The Paradox of Insurance

Moderating or even skipping life insurance can strengthen the widowhood most wives will experience, if those premiums are invested well.  Doesn’t seem right?  It’s a paradox.

There are many economic paradoxes: using a home equity loan to get that new car or vacation “you deserve” ends up reducing long-term life style, raising tax rates decreases total government tax revenue; sponsoring welfare kills personal initiative and fosters generational poverty; lowering lending standards to encourage home ownership creates a housing crisis.

Wouldn’t it be nice if we could trust our instincts to do the right thing?  We can’t.  Since most people pay more into insurance than they receive from it, astute consumers use it sparingly not liberally; and as soon as they can responsibly afford to, they’ll not use it at all.  That’s why Larry Burkett said, “Don’t insure that you can afford to pay for yourself”.

Recently a well-intentioned 61-year old husband called about buying a $250k 15-year level premium term life policy for $1250/year.  The actuarial tables say the chance (after screening with an exam and blood work) he will die within 15 years (by age 76) is highly unlikely.

Normal life expectancy is young 80’s for men, comfortably (for the insurer) beyond the reach of the 15-year level period. Think about it: how many $250,000 claims can they pay collecting $18,750 (15yrs x $1250/yr)?  After 15 years, at age 76, the premiums explode as he approaches normal life expectancy, forcing most policyholders to discontinue.

Many people play this game, speculating on a premature death for a segment of time ending well before normal life expectancy, (age 61-76 in this example).  Somewhat like the lottery, it’s a loser’s game.

Our imagination is often our enemy.  In this case they just had a close family member die from an accident.  With this fresh in their mind, their most easily recallable fear lures them to a plan unlikely to deliver.  She is likely to become a widow, but not in the next 15 years.

Here are some things to get firmly in mind:

  • How well are you self-insured? Get a handle on Social Security widow’s benefit, 401k assets, support from children, etc. “The cheapest form of insurance is self-insurance.”
  • Know what normal life expectancy is, considering your health, etc.
  • Know what future term policy premiums are after the level period.
  • Know the opportunity cost. Figure what premiums would accrue to if invested for the same duration.  Consider a Roth IRA.  Investing that cash flow at 8% grows it to over $50k by his age 81 normal life expectancy.  This is what the policy will likely cost her, i.e. the opportunity cost.

Many people bought level term policies 10,15, and 20 years ago who have exhausted that period and now must decide to let it go or re-up.  Often what made them buy that duration has been accomplished: the kids are independent, the mortgage has been paid, the 401k has grown…but they feel they need a little more time.  What to do?

Re-upping appeals because it creates an illusion of addressing the problem…for a low monthly outlay.  But it’s more illusory than real and for most it’s just kicking the can down the road and at 76 (in this example) they’ll be facing the same decision, but at much higher premiums.

Rather than taking the easy way out, it may be time to do some serious soul searching:

  • Do you have any inheritance coming?
  • At your death where will your widow live? If she moves to be near kids, what will housing cost there?  Will downsizing release equity for income?
  • Seriously consider not taking Social Security until your age 70, which will make her lifetime pension larger.
  • Have a heart to heart talk with your kids. What kind of support might mom expect from them?  I know you “don’t want to be a burden”, and you won’t unnecessarily, but the family unit is the oldest form of insurance, so don’t ignore it.  (This answer impacts the Long-term Care insurance decision too.)
  • Take a pulse on your wife’s fear and contentment level. The more content she is, the less you may have to dissipate on insurance today, the more you can invest, and the better off she’ll like be. If anxiety compels you, try to think like an actuary, and see if you can achieve unity in this delicate decision.

Most advice is given by commissioned agents who are happy to sell a policy.  They will not point out these weaknesses, nor advantages of alternative uses of premiums.  The commission is $900 if you buy, and nothing if you don’t.

Don’t insist on a perfect contingency plan for an unlikely segment of time.  It’s a contingency plan, not a probable plan.  Insisting it be perfect (“comfortable”) today, robs resources and usually leads to less financial margin in later years when health care and other unknowable’s may need it most.

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