There’s a difference between a broker and an agent. An agent represents the insurance company, and his job is to sell policies. The broker, on the other hand, represents the client, and shops the insurance market to find the product most suited to the client’s specific needs and goals. From the broker’s point of view, there is no good or bad policy – just unsuitable policies. Here’s an example: I’ve just finished painting a bedroom, and it’s time to put the switch plates back on the wall. I ask you to hand me a screwdriver. You pass me a Philip’s Head driver, and I need to send home a slotted screw. Does this make the tool you handed me a bad tool? Of course not – just the wrong tool for the job. This is why whole life insurance can be like a Philip’s head screwdriver – because too often agents sell it as the be-all and end-all solution to every financial need. As the saying goes, if all you have to sell is hammers, all the world’s problems look like nails.
I really don’t mean to malign insurance agents, the vast majority of whom are principled and focused on their client’s best interests. Insurance is a product that needs to be sold to people – we don’t wake up thinking, Let’s head over to Bloomingdale’s to see if they have any life insurance on sale. If it weren’t for the purposeful efforts of good agents, whose work enriches generations to come, most of us, quite frankly, wouldn’t have much coverage at all.
So what are some of the uses of life insurance? First and foremost, a death benefit to one’s survivors. Also common applications:
- To secure a loan. If mom and dad co-signed your student loans, they should have a cheap term policy on your life. If something happened to you, they’d be stuck with your bill otherwise.
- For tax-free income. Many cash value policies can be structured to be over-funded in earlier years, and pay out a tax-free stream of income in later years. This is a very powerful use of insurance. The only other place to go for tax-free income in retirement is a Roth IRA.
- For living benefits. Many policies today offer a measure of long-term care benefits. The death benefit can be advanced, on a discounted basis, to the policy owner, should the insured need substantial help and assistance to perform the six Activities of Daily Living.
- As an asset protection vehicle (along with annuities). Florida courts have long held cash values in insurance company products as being judgment-proof in civil litigation. Why do you think O.J. Simpson moved to Miami? Aside from being a fabulous city, there is the potential asset protection benefit. Now, if you anticipate being sued in the near future you can’t just go and stick everything into a life or annuity policy and expect to become judgment proof. Doesn’t work like that. But . . . if you are a physician who doesn’t carry malpractice insurance, this can be a viable strategy as long as it is pursued over time. Seek legal advice on this one.
- Mandated in a divorce settlement. Many will stipulate that one spouse maintain a policy payable to the other spouse. If the other spouse owns the policy on you, and this is a condition of the divorce, then the premium becomes deductible by the payor spouse and recognized as income by the payee spouse on the front of the form 1040.
- To fund estate taxes. You have a substantial estate in excess of $10 million. You’ve worked with your team of advisers: financial planner, accountant, and attorney. It has been determined that you’ll owe $2.0 million in estate taxes at the second death – yours or your spouse’s. You purchase a second-to-die policy in that amount, rather than leave your heirs to liquidate assets to pay the taxes.
- For legacy charitable giving. You want to benefit your alma mater, church, or synagogue. You have the charitable entity purchase and own a policy on your life. You make tax-deductible donations to the entity, which in turn makes the premium payments with your donations. This is a great way to gin up a lot of charitable giving with relatively small cash outlay.
How much insurance should you buy? Begin by answering this question: If you dropped dead tomorrow, what resources will be available to your family to continue without you? That would include your retirement account at work and IRAs, current life insurance, and current investments. Look at the liabilities that would need to be paid off – credit cards, for example, or perhaps your mortgage. Work with a good financial planner to then crunch the numbers to see how much you need to purchase.
Most people would, I think, agree with me that one’s financial responsibility to one’s family – the surviving spouse and the children one brought into being – does not end at death, but carries forward for perhaps years to come. On that score I think I’ve heard everything. One client told me that he wanted sufficient insurance to fund his children’s higher education and his wife’s income so that she’d never have to work, and could remain in their home to raise their family. Another man told me that his wife was a beautiful woman who’d certainly remarry in a few years, so he only wanted to leave enough to get her through the transition. Seriously. I heard this.
Is life insurance difficult to obtain? There’s a process, of course. It begins with you completing an application, which will go into your health history. Then a medical examiner will come to your home to ask more questions, draw blood, and get you to pee into a cup. For larger amounts there’s an EKG. The insurance company will check your DMV records, and then complete the underwriting process with an approval, denial, or rating.
Can you get it? For most people, sure. But if you’ve recovered from cancer or a heart attack within the last several years, probably not. Insurance companies price life policies based on standard rates. There are preferred rates and super-preferred for some of us, and table ratings for those who don’t qualify for standard rates. It is only after the insurance company has completed its underwriting process that you’ll get a formal offer of insurance and know what you’ll need to pay. Sometimes there are surprises, both good and bad. One man whom I’d proposed for insurance got a flat decline. It turned out that his PSA levels were high, and as a result of the insurance exam he addressed his medical issues before cancer set in. He didn’t get insurance, but the result of the process was certainly good. On the other hand I’ve proposed people as standard who ended up qualifying for a preferred rate – and lower premium.
The big debate about life insurance is term vs. cash-value. The people in the term insurance camp think that cash-value insurance is a bad deal, investment-wise. They have a point. The biggest bang for the insurance buck is in term insurance. The cash-value people talk about the guarantees of the policy, and the pot of cash that you’re building up. They have a point too. If you look at insurance cash values as part of your overall investment allocation, then perhaps these values can be seen as the conservative part of your allocation, meaning you can be more aggressive with everything else. There’s no right or wrong here – my focus as a planner is that the client has the proper amount of insurance. The composition of the insurance – term, permanent, or some combination thereof – is the secondary consideration.
In Part III I’ll go into other considerations in choosing a policy.