What kind of life insurance should you buy?

Certified financial planner Cass Chappell of Chappell, Mayfield and Associates discusses life insurance in today’s guest blog. Do you have a question for a financial planner? Comment below or email rcash@ajc.com to have your question addressed in Wednesday’s Atlanta Bargain Hunter blog.

Q. Other than the occasional ad for term insurance, I haven’t heard much about life insurance lately.  What is the current thinking on life insurance?

A. The answer probably depends on who you talk to, but a lot has changed in the last 10 years.  In the 80s and into the early 90s there was a popular theory about life insurance:  “Buy term and invest the difference”.

Essentially, you would buy a low-cost, 20-year term policy and invest the difference in premium (between the term policy and that of a whole-life policy) in an investment account each month.  The idea was that at the end of the 20-year period, you would have accumulated a large sum of money in the investment account and there would no longer be a need for life insurance.

Back then, most permanent life insurance was of the whole-life variety and premiums would be due until age 100.  The policies usually built substantial cash value and may have even paid dividends.  Because of this, the difference in premium between a 20 year term policy and a whole life policy could be quite large.  In some cases, several hundred bucks a month!

There were many problems with this strategy, however:

• The assumption for the rate of return in the investment account was often 10% or even 12%.
• There was an assumption that the life insurance needs in year 1 were the same as those in year 20. In year 21, this need magically “went away.”
• If all payments were not made to the investment account, or if any of the money was used before the end of 20 years, the entire plan would fall apart.
• Once the term policy expired, if new coverage was needed the insured’s health status would be unknown and more expensive (since he or she would be 20 years older and may not be insurable anymore).

In the late 90s, when the stock market seemed to be going straight up, many insurance companies began to offer new types of life insurance.  These new types of insurance allowed policyholders to basically invest their cash value in separate accounts.  The slow and steady (and often GUARANTEED) increase in cash value of whole-life policies seemed so boring.

But, since the policyholder was willing to take some risk, premiums for new policies were generally lower than those for whole-life policies.  This was a blow to the “buy term and invest the difference” camp.  The difference was no longer as substantial.

After the internet bubble burst, risk-taking went out of style and guarantees were back in vogue.  Universal life insurance was about to get its moment in the sun.

Universal life insurance (UL) was similar to other types of life insurance, with one large difference.  The growth in cash value was driven by crediting rates established by the insurance company.  While these rates could (and did) fluctuate, they were guaranteed to never be below a certain amount (3% was common).

Because of its more predictable nature, UL was even less expensive in many cases.  This was true especially if the policy holder chose to fund these policies at a minimal level.

One of the best features of UL is the ability to design a policy to last a specific amount of time.  If you wanted your policy to last until age 90 for example, the company could calculate what you would have to pay into the policy so your cash value would be just enough to last until that date.  The policy-holder still had some risk.  If the insurance company credited less than the assumed rate, or if they had to increase their internal charges, the policy would end sooner than desired.  This risk was real.

Whole-life insurance had become virtually extinct.

AND…..”Buy term and invest the difference” was officially dead.

But it wasn’t perfect……..yet.

The policy-holder still had some risk.  Interest rates (and thus, crediting rates) were really, really low during the mid 2000s.  Some policies that had been designed with “rosier” assumptions began to lapse.

The insurance industry came up with a good idea:

In response to this, “no lapse, premium guarantee” (NLPG) became a popular feature of UL.  Basically, the policy-holder would forgo much, if not all, of the cash value in their policy in return for a guarantee that their policy would stay in-force for the desired number of years.  The only risk to the policy-holder was that the company would be in business when it was time to pay the claim.

Term insurance is a valuable tool: A bunch of  temporary insurance for the smallest outlay possible.  But if there is a need for insurance longer than a term policy will allow, a NLPG policy could be the right solution.  The premium is more than a term policy, but the ability to keep the policy in-force for any period of time desired may be worth the added expense.  At the very least, it is much different than it was a generation ago.

Do have a question regarding life insurance? Comment below and Chappell will respond.

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