigner might be stuck paying back a student loan even though the cosigner had received no benefit from the loan. Life insurance can protect them against that risk.

Howard also points out that the cost might be lower if you buy now rather than waiting until you are older.

What to look for when buying life insurance

What to Look for When Buying Life Insurance?

Dave Ramsey is among many who recommend one particular kind of life insurance: term insurance. He advises against buying whole life or universal life policies.

Clark Howard is even more adamant. He points out that many of these so-called “permanent” policies have the word universal in their names, and he says you should “avoid anything with ‘universal’ in the name,” calling such policies “radioactive.” These policies are often advertised as being a combination insurance policy and savings account. According to the advertising, at some point, there’s a promise that premiums will no longer need to be paid. But Howard points out that it usually doesn’t work out that way. He cites one case of a California man who paid $25 per month on such a policy for 23 years only to be told that the premium was going up to $510 per month and that if he didn’t pay, he would lose everything he had paid over the years.

Howard does point out that there are a handful of cases involving persons with incomes over $400,000 per year where there might be tax benefits for a whole-life policy. But unless you are specifically aware of how those tax advantages would work in your case, he advises to stay away from whole-life policies and instead stick with much more affordable term life insurance.

The website Bankrate.com also advises you to shy away any time a life insurance policy is described as being an “investment.” Chances are, you can do better with other investments and shop for life insurance on its own.

Buying life insurance on someone else

There are occasions when you can buy life insurance on someone else’s life. But as the website nerdwallet.com points out, there are restrictions. First of all, you need to have an “insurable interest” in that person’s life. That means that you can’t just buy insurance on a stranger or even a friend. There has to be relationship such that you would have a true loss if the person dies. It might be a strictly financial loss, meaning that you could take out insurance on a business partner. Or it could be an emotional loss, meaning that you can generally buy insurance on a family member’s life.

The site also points out that it’s never possible to secretly take out insurance on another person. The insured person must sign the application, and he or she might even need a medical exam as part of the application process.

The reason the insurance company is always cautious about the requirement for an insurable interest is made clear by a 1957 case from the Alabama Supreme Court. In that case, Earle C. Dennison secretly took out life insurance policies on her two-year-old niece. After doing so, she poisoned the girl. She later confessed to the crime and was sent to the Alabama electric chair. The parents then sued the insurance companies for wrongful death and successfully argued that the insurance company provided the motive for murder. The jury and the Alabama Supreme Court agreed, and the parents were awarded a substantial verdict against the insurance companies. Given this risk, insurance companies will be adamant in making sure that a person agrees before someone buys insurance on his or her life.

Life insurance quotes

Financial expert Clark Howard gives advice on an easy way to get life insurance quotes: Simply pick up any money magazine, and you will see page after page of ads for companies selling life insurance. An easier way is to do it online and seek quotes from companies. Howard gives a list of links to insurance company websites.

Getting life insurance quotes online is relatively painless since most insurance companies provide this service. In fact, many websites, including nerdwallet.com, allow you to submit requests for quotes to multiple insurance companies at the same time.

Clark Howard also offers the reminder that when you’re looking for life insurance, you’ll generally have two options: There will be policies that require no medical exam, and “simplified issue” policies that require you to answer some health questions but do not require a physical exam.

Generally, Howard advises picking an insurance company that does not require a medical exam only if you have health issues. On the other hand, if you know that a physician will give you a clean bill of health, you’ll often save money by opting for a policy that requires a physical exam.

Either way, it’s important to be honest with the insurance company and the doctor when it comes to any health issues. That’s’ because misrepresentations in the application or at the physical could invalidate the policy.

Life insurance tips and advice

Life Insurance Tips and Advice

The website Bankrate.com has a number of tips for those buying life insurance. They first reiterate the advice that you’re probably best off avoiding policies that don’t require a medical exam. They point out that benefits are generally limited for two years, and you’re essentially paying premiums on the assumption that you’re in poor health even if you’re not.

They also remind you to carefully watch out for paying commissions to insurance agents, which are not always fully disclosed.

Clark Howard notes that you might want to clean up your credit rating before seeking an insurance quote. Many insurance companies use credit factors for setting premiums. At a very minimum, it’s a good idea to look for errors in your credit report since they might inadvertently lead to higher premiums.

Howard also points out that some professions will result in higher premiums. So if you’re a logger, aircraft pilot, miner, farmer, or truck driver or work in some other dangerous profession, your job might mean that the insurance company considers you a higher risk.

How much life insurance do I need?

According to Dave Ramsey, the biggest mistake you can make when buying life insurance is getting too little coverage to replace income. He points out that many people have policies through work that give them one year’s worth of income. But he calls this too little, since your spouse and children will depend on your income for much more than a year. He says to buy ten to twelve times your annual income, and he again stresses the importance of getting adequate coverage for a stay-at-home parent.

Clark Howard simplifies the equation with this simple rule: Have insurance equal to ten times your annual income. Forbes magazine, on the other hand, takes a more nuanced look and encourages you to evaluate your monthly expenses and come up with a figure for a necessary yearly replacement income that way.

Whichever approach you take, you want to keep in mind that whatever financial losses your family would suffer as a result of your death will probably continue for a considerable time after your death.

Who has the best life insurance policy?

Best Life Insurance Companies

Clark Howard advises that you should stick with insurers that are rated A++ by A.M. Best. This means that the companies are financially strong and are likely to be able to pay a claim. Saving a few pennies on the premium does you no good if the company goes out of business when your family needs to make a claim!

The website Policygenius.com has a long list of companies identified as “the best life insurance companies,” but only five of them have the A++ rating considered the benchmark by Howard. Those companies are Guardian Life, MassMutual, New York Life, Northwestern Mutual, and State Farm.

Similarly, the website goodfinancialcents.com has its own list of the “top ten” companies, but only two of these, Haven Life and New York Life, meet Howard’s criterion of a A++ financial rating.

The moral is that you need to look closely at the company you plan to do business with and evaluate it from a customer service perspective and in addition make sure it’s financially sound.

Worst life insurance companies

Perhaps more important the seeking out the best insurance company is avoiding the worst.

The website Life-Insurance-Law.com identifies what it calls the ten worst life insurance companies. Unfortunately, comparing the lists of best and worst might add to the confusion. Even though State Farm is on the list of companies with the A++ rating, it’s also on the list of ten worst based on its denial of flood claims after Hurricane Katrina.

How much is life insurance for a 55-year-old man?

It’s one thing to think about life insurance premiums in the abstract, but at some point, you need to sit down and consider how much the premium would be in your particular case. We’ll compare rates in this hypothetical case.

A 55-year-old nonsmoker living in Chicago looking for $500,000 of coverage would pay between $119 and $157 per month based on quotes from twelve insurance companies on the NerdWallet.com website. Many of the twelve companies listed are companies you’ve probably never heard of. None of the quotes, however, is from a company rated A++ by A.M. Best, although many of them had an A+ rating.

This example stresses the importance of shopping around. While a comparison website might net you a low price, you still need to do your homework, which might involve seeking out companies that you know are financially sound.

By: Miles Mason, Sr. JD, CPA

This article seeks to present general and basic financial concepts and research from various internet resources. It does not seek to present specific legal advice or legal definitions and does not represent any personal opinions of the author.

Why write this?  Divorcing clients often ask this question.  Also, this was written for personal research.

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