Selecting your first life insurance policy.
So you’ve decided to buy some life insurance for the first time. Perhaps a friend or relative has convinced you. Or was it the friendly broker? Whatever prompted this was quite real. With a huge array of options and choices, how can you know that you’ve made the right choice? What type of policy is right for you?
Some of the products appear complex but the concept is actually quite simple.
Before making any decision, ask yourself these questions:
* Do I need life insurance and Why?
* How much life cover do I need?
* Who it is for?
* How much can I afford to spend?
The purpose of life insurance is to provide for a financial shortfall in the event of your death. The ability to provide for the surviving family. Sometimes business partners will insure each other’s lives – especially where the loss of one partner could be critical to the running of the business.
The capital requirement or sum insured should be sufficient to pay off outstanding loans, to cover the cost of children’s education and to provide an income for the surviving family’s living expenses.
How much can you afford? Will this compromise the amount of cover? Think about this carefully. If you can only just manage the premium, then it is too much. As soon as you suffer a financial setback the premium – and the policy – will be at risk. Thousands of policies lapse each month and many more become early surrenders. To rephrase – how much you can comfortably afford?
Try to balance your life insurance needs with a complete financial portfolio of investments and retirement funding. A good financial advisor will be able to suggest a suitable basket of investments and insurance to meet your needs. Most financial analysts agree that between 10 and 15 percent of your income should go towards investment. Only a portion of this should be life cover. Money invested grows. Money paid in life premiums just disappears – unless you die!
An important decision is to decide on the type of insurance required.
Term insurance is the least expensive option. The premiums are fixed for the duration of the policy. You are covered by the sum insured for a fixed term. Your beneficiary will be paid the sum insured if you die. But only if you die within the term of the policy. If today is the end of the term and you die tomorrow, tough luck!
A whole life policy includes an investment portion. Premiums are higher than for the term option but the policy has a cash value – even if you live. The policy may also be used as security against loans and may include options to cash-in a portion of the investment while maintaining the life cover.
Whole Life policies often work on a universal life basis. The policy includes an investment portion which is used to offset the risk cover. The greater the investment, the less spent on risk. An ingenious concept and a very efficient option except for the expenses that life companies charge against these policies. Variations include flexible policies where the investment portion may be increased or decreased from time to time by the policy holder. One such option allows for a premium holiday if the investment portion is sufficient to cover the cost of life cover.
Life insurance options that include an investment are generally favoured by insurance brokers and agents. These types of policy attract huge amounts of commission – 85% of the first year’s premium is not unusual – so there is a lot of motivation to sell this type of policy. The commission not only provides an incentive for the broker, it has a major impact on the long term value of any investment. The investment is locked into the policy until the policy is cashed-in or the insured dies.
The rational choice is to take term insurance and couple this with a separate investment where the costs are much less. If there is a return of premium option then take this as well. The chances are that you will still be alive at the end of the term, so why just write off the premiums? The main problem with this choice lies in the discipline required to maintain the investment. If you are able to invest on a monthly basis and forget that the investment exist for a period of ten to twenty years, then this would be the most cost-effective option.
Disability cover is an additional option or ancillary benefit offered by insurance companies. This is very profitable business for the company as very few claims are ever paid. Read the conditions very carefully before taking out disability cover. Your own understanding of disability is almost certainly very different to the insurance definition.
Using a broker will involve commission costs. However, that may be a small price to pay as it could ensure that you take out the policy that is best for you. An independent broker is not tied to a particular company and will be able to advise on the best options available. Remember that a broker’s incentive is to sell policies that maximise his/her commission. It may be possible to negotiate a lower commission from a broker. He would rather get half the commission than none.
A financial advisor will charge a fee for his services, but will not be commission driven. S/he will be in a better position to provide objective advice..
Once you have sufficient investments, you do not need life insurance. If you do not have dependents you do not need life insurance. Don’t take out life insurance for investment purposes. Rather take out a term insurance and use the rest for investment.