The Pro’s and Cons of Child Life Insurance
It’s something that none of us wants to think about~ the death of a child. But not taking the time to think through the financial implications of your child’s death leaves you open to the aggressive marketing efforts of some unscrupulous life insurance agents. Child life insurance is big business in the United States. Companies like Gerber and many others specialize in this type of insurance and tout its benefits many reasons other than its original purpose: to insure the costs of the death.
Let’s start by looking at the difference between whole life and term policies. A term life insurance policy is all insurance and only insurance. That means that if an insurable death occurs, the policy pays out the face value. If you have a $10,000 policy, you will receive $10,000 upon the death of your child. Term insurance gets its name from the fact that the premiums are guaranteed for a certain term. Frequently, this is ten, fifteen or twenty years. That means that premiums are likely to rise to continue the insurance at the end of the term. As the child gets older, the cost of insurance gets more expensive. Eventually, term life ends, usually at age 75. It cannot be renewed after that point. Whole life, on the other hand, has both an insurance component and an investment component. You can keep your whole life policy for just that: your whole life. Most plans have guaranteed insurability, meaning that the policy will stay in force even if health circumstances change. You can withdraw the cash value of the investment side of the policy after a period of time and usually with fees and restrictions. Premiums on whole life policies are significantly higher than for term life, in part to cover the “forced” investment and in part because the claims will be higher than under a term life policy where many people will outlive it.
It may look on the surface as if whole life is the best option for parents with children. In fact, all the glossy brochures talk more about the savings features than the death payout. You may even think you’re giving your child a “gift for the future”~ a term frequently used in child life insurance marketing. However, there are many good reasons to stay away from whole life coverage for your child, and even term life in many cases.
The first goes back to the original point of life insurance: to cover the immediate and long term costs associated with a death. The immediate costs include the cost of a funeral and the lost income of the parents while planning and attending it. The long term cost of death is the lost income of the insured. For example, if a father earns $50,000 a year and dies at age 50, the wife and children have lost out on that $50,000 per year for 15 years (assuming the husband would have retired at age 65). That income needs to be replaced in order for the family to have the same lifestyle as they do now. In the case of a child’s death, there is no need for income replacement as the family was not dependent the child’s income to continue (unless of course if the child has an acting career or other such type of income). That leaves only the short term costs of a funeral ($6,500 on average according to the National Funeral Directors Association) and income replacement for the parents to plan and attend the funeral. Those are the losses that need to be insured. In most cases, a $10,000 term life plan per child is the most cost-effective vehicle to provide child life insurance.
The second reason why whole life is not the best plan for a child is the investment component. Many plans tout the fact that you are helping your child save for the future, whether it is college or buying their first house. The reality is that a whole life policy is an inferior savings product when compared to education savings plans or even simply, a savings account. You have no control over the types and returns of the whole life investments. You will also have to pay conversion or redemption fees in most plans to get at the money. It makes more sense to plan your child’s insurance and savings needs separately with the appropriate product.
The third reason is that, over the life of whichever policy you choose, you are paying over time for the policy’s benefits. Let’s say, for example, that you are looking at buying a whole life policy for your two-year-old. Because the policy is in force for life, there will be a 100% claims rate (except for those who stop paying premiums, so let’s say that drops us down to an 85% claims rate). That means that the insurance company will have to recover 85% of the face value of the policy through premiums. The premium for your two-year-old will be set with rates assuming he or she dies seventy or eighty years from now. The insurance company wins in the short term because you’re paying a hefty premium for a two-year-old. The fact is, children rarely die. The insurance company is not expecting to have to pay out on that policy in the short term. That leaves you insuring a short term risk (the death of a child) with long term premium rates.
The subject of losing a child is a difficult one to face, but doing so ahead of time in a practical and logical manner may save you financial grief in the future. Before you choose a child life insurance plan, make an appointment with a qualified financial planner (rather than someone who makes money from selling life insurance) to review your insurance and investment needs.