Why Term Life Insurance Makes Sense By Dennis Jarvis At Isnare.com Ezine Articles

One of the first considerations when investigating life insurance is the question of term versus whole or variable coverage. We first need to understand how they are different and take a look at the pro's and con's (loosely translated as cost!) of term life insurance.

Comparing the types of life insurance including term comes down to a simple point. Term life insurance is for a fixed period of time. Whole and variable life can usually be carried out for a person's entire life. This means there will be some payout at some point as long as the policy is kept in force (generally meaning that premiums are paid). This is counter-intuitive to the world of insurance and the very principle of how insurance works. Insurance is to protect against an unlikely but catastrophic risk across many people and thereby reducing the risk to any one given person. Whole life insurance is providing coverage for a very likely (like taxes, inevitable) risk to all.

Let's take an example. If 100,000 people buy life insurance ($100,000K) for a 10 year period and 15 people actually trigger the benefit, the total payout is $1.5M (15 people times $100,000). But this total amount is spread among the total risk pool of 100,000 people. The baseline premium that each person need to pay for this protection is $15. Very inexpensive.

Throw in inflation and investment returns (plus administration costs and profit) to this and you have the basis for your term life premium. The carriers have statistics to essentially guess what percentage of people will trigger the benefit according age, health status, and length of term. It's higher than the 15 above but you get the idea of how term life insurance, and more importantly insurance in general should work. This is also true for medical and property/casualty. The whole basis of insurance is that a catastrophic expense would wipe out one individual but if spread among a large enough pool of people, the group can handle it because only a percentage will trigger the benefit. It spreads out risk.

Whole life insurance (and variable) is something entirely different. The risk of you triggering the benefit is 100% (assuming policy kept in force). How can that be? Well, the premium has to be significantly more (usually around 10 times more) than term life insurance for smaller amounts. Here, the carrier is estimating that they can take the 10 times premium (let's say $150 per person for our above example) and make enough money investing that amount to pay out for everyone in the group at a lesser amount. They are essentially investing with your money hoping to earn off this "float" before needing to payout death benefits. They also plan to pay your death benefits with future money which is worth much less (due to inflation, $1 today might be worth 60 cents 10 years from now and 20 cents 20 years from now). You're not purchasing life insurance to have money invested. You are buying life insurance to protect against a risk.

It's equivalent to purchasing health insurance to cover 100% of all expenses (no copays, no deductibles, and no co-insurance). The cost for such a plan would be so high that it would quickly price itself out of the market. This is why we have the constant movement towards higher deductible and more cost sharing. Covering 100% of the risk of death just isn't cost effective which leads us to our next point.

Premium premium premium

Premium is the amount you will pay to keep a life insurance plan in effect and this is where the tire meets the road when comparing term and whole life insurance. Term is so much less expensive than whole life that it's hard to make the case for whole life. If you have enough money to afford large amounts of whole life insurance than the question begs whether you need life insurance to begin with. It takes a great deal of premium to buy large amounts of whole life. Some (usually insurance brokers selling whole life) would argue that you build up cash values with whole life which means that after a period of time, you start to have a portion of the whole life policy that is essentially your asset (to borrow against for example). Why would you pay your own money in premium to have a life insurance company hold it (and invest with it) as your own money for you to borrow against. Why not keep 9/10ths of your premium to yourself and buy term with the other 1/10th (difference in premium) of the whole life premium. In our view, this is a gimmick for people who do not understand how money works. You're essentially giving the life carrier money to invest for themselves, and they will give you back a smaller amount at the time the benefit is triggered. Keep your own money and spend a fraction of it to protect against the real insurance risk. That's term life insurance in a nutshell.

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