How to Buy Life Insurance
When shopping for life insurance, many people compare premiums, but other factors should also be considered, such as the financial strength of the company, which can be compared by their grade from the rating services, such as A.M. Best. An important consideration for term insurance is guaranteed renewability, which is a guarantee that your term insurance will be renewed without providing more proof of insurability. The premium will increase as you age, but you will not need a medical examination to renew your policy.
However, when shopping for a new cash-value policy, such as whole life, universal life, variable life, or variable-universal life, premiums do not convey an accurate picture. Other things to consider are dividends, cash values, and the time value of money. When shopping for a cash-value policy, it might be prudent to compare its value to buying term insurance and investing the rest of the premium that would otherwise go to increasing the cash value of the account or for dividends. Because insurance companies have high expenses compared to other investments, such as mutual funds, stocks, or bonds, you may well do better by buying term insurance and investing the rest of the money yourself.
The cost of life insurance can be reduced by avoiding paying fractional premiums, paying the annual premium in semi-annual, quarterly, or monthly installments. Most insurance companies charge more for more frequent premium payments, and some charge a lot more.
The Cost of Life Insurance
The cost of life insurance is determined by several methods. The main disadvantages of these methods are the need to project what dividends, interest rates, and cash values will be in the future. Assumptions about these values can result in small variations in the net cost index from different companies with similar policies.
The traditional net cost method simply subtracts the total premiums paid over a given time period from the projected dividends paid plus the cash surrender value of the policy at the end of the time period. This net is divided by the number of years in the period to arrive at the annual cost. There is no accounting for the time value of money. This method often yields a negative price for the insurance, but, of course, it can't really be negative, since that would mean that the insurance company is paying you so that they can pay big money to your beneficiaries if you die while the insurance is in force! You can take it for granted that insurance companies are not that generous.
The interest-adjusted cost method does account for the time value of money by adjusting the factors by an interest rate.
The surrender cost index assumes that the policy will be surrendered for its cash value at the end of a specific time period, whereas the net payment cost index assumes that the policy will not be surrendered, but that the insured will die at the end of the time period. You can get net cost indexes from either your insurance agent or from the insurance company.
Shopping for Life Insurance
When shopping for life insurance, 1st decide what type of policy best serves your needs, then compare plans from at least several companies because prices vary widely even for similar life insurance policies. Compare similar plans from different insurers, but ignore small variations in cost index numbers, because there may be slight variations in features, and, as noted above, small variations will result from different projections about future dividends, interest rates, and investment results.
Another important method for finding the best value is to ask for premium rates for policies with different face values, because insurers may have discounts for higher value policies. For instance, if you were thinking about getting $200,000 worth of coverage, you may benefit by getting quotes for $200,000, $250,000, and $300,000 to see the differences in premiums. Because of discounts for higher face value policies, premiums may be only slightly higher or may even be less.
Most states have adopted the Life Insurance Policy Illustration Model Regulation by the National Association of Insurance Commissioners (NAIC), an organization that often helps states write insurance laws. The Life Insurance Illustrations Model Regulation provides illustration formats, standards, and requirements, and a narrative summary to inform the consumer about life insurance and to prevent deceptions by agents selling life insurance. This regulation applies to all group and individual life insurance policies except variable life insurance, annuity contracts, credit life insurance, and policies with death benefits of less than $10,000. This regulation also specifies the information that should be contained in the insurer's annual report to the insured, which includes the current death benefit; the net cash surrender value of the policy at the end of the reporting period, and all credits and debits to the account, such as interest, mortality charge, expenses, and riders.
How much your premium will be for any given line of insurance depends not only on the information that you supply in your insurance application, but also on information held in various databases that insurance companies draw upon when underwriting your application. Underwriting for personal lines of insurance relies heavily on insurance scores and/or credit scores and underwriting for health and life insurance draws information from the Medical Information Bureau (MIB) database. Therefore, request a free report from MIB at MIB.com - Request Your MIB Consumer File to ensure there are no mistakes in the report before applying for health or life insurance. Since insurance scores and credit scores are derived from information in your credit file, periodically review the files held by the 3 major credit reporting agencies. Get your free credit reports from each credit reporting agency at AnnualCreditReport.com.
Rate of Return
Various methods have been devised to determine the rate of return on the savings component of cash value life insurance policies. These methods generally separate the insurance component from the savings component to determine the rate of return on the savings component. The savings component is, of course, the cash value of the policy.
One such method is the Linton Yield, equal to the average annual rate of return of a policy held for a specified number of years.
Another method is the yearly rate of return that determines the rate of return using the cash value at the start and end of the year, the premium paid, the death benefit, and the assumed price per $1,000 of protection for 1 year.
|R =||(CV + Div) + AMC × (Death Benefit - CV) × .001 |
Premium + CVS
|R = Rate of Return, expressed as a decimal, |
on cash component of life insurance.
CV = Cash Value at end of term.
CVS = Cash Value at start of term.
Div = Dividend
AMC = Annual Mortality Charge for $1,000 benefit.
This method is more useful since most of the information can be collected from the insurance companies. The cost of yearly protection, along with the rest of the information, can be found in the annual reports sent by insurers to policyholders, or, to ensure that the mortality charge is competitive, by getting the cost of term insurance for your age group for 1 year, since if you didn't have a cash-value policy, then you would probably have term insurance.
Life Insurance Company Ratings
One major consideration in selecting a life insurance company is its performance and solvency. Performance is the company's ability to manage expenses, mortality, which consists of claims and underwriting, and investments. Solvency is the ability of the insurance company to pay claims. All states have state guaranty funds that pay the claims of insolvent insurers, but the payment amount is limited, and it may not be easy to borrow or receive cash value from the policy, so it is important to consider the likelihood that the company will be around when you or your beneficiary will need it. There are 5 major rating agencies that rate insurance companies based on their financial integrity: A. M. Best, which is the only rating agency that rates insurance companies exclusively, Fitch, Moody's, S&P, and Weiss. Although the different rating agencies use different letter rating categories, they generally range from a high of AAA or some variation thereof, to a low of C, D, F, or R. More info: Insurance Company Credit Ratings
Once you narrow your selection to a few insurance companies, get several ratings on each company, since the rating agencies use different methods, with varying degrees of success in accurately assessing the financial state of the insurance company.
Life Insurance Agents
There are some life insurance companies that sell no-load insurance policies either by telephone or the Internet, without using an agent, especially for term life insurance, which is the simplest type of policy. However, most insurers use an agent, which adds considerably to the initial expenses of life insurance. Almost anyone can sell life insurance, and many have inadequate training. Furthermore, they may try to sell you a policy that earns big commissions for them, but may be inappropriate for you. It is best to use an agent who is a Chartered Life Underwriter (CLU), Chartered Financial Consultant (ChFC), or a Certified Financial Planner (CFP). These agents will have at least a minimum of education, and are bound by a code of ethics to give your needs top consideration.
Should You Replace Your Cash-Value Life Insurance Policy?
If you want to replace term insurance, you only have to consider the cost, front-end expenses, and whether you are still insurable. These factors applied to a cash-value policy as well, but there are other considerations.
Are you insurable? If your health has deteriorated, it may cost a lot more to buy a new policy, or you may not even be able to get a new policy.
Consider the amount of money lost by switching policies. Most cash-value policies do not accumulate any cash value in the 1st 3 or 4 years because acquisition costs and sales commissions must be paid, and the same will be true for a new policy.
The 2-year period for the incontestability clause and suicide clause will begin anew (Common Life Insurance Provisions). All facts entered into a new application for life insurance will be contestable by the company for 2 years; if you die within that 2 years, the insurance company can deny coverage if there was a material misrepresentation in the application; suicide will also not be covered during that time.
Remember that salespeople make more money selling new policies, so be wary of any sales pitch, since sales pitches are slanted to get you to buy and may not be in your best interest.