Late last evening I received terrible news about the medical prognosis of a friend.
I don't talk about life insurance with my friends, but I know a lot about life insurance. Life insurance is not something you really discuss with your friends, even if you are in the habit of discussing the markets or specific investments with them from time to time. You won't read about it on most stock-oriented websites or hear about it on CNBC. But it is an absolutely critical part of your overall family financial perimeter and one we spend plenty of time examining when performing capital management. Just like other parts of the financial picture, there are many different approaches and plenty of strong opinions about which way is best, although people typically pay less attention to the insurance debate and are generally much less well-informed about it than about other areas of capital management.
Most people don't even know the difference between the various forms of permanent insurance (universal life, variable universal life, whole life, and so on) and typically rely entirely on term insurance, which carries much lower premiums and which is also the type of insurance usually provided through their employer.
Insurance needs vary widely from individual to individual and family to family, of course. Term insurance is an important component in your insurance picture and many people should carry some of it during their working years because it provides the largest benefit to the size of the premium. "Buy term and invest the difference" is a common mantra among those who provide investment advice, because they see the accounts where "the difference" is invested as the "main engine." In the statistically improbable event of untimely death during the term of the temporary insurance, the death benefit springs up to replace the main engine that did not get built.
But that is where most people's analysis of insurance ends, and they fail to go any further and see that these strong points of term insurance lead to its weak points and to the reason it should not be the only form of insurance for most families. First, most people will never collect their death benefit, because they are going to live through the term (this makes it by far the most profitable product that insurance companies sell, even though its premiums are much lower than the others). By definition, it does not create a long-term accumulation vehicle the way permanent insurance policies do. The "buy term and invest the difference" argument says it is better to create that accumulation vehicle somewhere else, where it can potentially earn a better rate of return.
The problem with that argument is in the fact that it provides no protection in the event of incapacitation that does not result in death. In the "buy term and invest the difference" scenario, serious incapacitation will likely lead to the loss of any ability to continue "investing the difference" somewhere else. Only one form of insurance, what used to be called "ordinary insurance" or whole life insurance, comes with the ability to buy a disability rider by which the insurance company pays the "invest the difference" premiums in the event that the owner becomes incapable of working. Whole life insurance with a disability waiver of premium rider insures the continuance of the building of cash value as well as the continuance of the insurance.
You can buy a disability waiver of premium rider on a term policy, but that only insures the continuance of insurance, not the continuance of building cash value (term policies do not build cash value), and the relative price of the disability rider on a term policy is much higher. You can also buy a disability waiver of premium rider on some variable life, universal life, and variable universal life policies, but these differ in an important way from those on a whole life policy in that the insurance company only pays the portion of the premium that applies to the insurance. In other words, these enable the continuation of the insurance portion (as does the disability rider on a term policy) but not the continued accumulation of greater cash value.
For this reason alone, regardless of its other beneficial features, whole life insurance deserves serious consideration among those who have children and who are still working towards significant wealth, even if they are the company's fastest rising star on the sales team, or even if they are working at a promising start-up that will probably have an IPO in a few years. Again, it is not a solution that works to the exclusion of term life but rather in conjunction with it, in most cases.
Further, whole life insurance has other features that enable it to work as an important part of the complete financial picture of families with significant wealth. You might be surprised to learn that families with balance sheets of ten million dollars and more often own more insurance than those with less than a million.
At Taylor Frigon Capital Management we don't sell insurance.
For later posts dealing with this same subject, see also:
- "The hard-money real-estate sinkhole" 09/17/2009.
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