- Personal Finance»
Insurance is for the Birds and Other Myths
Term, Whole, Universal? Indexed, Uniindexed. What’s the Difference?
To every consumer, the insurance world must appear as an alphabet soup of choices. Every agent they see presses them on a different plan with different premiums, all assuming they are the best in the business. It likely gives you the reader a headache. Well, I am here with two advil and a glass of water.
Now, first of all, let me make this sexy for you so you will stay awake for the duration. Ok, I tried and nothing came to mind. No surprise there, huh. How about, YOU’RE LIFE COULD DEPEND ON IT!! Anything? Oh well, let’s move forward.
They all have pluses and minues so let’s start with the basics. There are just two different types of insurance and a third that is a hybrid of those two. The first is term insurance. Term is short for ‘term period’ so term insurnce means that it only lasts for a specified ‘period of time.’ That specified term can be pretty much anyting from one year to 100 years, and there are reasons to get and not get each of those. However, for the most part, term insurance is sold in periods of 10, 20 and 30 years. Ok, what is it good for?
Well, what do you know that only lasts a short time? Marriages? Funny, wiseguy but actually yes those are included. How about mortgages? Yes, those are another. Short-term job changes and job transfers are other examples of how term insurance is used. How that works is the following: In the case of the marriages, the term insurance acts like a prenuptual agreement. The person who takes out the policy, the insured, is protecting their assets against possible dissolution of the marriage at a future date. If the marriage fails before the term is complete, the policy pays the insured its face value. That way, whatever the insured paid into the union is made back by the policy check if the union fails. The wealthier party in the marriage might do this if they are paying the bulk of the bills in the house.
Mortgage policies are sold all the time. They are set up in case the main income producer of the home becomes unable to produce that income for any extended period of time. Essentially, mortgage policies are disability policies that are designed to pay off the mortgage of the home with some left over for bills while the other party in the home looks to replace the income. Mortgage policies can be anywhere from 10 to 30 years long.
Short term job changes or transfers are frequent uses of term policies. Again, they act like disability policies or reinsurance policies on the company’s own life policy. If the policy holder becomes disabled while on the job, their workman’s compensation policy should kick in but it usually does not amount to much. The secondary term policy adds a little more weight into the insured’s wallet just in case.
There are two sides to term policies. Since a term policy only pays out if something happens to the insured during the term, the insurance company bets that that wont happen or they would go out of business. If nothing happens to the insured during the term, the policy becomes null and void the day the insured passes out of term. Therefore, the insurance carrier is hoping the term will pass wihtout incident for they will owe nothing on that policy once that happens. Therefore, the insurance companies offer these policies at dirt cheap prices because their actuaries tell them that there is little likelihood the insured will collect. That, of course means that the insured paid all those bills and received nothing for it. Bummer for them. However, the negative side to the insurance company is that the policy becomes active the day it is signed bythe insured. That means that if the insured is disabled one month into the policy period, sometimes before they have written their first premium check, the carrier is still on the hook for the entire face amount. So there is a good and bad to these policies from both sides of the coin.
As term policies with very low premiums, these policies are not investment vehicles for they cannot build cash value. As a matter of fact, many insurance advisors tell their clients to avoid whole life insurance with its cash value investment contract because they think their clients can save the extra premium they would have put into their whole life policy for what their advisor considers a far better investment vehicle like a stock or a bond. Well, again, there are positive and negative views of each of those scenarios. Everything really depends on the purpose of purchasing the term policiy or whole life policy in the first place. And for the investment side of the matter, I haven’t even mentioned annuities which are a whole ‘nother kettle of fish entirely. Maybe, those will be another topic to be added to the list of future article ideas. The field of insurance has quite a few of them. I ran out of room for this article just talking about term insurance. I will have to leave the rest for other days.