The Questions and Answers on Life Insurance Workbook

1. Assess Your Life Insurance Needs and Situation

Master Yoda would say: In motion the future is.

Identify your reasons for coverage. Life insurance is primarily needed for income replacement, debt coverage, funeral expenses, education funding, estate planning, and providing for dependents with special needs. Evaluate your current financial situation, including assets, debts, and future financial goals. Use a simple formula to calculate your coverage needs: multiply your annual income by the number of years you want to provide for your dependents, then add any outstanding debts and future expenses like college tuition.

Common reasons for life insurance:

• Primary breadwinner for a family
• Significant debt (mortgages, loans)
• Saving for children's education
• Providing for a special needs child
• Estate planning and tax considerations

2. Choose Between Term and Permanent Life Insurance

Term life coverage means that the face value of your policy will be paid to your beneficiary if you die within the term period and not afterward—unless the term policy is renewed upon its expiration, which almost always means higher premiums.

Understand the key differences. Term life insurance provides coverage for a specific period, typically 10, 20, or 30 years, and is generally more affordable. Permanent life insurance, such as whole life or universal life, provides lifelong coverage and builds cash value over time but comes with higher premiums. Choose term life if you need coverage for a specific period or financial obligation. Consider permanent life if you want lifelong coverage or to use the policy as an investment vehicle.

Types of term life insurance:

• Annual Renewable Term (ART)
• Level Premium Term
• Decreasing Term
• Return of Premium Term

Types of permanent life insurance:

• Whole Life
• Universal Life
• Variable Life
• Indexed Universal Life

3. Understand How Health Factors Affect Rates

Think of it like a credit rating. In finance, the better your credit score, the more favorable your interest rate. The worse your credit score, the more you'll pony up. In life insurance, good "credit scores" are known as preferred or standard rates.

Health impacts premiums. Insurance companies use underwriting to assess risk and determine premiums. Factors like age, gender, medical history, family health history, lifestyle habits, and occupation all play a role. Maintaining good health, avoiding tobacco use, and managing chronic conditions can help you secure better rates. Be honest about your health history during the application process to avoid potential claim denials later.

Key health factors affecting rates:

• Tobacco usage
• Family health history
• Driving record
• Blood pressure
• Cholesterol levels
• Alcohol/substance use
• Height-to-weight ratio

4. Select a Reputable Life Insurance Company

You might think that large, respected life insurance companies are exempt from financial meltdown. But they're not.

Research financial stability. The financial strength of an insurance company is crucial, as you're entering into a long-term contract. Use independent rating agencies like A.M. Best, Fitch, Moody's, and Standard & Poor's to evaluate insurers. Look for companies with top ratings from multiple agencies. Consider factors like the company's size, diversification of products, and history in the industry. Check for any complaints or regulatory actions against the company through your state's insurance department.

Steps to evaluate insurance companies:

1. Check ratings from multiple agencies
2. Review the company's financial statements
3. Assess product diversity and market focus
4. Investigate complaint records
5. Consider the company's history and reputation

5. Choose a Qualified Insurance Agent or Advisor

I emphasize qualified and ethical here because less scrupulous advisers will encourage you to purchase a replacement policy regardless of whether it's advantageous for you to do so because it often means a new commission for them.

Seek expertise and integrity. A knowledgeable and ethical agent can guide you through the complex process of selecting and maintaining a life insurance policy. Look for agents with professional designations like Chartered Life Underwriter (CLU) or Certified Financial Planner (CFP). Consider working with an independent agent who can offer products from multiple insurance companies. Verify the agent's licensing status with your state's insurance department and check for any disciplinary actions.

Questions to ask potential agents:

• What are your professional qualifications?
• How long have you been in the insurance business?
• What types of insurance do you specialize in?
• Can you provide references from long-term clients?
• How are you compensated?

6. Customize Your Policy with Riders and Beneficiaries

A policy rider is an optional benefit that can be added to a policy for an extra premium.

Tailor your coverage. Policy riders allow you to customize your insurance to meet specific needs. Common riders include accelerated death benefits, waiver of premium, and accidental death benefits. Carefully consider which riders provide value for your situation, as they increase your premium. When selecting beneficiaries, be clear and specific to avoid potential disputes. Consider using per stirpes designation if you want benefits to pass to a beneficiary's heirs if they predecease you.

Popular life insurance riders:

• Accelerated Death Benefit
• Waiver of Premium
• Accidental Death Benefit
• Child Rider
• Long-Term Care Rider
• Return of Premium Rider

7. Monitor and Review Your Policy Regularly

Life insurance doesn't end at purchase. Policies are living things, and there are many components that can affect their performance.

Stay informed about your coverage. Regularly review your policy, ideally annually, to ensure it still meets your needs and is performing as expected. For permanent policies, request in-force illustrations to assess the policy's projected performance. Be aware of any changes in your insurance company's financial strength ratings. As your life circumstances change (marriage, children, career changes), reassess your coverage needs and adjust accordingly.

Annual policy review checklist:

• Review coverage amount and term
• Check beneficiary designations
• Assess any changes in personal circumstances
• Review policy riders
• Evaluate policy performance (for permanent policies)
• Check insurer's financial ratings

8. Consider Policy Replacement Carefully

Replacement can be a very good idea—or a very bad one. It depends.

Weigh the pros and cons. Replacing an existing policy with a new one can sometimes provide better coverage or rates, but it's not always advantageous. Consider factors like your current health, changes in insurance needs, and potential loss of accumulated cash value. Be aware of new contestability periods and potential tax implications. Always compare the old and new policies side-by-side, considering both current and guaranteed values. Consult with a trusted advisor to ensure the replacement is in your best interest.

Factors to consider in policy replacement:

• Current health status vs. when original policy was issued
• Changes in insurance needs
• Differences in premiums and coverage
• Loss of accumulated cash value
• New contestability and suicide clause periods
• Potential tax implications

9. Know Your Options for Terminating a Policy

In rare instances, you'll just want to terminate (or unwind) your policy. In other words, get rid of it entirely, with no intention of replacing it.

Understand the consequences. If you no longer need or want your life insurance policy, you have several options. For term policies, simply stop paying premiums. For permanent policies, you can surrender the policy for its cash value, exchange it for an annuity through a 1035 exchange, gift it to a charity, or sell it in the secondary market (life settlement). Be aware of potential tax implications, especially if there's a gain on surrender. Carefully consider your reasons for termination and explore alternatives before making a final decision.

Options for terminating a permanent life insurance policy:

1. Surrender for cash value
2. Exchange for an annuity (1035 exchange)
3. Gift to a charity
4. Sell in the secondary market (life settlement)
5. Allow to lapse by stopping premium payments

Last updated: August 18, 2024