What Type of Life Insurance Policy Should You Buy

What Type of Life Insurance Policy Should You Buy?

What Type of Life Insurance Policy Should You Buy?
By Ronald J. Pawlikowski, CLU

Okay.  You realize you need life insurance, and you’ve determined an appropriate amount (see “How Much Life Insurance Is Enough?”).  What type of policy should you buy?

There are two basic types of life insurance policies – let’s refer to them as term and cash value.  Term policies provide protection for a specified term, and cash value policies provide some form of living benefits (e.g., the ability to borrow) in addition to the protection component.

To understand the difference between these two generic types of life insurance, it is imperative to understand why there are two types.  After all, there’s no cash value health insurance, homeowners insurance, car insurance or professional liability insurance.  Why?  Why does life insurance offer this feature that isn’t available elsewhere?

All of the other forms of insurance insure a potential event – you might have to go to the hospital, your home may be vandalized, or you may be in a car accident.  Life insurance insures a known event.  Jim Morrison notwithstanding, nobody gets out of here alive.  Additionally, death becomes more likely with each passing year, and, unlike all the other forms of insurance, there is one claim and only one claim on life policies.

Actuaries used these differences to create whole life insurance, the original cash value policy that featured level premiums for life, along with guaranteed cash values.  The policies are designed so that the guaranteed cash value, which increases each year, equals the face amount at age 100.

The premium for term insurance originally increased each year (as do the odds of dying), but recently companies have introduced term policies that feature level premiums for 10, 15, 20 and even 30 years.  Although most policies allow for continued coverage after the initial term period, the premiums increase dramatically.

Many variations of whole life have been developed over the last 30 years or so.  Universal life, introduced in the 1970s, allows the policyholder to vary the premium (within limits), while variable life allows the policyholder to choose how the cash value is invested (again, within limits). Guaranteed universal life, introduced within the last five years, guarantees the death benefit to a specified age.

So, which one of these policies is right for you?  That depends on your objectives.  Term insurance is appropriate to insure a risk that has a definable term.  Cash value insurance is appropriate for those risks that have no definable term.

You have undoubtedly heard the phrase “buy term and invest the difference”, which suggests that one would come out ahead by procuring a term policy and investing the difference between the term premium and the premium on a whole life policy.  It is highly unlikely that this would ever be the case, for several reasons.

First, insurance companies invest most of their portfolio in very conservative vehicles such as bonds and mortgages.  Were you to invest the difference in T-bills or T-bonds, you would not come out ahead.  Were you to invest the difference in equities, you might come out ahead if 1) your investment did reasonably well over time and 2) you were disciplined to do this over a long period of time (over 20 years).  Don’t forget, your investment must ultimately exceed, after taxes, the face amount of the life insurance.

So, let’s get back to the original question, “What type of life insurance policy should you buy?”  Young newlyweds will usually buy at least some term insurance, just because of the significant amount required.  If you’re under 50, whole life from a reputable mutual insurance company (i.e., one that pays dividends) is still the best buy for your permanent needs.  If you’re over 60, some type of universal life will probably be most cost efficient.  In between the ages of 50 and 60, it is very difficult to generalize, and such issues as your health and your family’s health history will need to be considered before reaching a decision.