Do I Need Life Insurance?

No one likes to think about dying, let alone think about life continuing without them. For this reason, many people leave it too late to consider whether life insurance would be a good idea.

In reality, there are very few individuals who would not benefit from some form of life insurance as it can be used for a number of purposes. For those who are the main income earner in the family, it can be an integral part of financial planning for the household to ensure there will be no shortage of money for dependants if the worst should happen. But as well as offering ongoing financial security for the family to be able to continue paying for everyday costs without hardship, life insurance can also be a way of offsetting a tax burden.

Despite the arguable need for almost every American adult to consider some form of life insurance, research has shown that coverage is at a 50-year low, with only 44 percent of U.S. households having individual life insurance.¹ The same study showed that even though many had no insurance, four out of ten said that household expenses would immediately become unmanageable if the main breadwinner were to die, while a further three in ten said they could only survive for a few months.

However, one of the primary reasons that individuals don’t take out life insurance is due to the cost, with around four in ten Americans citing other financial goals as a greater priority. This has become a particular issue given the current economic climate. But it is possible to obtain insurance relatively cheaply and there are many different types of insurance to consider, depending on the aim and how much coverage is required.

There are primarily two types of life insurance—term (also known as temporary) and permanent.

Term insurance is by far the cheapest type of life insurance and offers coverage for the number of years selected. Once this period expires, the insurance ceases and there is no cash value to be paid out. Some people consider this a waste of money but this can be viewed in the same way as insuring a house or a car. But while term insurance offers a way into the market for the lowest premium, it is not suitable for everyone and can work out more expensive in the long run. This is because life insurance is a long-term contract and the insured has no obligation to inform the insurer of any changes in their health while the policy remains in force. Once a policy expires and the insured wishes to renew it, if there have been any health problems the individual must tell the insurer and may face higher costs, or even refusal from some carriers. As term policies eventually expire, this can pose difficulties in trying to renew coverage.

Term insurance is particularly suitable for those who wish to (or are required to) cover a certain debt obligation. They can then be safe in the knowledge that if something happens to them, their dependants will not have to try to meet the repayments. Taking out 10-year term life insurance to cover a home loan, for example, is a common practice. However, it is less suitable for those who wish to use their insurance for estate planning or funeral costs. This is because it can be problematic to ensure continuous coverage from one policy to the next for the reasons described above. For these individuals, as well as those who just want to ensure their family is well protected, permanent insurance may be more appropriate.

Permanent life insurance is usually more expensive than term insurance, but is designed to last the individual’s entire lifetime with no cessation in coverage. The carrier usually designs the policy so that payment of premiums ceases at a certain age, while the insurance continues thereafter. This is effectively paid for via a policy’s cash value, which accumulates over the years of premium payments. It is possible to withdraw some of this cash value but that is usually not recommended as it can mean either an increase in or extension to the premiums.

Having decided to take out life insurance, the final step is to decide how much is needed. To do this, a number of factors need to be considered depending on what the coverage is intended for. Insurance to pay for funeral costs and ongoing living expenses for the family is known as personal protection and as a rough rule, between five and ten times the breadwinner’s income, plus any outstanding mortgage, is usually recommended. Those with more liabilities and young dependents should consider coverage at the upper end of the range whereas those with few debts and a grown-up family may not need so much. It is possible to calculate more precisely how much coverage is needed depending on individual circumstances, and there are various online calculators that help to do this. Alternatively, a broker will also go through the same process for those who prefer to get professional advice.

Individuals who already have personal protection in place and want further coverage for tax planning reasons will need to match the amount of insurance they have to their liabilities, although most insurers will allow a degree of inflation to take into account future likely growth.

What many people do not realize is that it is not possible to simply take out the amount of insurance you want, as the provider may refuse to agree to it. Insurers will sometimes want an explanation of why the amount of coverage sought is needed, and may ask for further information to validate the amount requested.

The life insurance industry has been in existence in the USA since 1760 and the centuries that have passed since then have allowed many different forms of coverage to be created. Individuals can now opt for policies that require no medical evidence or offer a guaranteed payout. Both of these types of insurance can work out to be more expensive in the long-run, sometimes paying out less than has been paid in, but for those with severe health problems and who are unable to procure coverage elsewhere, the peace of mind can sometimes be worth the cost. For others, taking the time to get either a more conventional term or permanent life insurance policy is the recommended route.

1. LIMRA International, Inc, Trends in Life Insurance Ownership, 2010.