Life insurance seems easy to understand; however, it can be more complex than it appears at first glance, which is why the best path to choosing the right plan for you starts with being a well-educated consumer.
Consider Your Own Needs Before Looking at Life Insurance Options
The best place to start is not with a discussion of life insurance options but, instead, with a close look at your own needs. It’s about considering where you are now, where you want to go and where you want your loved ones to be in case the worst comes to pass. The life insurance industry often starts with selling a particular policy and fitting that policy into your needs rather than the other way around.
What Type of Risks Need to Be Covered
As with any type of insurance, the first question you should ask is if you have a risk that needs to be covered. If you have someone who is financially dependent upon you and you do not have other sufficient assets, then you need life insurance. Examples include:
Income replacement for a spouse
Financial support for dependents
Payment of outstanding debts/final expenses
Liquidity for estate taxes
Business needs such as key person insurance (when you are integral to the business) or funding a buy-sell agreement.
If you do not have someone who is financially dependent upon you, you don't have a need for life insurance.
Buying Life Insurance Before You Need It
You may be prompted to buy life insurance before you have a need, to either guard against possible future uninsurability (not being able to medically qualify) or to use life insurance as a savings vehicle.
Consider this, would you buy auto insurance on a car you might buy someday? There is no certainty you will buy that car, just a possibility you might. In fact, an auto insurance company will only sell you a policy if you own the car. Buying life insurance because you may need it in the future really doesn't make sense. Your need may never materialize. (For related reading, see: When Life Insurance Isn't Worth It.)
How to Choose the Right Policy for You
If you do have a need for life insurance, you should buy it as soon as possible since the premiums to purchase a policy do increase with age. Here are some factors to keep in mind:
Consider coverage that matches your need. For example, if you are protecting a 30-year mortgage, you most likely need coverage for 30 years.
Calculate your coverage need. There are many different ways to calculate how much life insurance you should have. Most include using a simple rule of thumb such as a multiple income while others use a complex needs analysis. The main issue with these methods is your needs are constantly changing, and how these needs are met will depend upon your circumstances at a specific time. Instead, have enough life insurance coverage to provide a sufficient income stream to replace the income your beneficiary relies on. For example, if your beneficiary would need $50,000 a year and you are comfortable they could earn a 5% return rate, you should consider a policy with a $1 million death benefit. One million dollars invested and earning 5% per year would yield an income stream of $50,000 a year (before taxes).
Choose the type of life insurance. Term life insurance provides coverage usually with a guaranteed level premium for a specific period of time. After that time, the coverage will terminate. Cash value (permanent life) insurance comes in many forms, including whole life, universal life, variable life and indexed life. Permanent life insurance policies can accumulate a cash value and are designed to continue to age 100 or longer. However, most people’s need for life insurance is temporary because their kids become financially self-sufficient and the need to provide coverage for a significant other will decline as your other assets grow. If you do have a need for permanent life insurance coverage, consider guaranteed universal life insurance, which works similarly to term life insurance; it provides a guaranteed death benefit up to age 120 with a guaranteed level premium and does not build a cash value. Remember, you are buying life insurance to protect a risk and as such, you should minimize your premium. (For related reading, see: Guaranteed vs. Non-Guaranteed Permanent Life Insurance Policies.)
Compare several insurance companies. You should always check multiple companies before deciding on a policy, so work with an agent or entity that represents multiple companies, especially if you have a health issue. Each company has their own rating criteria so where one company may offer you their best available rate, another company would offer you their third-best tier. Keep in mind it's important to disclose all information so you can get an accurate quote based upon your specific situation.
Check the company's ratings. Review the financial strength of the company with the four major rating services: A.M. Best, Fitch, Moody's and Standard & Poor’s. A rating is a way for these agencies to express their independent judgments of a life insurance company’s financial soundness and creditworthiness. Each agency’s rating system varies in its stringency and its methodology, but all four consider a company’s financial leverage, management stability, recent performance, overall financial health and such external factors as competition, diversification and market presence. The financial strength of a life insurance company is highly important because a life insurance policy is a long-term commitment.
Research the agent. In terms of finding the right insurance agent, check their qualifications and see if they have a professional designation and/or experience. LinkedIn and Google Search are good places to start. You can also check with the appropriate state insurance department. Judging if an agent is working in your best interest is part determining if they are a professional and part trusting your instincts. Learning about life insurance before purchasing a policy will allow you to ask informed questions.
Educating Yourself Will Lead to Life Insurance Success
Life insurance is an important component of a sound financial plan. Becoming educated and taking the time to understand what you are buying will help ensure you get the best coverage to meet your needs at the most affordable premium.
(For more from this author, see: A Real Solution for the Health Insurance Market.)