I began my career in the early seventies as a life insurance agent for Metropolitan Life in Augusta. I had just earned my MBA from Wharton in insurance, and the prospect of participating in a management training program and living in Aiken with my parents led me to accept that first job with Metlife.
Over the years, I moved on to other companies and other positions, but I often harken back to those days when our sales managers would implore us to sell whole life insurance policies. Upon retrospect, perhaps the rationale behind this directive was the fact that selling such policies enabled the company to afford to support its huge complement of career agents.
I also can speak first-hand that most life insurance agents are professional and ethical in their dealings with clients. However, the fact remains that life insurance agents will go broke if they only sell term life insurance policies to their clients.
That fact notwithstanding, the question remains, does it ever make sense to purchase permanent life insurance? The answer is: In the right situation it will often make perfect sense to buy permanent insurance.
First, by way of review, permanent insurance refers to those life insurance policies that will remain in force for the entirety of life, provided the required premium is paid each period. Such policies typically have a cash value component while term insurance policies do not.
Permanent insurance can be: fixed premium policies from either a mutual company (owned by its policyholders) or a stock company (owned by its stockholders). Permanent policies includes universal life policies in which premiums can vary based on current interest rates credited to the policy cash values; variable life policies in which the cash values are usually invested in underlying equity investments, or equity-indexed policies, in which policy cash values are credited with earnings linked to a specific stock market index such as the S&P 500.
Term insurance policies, on the other hand, only provide a death benefit for the time period specified in the policy itself, such as one year, 10 years or 20 years. Term policies are usually unavailable for persons beyond age 70. Premiums are due, of course, each year and these premiums remain level throughout the period of coverage. The most competitive premium that I could find for a 20-year level term policy of $1.2 million for a healthy 30-year old male is only $421 annually.
The reason that any bread winner should purchase life insurance should be to indemnify his/her family for the loss of the future income stream from his/her salary and other compensation. There are three important considerations in buying insurance for this purpose: how much insurance will be required to replace that income stream; how much can I afford to spend on life insurance; and, for how long will I need to maintain any life insurance coverage?
After 9/11 occurred, the federal government determined that the income replacement ratio for those that perished was 16 times income. Using that benchmark, our 30-year-old should consider buying a policy with a death benefit of $1.2 million. If those death proceeds were invested, the pre-tax income would total approximately $60,000 ($1.2 million x 5% interest=$60,000). Income taxes would be due, however.
Without going into a lot of detail, the surviving spouse and each child would be entitled to monthly Social Security benefits. The total of those payments would essentially make up the shortfall from our income stream of $75,000.
In next week’s column, we will examine specifically the rationale for purchasing permanent insurance.
Correction: In last week’s column, I stated when stock shares are sold using the actual dates of each stock purchase vs. the “first-in, first-out” method, the tax savings would be $6,000. I should have stated the capital gains savings would have been $6,000, not the taxes themselves.