Life Insurance 101 — What It Covers and What to Weigh Before Buying

If hurricane insurance protects against the consequences of hurricanes, and disability insurance protects against being unable to work due to disabilities, does that mean that life insurance protects against… life…? Since life insurance actually protects against the consequences of death, why is it called life insurance? A big part of why it's called life insurance is that most people don't like to think about death and believe it's not something they need to plan for anytime soon. As someone who used to price life insurance for a living, I can tell you that most people won't die unexpectedly and I can show you the actuarial tables that prove them right. However, as someone whose dad died unexpectedly at the age of 49, I'm uniquely aware that low probability of death is not the same as no probability of death and being prepared can help loved ones through unexpected losses.

I was eighteen when my dad passed away with life insurance so the value has been something that I've understood for my entire adult life. So you would think that I was a model citizen with my own life insurance purchases and had it when I needed it, right?

At this point of the story it's important to remember that personal finance is rarely achieved with perfection.

Even though I was a homeowner, had a partner still in school, one child, and worked at a life insurance company; I didn't buy life insurance until 2018 when I was looking at moving into a bigger house with a bigger mortgage and had a second child on the way. So what were the obstacles for me to buy life insurance and what are common reasons that 42% of Americans feel like they need life insurance or need more of it?

What life insurance is actually doing for you

"Life insurance is sold, not bought." This is a common refrain in the life insurance industry that summarizes how people feel about buying life insurance. To put it in plain terms, buying life insurance isn't the least bit sexy or exciting. I have never seen a social media video bragging about the great life insurance policy of the creator.

In addition to lacking natural appeal, 74% of American adults (Gen Z and Millenials) overestimate the cost of life insurance. This results in 'Perceived to be too expensive' being listed as a top reason for not having life insurance. It's important to remember that expensive is a subjective term that varies not only on the price but also on how the value gets perceived. For example, something that costs $200 can't be determined to be expensive until you know what you're getting in return. Front row seats with backstage passes to your favorite artist? $200 is a great deal! Nosebleed seats to see your partner's favorite artist? Sounds expensive!

The same line of thinking goes for life insurance. It seems expensive because the value of life insurance is harder to grasp than most other purchases. So what exactly is the value of life insurance? The true value of life insurance is peace of mind and a genuinely unselfish act for your beneficiaries. It's similar to the concept of having an emergency fund as opposed to spending that money on immediate pleasure; knowing that the unexpected won't result in an abrupt lifestyle change is worth leaving that money set aside. Ok, that's the 'why' of life insurance but what about the 'how' and 'what'?

Term vs. permanent: the two paths most people run into

If simplicity is beauty, life insurance products can be pretty darn ugly. However, the products don't have to be complex and the choice can be made easier with an understanding of the common product offerings. The most common life insurance products can be broken into two categories as shown below:

Term - Term life insurance is for a certain period and the premium is generally level for the entire period. Typical offerings are for 10, 15, 20, 25 and 30 year periods. This is generally the simplest and cheapest form of life insurance. Depending on your goals, this can make sense if your primary value is peace of mind with your protection during a certain period of time; often while paying off a mortgage or raising dependents. However, it's likely that you will outlive the policy and allow the policy to end with no benefits being paid.

Permanent - These are permanent life insurance policies that can come in many forms and offer coverage until death, surrender, insufficient premium payments or even maturation at ages typically over 100. Primary differences between permanent insurance and term insurance are that the permanent policies often have the ability to grow a cash value within the policy. This cash value can be borrowed against or even withdrawn in later years or can be received upon surrendering the policy.

You can think of permanent policies as a combination of the standard protection of life insurance with an investment component as well. The investment component varies by the type of permanent insurance with different variations including whole life, universal life, indexed universal life and variable universal life insurance. Because of the added complexity and potential for cash accumulation, these policies tend to be a bit more expensive than term life insurance.

How people land on a coverage amount

If you ask five different financial planners how much life insurance you should have, it's pretty likely that you will get five different answers. This isn't because any of the five is 'right' or 'wrong' but it's because coverage amounts are a somewhat subjective decision with a lot of factors. The biggest factors to consider are spending patterns, dependent children, educational costs, debt, and anything specific to your situation that is relevant to your beneficiaries.

Here are a few ways to think about a coverage amount:

• Multiples of income - this is a really common approach as it's pretty straightforward. Depending on your stage of life, coverage recommendations can be anywhere from five to 30 times your income.

• Online calculators - There is an abundance of calculators online that attempt to consider income and other attributes that might impact desired coverage amount. It's best to run more than one. If they're wildly different, that's usually a sign to dig into why.

• Specific purposes - this can align with paying off all debt, buying out a business relationship upon death or paying estate taxes.

Another consideration when landing on a coverage amount is price. While prices go up as coverage amounts go up, a $1 million policy isn't typically double the price of a $500,000 policy. So if you have landed on a certain coverage amount, you might consider getting quoted on some slightly higher coverages to see if it's worth the additional coverage.

Where a Fruition Mentor fits in

Decisions around life insurance are personal, important and can be complicated, so it's a great opportunity to have an objective outsider help make a sound decision. A Fruition Mentor is an unbiased source to discuss life insurance concerns and ask questions about your situation. Whether you want to explore changing an existing policy or are looking to buy your first policy, I hope this helped answer some questions and I wish you good luck on your journey!