Life Insurance: Frequently Asked Questions

Table of Contents

• How do insurance companies classify individuals for rate purposes?
• What questions should I ask my life insurance agent?
• What should I watch out for when buying life insurance?
• How do I compare the cost of several insurance policies?
• Do I really need life insurance?
• How much life insurance should I buy?
• What type of life insurance should I buy?
• Should children have life insurance?
• How do I balance life insurance with my other investments?

How do insurance companies classify individuals for rate purposes?

Premiums vary among insurance companies, so it’s a good idea to comparison shop in order to get the best premium. It’s also helpful to understand how premiums are calculated by insurers. Here’s a quick look at how this works.

Insurance companies place individuals into four risk groups: preferred, standard, substandard, or uninsurable. A terminal illness at the time you apply for insurance may make you ineligible for coverage. Having certain chronic illnesses may place you in a higher-risk category. People with conditions such as diabetes or heart disease may still be insured, but they may pay higher premiums.

If you have a high-risk job or hobby, you may also be considered a higher risk.

The premiums charged will generally reflect the category you are placed in. Thus, a standard-risk applicant will typically pay a premium in line with other applicants in a similar category.

One company’s classification of you may differ from another company’s classification, so it can still pay to shop around even if one insurer has labeled you a higher risk.

Once an insurance company approves you for coverage, the policy generally remains in force as long as you meet its terms, including paying premiums when due. The specific policy provisions determine when coverage can end.

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What questions should I ask my life insurance agent?

Here are some questions to ask about policies:

• How do cash values accumulate? If you are considering a cash-value policy, ask how the cash value is expected to build over time and which portions, if any, are guaranteed.
• How has the policy’s cash value performed in the past? Ask to see the policy’s historical performance and compare it with the insurer’s projections and those of other insurers. Remember that past performance does not guarantee future results.
• Do the special features add value? Find out whether optional benefits and additional features meet your needs or simply increase the cost.
• What is the company’s financial strength rating? Check ratings from recognized rating agencies and understand what they indicate about the insurer’s financial strength.

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What should I watch out for when buying life insurance?

Policy provisions that are hard to understand and compare. Some insurance products combine life insurance with investment features. These products can be complex, and their costs and benefits may be difficult to compare. Make sure you understand the policy’s terms, fees, risks, and guarantees before making a decision.

Pushing inappropriate policies. Make sure your agent carefully identifies your needs and explains why a recommended policy is suitable for you. You may also want to have your accountant or financial planner review the recommendation before purchasing.

High commissions and costs. Review the costs of any recommended policy carefully. Ask how much of your premium goes toward insurance costs, administrative expenses, commissions, and any cash-value component.

Life insurance and investments serve different purposes. If you need both protection and investment growth, compare the costs and benefits of buying life insurance separately and investing independently. Term insurance may provide a death benefit at a lower initial premium than many cash-value policies, but the right choice depends on your circumstances and needs.

Safety of the insurer. Check an insurer’s financial strength and claims-paying ability before purchasing a policy. Ratings can help with your assessment, but they do not eliminate the risk that an insurer may experience financial difficulties.

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How do I compare the cost of several insurance policies?

When comparing life insurance policies, look beyond the premium. Review the death benefit, policy duration, guarantees, fees, exclusions, surrender charges, and any projected cash value.

Some policies provide cost-comparison measures or illustrations that can help you evaluate their costs over time. Ask your agent to explain the assumptions used in each illustration and whether the figures are guaranteed or merely projected.

For term insurance, compare premiums for the same coverage amount and term length, while also checking renewal terms and whether premiums can increase.

For cash-value policies, compare projected cash-value growth and cash surrender value. The cash surrender value is the amount you would receive if you cancelled the policy at a particular time, after applicable charges and outstanding policy loans. It may differ from the policy’s stated cash value.

When comparing two universal life policies with similar premiums, death benefits, and assumed interest rates, a higher projected cash surrender value may be attractive. However, also compare the assumptions, charges, guarantees, and risks behind those projections.

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Do I really need life insurance?

The purpose of life insurance is to provide financial support for your children, dependents, or other beneficiaries if you die. It can also serve estate-planning purposes, such as leaving money to charity, providing liquidity for estate expenses, or funding a business succession arrangement.

Whether you need life insurance depends on whether anyone relies on your income or whether you have other financial obligations you want the policy to cover. Consider the following situations:

• Families or single parents with young children or other dependents: Life insurance can help replace lost income and provide for childcare, education, housing, and other household needs. If both spouses earn income or provide essential services, both may need coverage.
• Adults with no children or other dependents: You may need less coverage if your spouse or partner can manage financially without your income. You may still want to provide for debts, funeral expenses, or other obligations.
• Single adults with no dependents: You may need little or no life insurance unless you want to cover debts, final expenses, or specific estate-planning goals.
• Children: Children generally do not need life insurance to replace income. Families may instead plan for possible final expenses through savings or other resources.
• Retirees: The need for life insurance may decline after retirement, but coverage can still be useful for a surviving spouse, outstanding debts, final expenses, or estate-planning objectives.

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How much life insurance should I buy?

Determining how much insurance to buy requires you to calculate your household’s current and future financial needs, followed by your assets, debts, and other sources of income. A qualified financial advisor can assist with this calculation.

The appropriate amount of coverage is generally the amount that would help your dependents maintain their desired standard of living after your death, taking into account other available resources. The old rule of thumb of buying five, six, or seven times your annual salary may serve as a starting point, but it is not a substitute for calculating your family’s actual needs.

Consider including the following in your calculation:

• Income your family would need to replace.
• Outstanding mortgage, loans, and other debts.
• Childcare and education expenses.
• Funeral and other final expenses.
• Ongoing household expenses and financial commitments.
• Existing savings, investments, employer-provided coverage, and other available resources.

It is important to estimate your family’s needs as accurately as possible. Too little coverage may leave your dependents financially vulnerable, while too much coverage may result in unnecessary premium expenses.

To estimate your household’s annual income needs, review bank statements, credit card statements, household budgets, loan balances, and your most recent tax return.

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What type of life insurance should I buy?

Once you have an idea of how much coverage you need, you can decide which type of insurance may best meet those needs. Broadly, life insurance products include term life insurance and cash-value or permanent life insurance, such as whole life, universal life, and certain variable policies.

With term insurance, you pay for coverage for a specified period. If you die while the policy is in force, the insurer pays the death benefit according to the policy terms.

Cash-value life insurance provides a death benefit and may also accumulate cash value. These policies often cost more than term insurance, and their costs, guarantees, and investment risks vary. A convertible term policy may allow you to change to permanent coverage under specified conditions, sometimes without another medical examination.

Term Insurance

Common types of term insurance include:

• Renewable term: The policy may be renewed for additional periods under its terms. Premiums generally increase as the insured person gets older.
• Re-entry term: Renewal or continued eligibility for a lower premium may depend on meeting specified requirements, which can include a medical assessment.
• Level term: The premium remains the same for a stated period, such as 10, 20, or 30 years, depending on the policy.
• Decreasing term: The death benefit decreases over time while the premium may remain level. This type of policy may be designed to cover a declining obligation, such as a mortgage.
• Return-of-premium term: Some policies return eligible premiums if the insured outlives the term and meets the policy requirements. These policies generally cost more than comparable term coverage.

Cash-Value Life Insurance

Common types of cash-value life insurance include whole life, universal life, variable universal life, and variable whole life. The guarantees, flexibility, fees, and investment risks differ by policy.

Whole Life. Whole life insurance generally provides a death benefit and builds cash value. Premiums are typically level under the policy’s terms. Some policies may pay dividends, but dividends are not generally guaranteed unless specifically stated in the contract. Cash-value growth and guarantees depend on the policy provisions.

You may be able to borrow against the policy’s cash value. However, outstanding loans and interest can reduce the death benefit and cash value, and an unpaid loan may affect whether the policy remains in force.

Participating whole life policies may be offered by mutual insurers and other insurers. These policies may pay dividends based on the insurer’s experience, but dividends are not guaranteed and should not be treated as certain returns.

Universal Life. Universal life insurance typically offers more flexibility in premium payments and death-benefit options than traditional whole life. Premiums are used to cover insurance costs and expenses, with any remaining amount credited to the policy’s cash value according to its terms. Cash value may earn interest, subject to the policy’s guarantees and conditions.

You may be able to vary premium payments within specified limits or make withdrawals or loans. However, if payments and cash-value growth are insufficient to cover policy charges, additional premiums may be needed to keep the policy active.

Variable Universal Life. Variable universal life allows you to allocate cash value among investment options offered by the policy. This may provide greater growth potential, but the cash value can decline with investment performance and fees. Guarantees, if any, depend on the contract.

Variable Whole Life. Variable whole life combines permanent life insurance with investment options. The cash value and, depending on the policy, potentially the death benefit can be affected by investment performance. Review the risks and fees carefully before purchasing.

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Should children have life insurance?

Since the main purpose of life insurance is to provide for dependents after the insured person’s death, children generally do not need substantial life insurance to replace income. Families may instead plan for potential final expenses through savings or other resources.

Some parents choose cash-value life insurance for children because it combines a death benefit with a savings component. However, these policies have costs and limitations, and they should be evaluated carefully against the family’s financial priorities.

Alternatives for preparing for possible expenses include:

• Using savings already set aside for emergencies or final expenses.
• Checking whether a parent’s life insurance policy offers a child rider.
• Prioritizing adequate life insurance coverage for parents or other adults whose income supports the family.

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How do I balance life insurance with my other investments?

Life insurance and investments serve different financial purposes. If your primary need is to protect dependents, compare the cost of term life insurance with your coverage needs. You can then assess how much to allocate to savings and investments, including eligible tax-advantaged retirement accounts.

If you already own a cash-value policy, do not cancel it without first understanding the consequences. Consider its current cash surrender value, surrender charges, outstanding loans, tax implications, replacement coverage costs, and the potential loss of existing benefits or guarantees.

A cash-value policy may suit some long-term financial plans, but returns depend on the policy’s charges, guarantees, and performance. Compare it with other investment options based on your goals, risk tolerance, time horizon, and need for insurance protection.

Before changing or replacing a policy, consider consulting a qualified financial or tax professional who can review your specific circumstances.

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