Life insurance is a contract between an insurance policy holder and an insurer, where the insurer promises to pay a designated beneficiary a sum of money (the “benefits”) upon the death of the insured person. The premise behind life insurance is straightforward, in theory. It’s also gloomy, at least compared to other financial services. Depending on the contract, other events such as terminal illness or critical illness may also trigger payment. You pay little amounts at regular intervals or a lumpsum, and should you expire, a beneficiary of your choice gets a sum of money approximating what you would have earned had you stayed alive.
That’s the harsh truth right there, which a lot of life insurance customers fail to understand. The service is supposed to be nothing more than a substitute plan. The thought is that should your family suffer a crisis, at least their finances won’t be impacted too negatively. The advantage for the policy owner is “peace of mind”, in knowing that the death of the insured person will not result in financial hardship for loved ones. If you die, your spouse and kids won’t have to take on multiple jobs, beg for alms nor lose the house and car.
Hedging your financial responsibilities and future income
It’s important to remember that life insurance isn’t really “insurance” in the dictionary sense. When you buy life insurance, you’re not “insuring” anything. No matter how much money you give them, insurance companies can’t shield you from dying. Life insurance is more about hedging your financial responsibilities and future income than anything else. While you’d prefer to live, if destiny has an alternate plan then you can spend money now to help your family avoid multiple catastrophes later.
But as a result of it being called insurance, there are excessively conventional type of people who believe that if “coverage” of some kind is good, then more coverage must be better. Buying life insurance thus becomes a test of one’s capacity as a responsible adult and breadwinner. What kind of person doesn’t want to protect their loved ones? To that end, some people insure anything that moves – even their children.
Sounds great in principle, until you remember that kids don’t earn any money or at least not any money that’d be not easy to replace which reinforces the morbidity of life insurance. Losing a child is such a massive tragedy that if there’s any eventuality that needs to be ready for, it’s that. Some parents dispute that they couldn’t function after the death of a child, and thus a policy on said child helps them sleep at night. But if you claim you’re not going to be able to function anyway, why not keep the money you’d have otherwise spent on life insurance for someone who hardly earns any income?
The same goes for older relatives. Both the healthy and infirm have a decreasing amount of time remaining and the less healthy an older relative is, the smaller the death benefit you’ll receive for a policy of a similar premium size. Add retirees’ limited income (regardless of how substantial their net worth may be), and much of the time, senior insurance seems like an unwise move.
How much you’ll benefit
Stay alive, and a standard term life insurance plan has zero return. Start a 20-year term policy today, and if you don’t die by 2032, you’ll have received nothing. That’s not a bug of life insurance design, but a feature. After all, throughout the policy’s term you’re getting whatever peace of mind comes with knowing that your death won’t impoverish your family. Most policyholders understand this, and appreciate that life insurance isn’t intended to be an “investment” in the conventional sense.
Term assurance provides life insurance coverage for a specified term. The policy does not accumulate cash value. Term is generally considered “pure” insurance, where the premium buys protection in the event of death and nothing else.
There are three key factors to be considered in term insurance:
- Face amount (protection or death benefit),
- Premium to be paid (cost to the insured), and
- Length of coverage (term).
Other insurance customers are uncomfortable at the idea of sending a long series of fixed payments to a insurance company with the certainty that they’ll never see any potential for profit. Rather than accept life insurance for what it is, these customers want some sort of return. And for this purpose insurance companies came up with myriad of products with heavy frontloaded costs to compensate the intermediaries.
Purchasing policies more complex than term insurance policy could make economic sense if the cash value increases quickly enough. But investing and insuring are two different and usually incongruent goals. Surely there are more direct and better ways to invest, beyond enhancing one’s life insurance policy.
A combination protection plan/investment plan is like a wayward combination say a hat/hammer, assuming such a thing exists. The hybrid probably isn’t going to perform either task as well as the dissimilar products it aims to replace.
Finally
If you’ve got just enough income, a risky enough chances of staying alive (which a prudent insurer will take note of and charge a correspondingly higher premium for), and enough dependents with little earning power among them, a term policy is a good way to spend your money on. Just remember that investing is deferring spending in hopes of a financial gain. Insuring is spending now in hopes of avoiding financial loss. In that respect, the two activities are almost opposites. An insurance policy that faces off as an investment is rarely going to be your best option for accomplishing the conflicting goals of maximizing return while minimizing risk.