An Important (often overlooked) Feature of Term Life Insurance – Case Study #5

I’m currently doing a Life Insurance Checkup for a couple in Tennessee that underscores an important cost aspect of level term life insurance…but it’s not the premium rate.

The first step in a Checkup is rightsizing the size policy. This couple, like many, used a rule of thumb (a multiple of income plus debt) promoted by Dave Ramsey, whom I highly respect. However rules of thumb are a crude way of giving wholesale advice. I prefer fine-tune efficiency which comes best through customization. The difference can be dramatic, as it was in this case.

He is a veteran construction manager who had already retired from one employer and had a pension with a significant monthly survivorship benefit for his wife. (This is tantamount to a lot of life insurance.) There are no kids in the picture, they have a reasonable 401(k) and a $750K life insurance policy on him with Allianz. Their emphasis is on debt repayment and they don’t want to spend unnecessarily on anything, including life insurance. After reviewing her income needs and their assets and debts, they think the appropriate insurance need is $350K rather than $750K. How do we best make this adjustment?

The easiest way would be to reduce the current policy. Allianz is a strong company, ranked AA with Standard & Poor’s. He bought this 20 year level term policy four years ago when younger, so a comparable policy would cost more today at his older age. Also, if he had had a health decline it would put him in a higher rate category.

The problem is, though many companies allow a policy reduction during its lifetime, Allianz does not. Some allow it only once during the policy’s life and some allow multiple times. Since Allianz doesn’t at all, it forces him to consider a new (appropriate amount) policy, at an older age, subject to insurability, losing the reserves of the old policy, new contestability period, new commissions, etc.

Let me take a moment to emphasize an important aspect of insurance planning: the amount of insurance you need is rarely static. For most people it reduces as assets grow (401(k), savings, etc.) and liabilities diminish (mortgage is repaid, young children mature, etc.) So the thought that you’re going to need the same amount of insurance for 20 years is probably unrealistic. Yet many people buy such policies and keep them at the original amount for decades. This accounts for the invisible waste of much premium, as people imperceptibly become over-insured. Few people reassess (even if it’s only every 5 to 10 years) their insurance needs…though it’s usually profitable to do so.

Reducing term policies (almost a relic of the past) recognized this dynamic: the amount of insurance needed declines over time. Today’s most competitive policies (level term policies) do not. Thus it’s incumbent on the consumer to make his own adjustments. To do so your policy must permit it.

So when you’re buying a term policy, be sure to find out if the policy owner can reduce its amount at least once during its life. Another possibility is buying multiple policies for different durations: for example a 20 policy for $350K, and 10 policy for $400K. This automatically schedules a decline in insurance as your needs likely decline. The problem with this is that you don’t know the rate at which your needs will decline. Another problem is poorer pricing on multiple/smaller policies.

We tend to think that buying a good term life policy is simply a matter of buying a strong company with low premiums. However there are other important features. The ability to reduce the policy at least once during its life is one of them.

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