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life insurance

5 Reasons you may not Have Enough Life Insurance Coverage

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Hopefully, you have life insurance. Having a proper policy in place is an excellent way to protect your loved ones against the unknown. Life has a way of throwing some crazy things at you.

Unless you can predict the future (and if you do, let us know), then you should have a life insurance to protect your family’s finances.

If you already have a plan, you need to take a long look at your insurance coverage. Sadly, you may realize you don’t have nearly enough insurance. Let’s look at some of the reasons why you might not have enough insurance.

Even if you don’t like math or thinking about your passing (and who wants to?), don’t worry, it’s not going to be complex math. Looking at these categories is one of the most important things you can do.

Kids

Having children is one of the most common reasons people get life insurance coverage. When a couple has their first child, they tend to purchase a term life insurance policy, but they don’t let their policy grow as their family does. If you bought your life insurance many years ago, you might have had more children since you purchased it.

The more children you have, the more life insurance coverage you need. If you’ve had more children, look at your life insurance to ensure they will have the coverage they need.

Job Promotion

One goal of your policy is to replace your paycheck if you were to die. If you have people who need your paycheck, like a spouse or a child, then make sure they have the money they need to replace the income.

If it’s been several years, you may have gotten several pay increases or job promotions. The more money you make, the larger your life insurance you should buy to replace your stream of money.

Your plan should be big enough to replace your paycheck for at least 5 years. Preferably, it will be able to give your family seven to ten times your annual income.

New House

Your mortgage is your biggest expense. If you have a mortgage loan, it’s probably the biggest bill you have and will ever have.

You don’t want to think about passing away, but if you did, your spouse is still going to have to pay for your mortgage bill. They would only have one income, but if they have your life insurance money, they can pay off your mortgage bill.

You might have owned a smaller home when you originally purchased your life insurance plan. If you’ve moved into a larger home, you have a larger mortgage. Make sure your plan is still big enough to cover those expenses.

Return-of-Premium Insurance: Is it a good idea?

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Over at Bargaineering, Jim recently discussed an relatively new insurance instrument called “Return of Premium Insurance.” This is a type of term life policy whose issuers promise to return your money after the policy expires.

In term insurance, you pay a specific monthly or annual premium so that the company will pay a benefit to your survivors should you die an untimely death. Unlike whole life insurance, which builds something like equity at a very low return, term does not pretend to be any sort of “investment.” It exists simply to protect a spouse or children from the loss of your income. A policy normally has a beginning and an end (typically ten to thirty years), after which it expires and, if you still need coverage, you have to buy a new one.

Return of premium (ROP) insurance offers to return your premiums after the policy expires. In other words, if you paid a total of, say, $15,000 over the term of the policy, at the end of the term you get the 15 grand back. Thus you appear to be getting something for nothing: the insurance coverage works like any term policy, but the amount you pay for it is returned to you if you outlive the policy.

This, we’re told, amounts to a kind of “investment,” and oh, joy, the money you get after 30 years is tax-free! (It’s really not income: it’s a refund.) This strategy supposedly has the advantage, in addition to providing “free” insurance coverage, of forcing you to save over a long period.

Let’s think about that.

ROP insurance costs significantly more than ordinary term insurance, and the costs are going up in 2010 because regulatory agencies now require companies to return a significant portion of your premiums should you cancel the policy before the end of the term. These policies can cost as much as 50% more than a plain term policy. If you can afford to pay that much for life insurance premiums, it stands to reason that you can afford to pay the cheaper amount for the same coverage with a term policy and put the difference away in a mutual fund.

A few insurance premium calculators that don’t make you a target for insurance salesmen reside on the Web. According to this one, an ordinary 30-year term policy for a 30-year-old man ranges from about $620 to $825 a year. A middling premium for term insurance, then, would be about $720. A similar calculator for ROP shows him paying $2,270.50 a year for a 30-year ROP policy.

The difference between $2,271 and $720 is $1,551 a year, or $129.25 a month.

At the end of his 30-year policy, our ROP buyer, who by then is 60 years old and contemplating retirement, gets $68,130 back. At that time, an average 4 percent inflation rate  has reduced the buying power of this amount to $21,005.75, in 2010 dollars.

What happens if our consumer buys the old-fashioned, plain-vanilla term policy and stashes the extra $129 a month in savings?

Let’s say he starts with nothing but invests the $129, faithfully, month after month, in a mutual fund returning a fairly typical 6 percent. In 30 years his fund is worth $129,582.44. The corrosive effect of inflation erodes the purchasing power of this amount, over 30 years, to $39,952.69. But even this pallid value is almost twice as much as he would have had were his premiums simply refunded to him.

Meanwhile, however, the insurance company is not hiding our consumer’s premiums under a mattress. It also is investing the money, but instead of a mere $129, the company has his entire ROP premium to invest: $189.25 a month. In 30 years at 6 percent, the policy earns $190,104.47 for the insurance company. After the company returns $68,130 to the customer, it sees a profit of $121,975.

That’s assuming the company stays in business for 30 years. We’ve seen what “too big to fail” means…who would have thought, just five years ago, that major banks would go down in the dust? An insurance company is just another financial institution, no more nor less vulnerable to the vagaries of future recessions than any other corporation. If the company folds before the 30-year policy expires, our consumer could very well lose all of his “investment,” since a bankrupt company is unlikely to honor a contract to return money it doesn’t have.

Pretty clearly ROP life insurance is a great idea…for the insurance companies!

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