[Editor's Note: The following guest post was submitted by insurance expert and long-time advertiser, Lawrence B. Keller, CFP®, CLU®, ChFC®, RHU®, LUTCF. Larry has written extensively about disability insurance in the past for WCI but today he gives us an “insurance guy's” perspective on what to look for when purchasing term-life insurance.]
Over their careers, physicians generally purchase large amounts of term life insurance. Term Life insurance, for the most part, is a commodity, so the pricing is very competitive and comparison shopping is easy. So, why is it that so many physicians have the wrong type of term life insurance and/or are paying significantly higher premiums than they should be for their policies?
Term life insurance provides pure insurance protection and does not build cash value. It allows you to purchase the largest death benefit while minimizing your initial premium outlay. When you purchase a term life insurance policy, you are buying coverage for a specified period of time. If you die within the term of the policy, the insurance company will pay the death benefit to your beneficiary or beneficiaries.
While I am probably best known for my expertise in disability insurance, I am also often asked to review existing life policies. This post will focus on things that I take into consideration while evaluating existing policies and/or reviewing illustrations that have been presented when new coverage has been proposed.
Top 7 Things I Consider When Evaluating Term Life Policies
1) What type of policy was purchased?
Term Life Insurance typically is purchased with an annually increasing premium rate (known as “Annual Renewable Term” (ART) or “Yearly Renewable Term” (YRT) or a Level Premium Term, where premium rates are guaranteed* for a specific period of time.
However, unlike Level Premium Term (the most popular type of term life), this product has an indeterminate premium structure. This means that there are two sets of premium rates: a “non-guaranteed” Scheduled Premium rate and a “guaranteed maximum” premium rate (and the guaranteed maximum is typically a multiple of the Scheduled Premium rate). Generally, after the first policy year, the annual premium payable may be more than the scheduled renewal premium, but it will never be more than the guaranteed maximum renewal premium (similar to an Adjustable Rate Mortgage).
As an agent that sold a large amount of ART/YRT policies in the past (before Level Premium Term became available), I can tell you that my experience with this product has not been favorable. In my opinion, it is the equivalent of “lighting the fuse and hoping you can run away fast enough before your legs blow off” as it becomes prohibitively expensive over time.
As a result, very few companies still offer this type of coverage. In many cases, it is sold for very short-term needs (a loan that needs to be insured but will be paid off quickly) or for an insured that knows that they ultimately want to purchase Whole Life Insurance and are simply purchasing this product as “pre-conversion” term. However, more often than not, this is not the goal of the insured and they, in fact, typically, don’t realize that they are purchasing this product for this specific reason.
2) When was the policy purchased?
Level Premium Term Life Insurance policies are typically available with guaranteed level premium periods of 10, 15, 20, 25 and 30 years. One company makes policies available with level premium rates from 16-30 years (in one-year increments), as well as, a 35-Year Level Premium Term policy.
How many years with a level premium remain? For example, if a 20-Year Level Premium policy was purchased 10 years ago, 10 years remain with a level premium rate. How does the cost of a new 10-Year Level Premium Term (the number of years remaining with a level premium) compare to what the insured currently owns?
3) What underwriting classification was the policy issued in?
Purchasing term life insurance is pretty straightforward. Insurance companies look at age, height and weight, personal medical history and immediate family (mother, father, brother, sister) history of cardiac disorders or cancer. Some carriers ignore immediate family history of cancer altogether, others take a diagnosis of cancer or cardiac disorders in a parent or sibling prior to the age of 60 into consideration and may prevent the proposed insured from qualifying for the most favorable underwriting classification while others only take this family history into consideration if it resulted in death.
Lawrence Keller
So, if the policyholder did not qualify for the most favorable underwriting classification with the company from which the policy was purchased, could they potentially qualify for a more favorable underwriting classification elsewhere and, pay a lower premium as a result?
4) Does the policy include a Waiver of Premium Rider?
This rider is designed to have the premiums of the policy paid for by the insurance company (waived) in the event of your disability. Generally, it has a six month waiting period and for the next year and a half (total of two years) or, in some cases next four and a half years (total of five) years will allow your term life insurance policy’s premiums to be waived. However, after this time, you must be unable to perform any occupation that is “reasonable” based upon your education, training and experience.
Again, if your goal is to ultimately convert some or all of your term life insurance to permanent life insurance, like Whole Life, it is important that this rider be included in your term life insurance policy. This way, when you convert to a permanent insurance policy, it will allow the premiums—which are substantially higher compared with term life insurance—to be waived. Otherwise, if you plan on sticking with term insurance, you will want to forego this rider, because it is relatively expensive and will only waive the premiums associated with your (inexpensive) term life insurance policy.
5) Does the policy include an Extended Conversion Rider?
Some policies allow for the conversion to permanent insurance (like Whole Life Insurance) for the entire guaranteed premium period. Other policies, however, may have a limited conversion option (typically five years) in order to reduce the premium rates for the policy. If one does not have the desire to convert their term policy to permanent insurance, this is likely something that can be removed from the policy in order to reduce the premium rate.
6) Does the policy include an Accidental Death Benefit Rider?
Personally, I never understood this rider and would not be willing to pay for it myself. Why would your family need more money if you died peacefully in your sleep or died as a result of an accident? You should simply determine the amount of coverage your family needs in the event of your death and purchase that amount of coverage. Term Life insurance is inexpensive. At worst, you overestimate the amount of coverage and simply reduce the death benefit should your needs change.
7) Should the coverage be “laddered”?
A good rule of thumb when purchasing term life insurance is to replace 7-10 times your gross annual income. In many cases, physicians will simply determine the amount of coverage that they need or want and purchase a 30-Year Level Premium Term Life policy in this amount.
However, as children age, as student loans and mortgages are paid down and educations are funded, short of estate planning, the need for long-term death benefit is also reduced.
Let’s use a $4,000,000 death benefit as an example. What about purchasing $3,0000,000 of coverage with a 20-Year Level Premium and $1,000,000 of death benefit with a 30-Year Level Premium instead? In this example, the insured would have the same $4,000,000 death benefit for his or her family for the first 20 years. It would then decrease to $1,000,000 for the remaining 10 years.
For comparison purposes, the cost for $4,000,000 of 30-Year Level Premium Term Life Insurance for a 35-year-old male in New York State obtaining the best underwriting classification would be approximately $2,960 annually. Using the “laddered” example above, the annual premium would be reduced to approximately $1,938, providing similar protection with an annual savings of $1,022 or approximately 35% less than purchasing coverage with long-term guarantees that might not be needed.
One carrier allows insureds to “ladder” their coverage within a single policy. The base policy purchased is the one with the longest duration and the additional coverage is purchased using Level Premium Term Riders. This provides an annual savings of $60 for each separated policy that would normally be purchased.
Examples of Policies
Here are three examples of policies that I recently reviewed, my recommendations and the outcomes:
- A $3,000,000 10-Year Level Term policy was purchased 5 years ago by a 28-year-old male physician. Also included was a Waiver of Premium Rider, as well as, an Extended Conversion Rider. The total annual premium was $988.55 ($785.00 for the death benefit, $180.00 for the Waiver of Premium Rider and $23.55 for the Extended Conversion Rider).
This client was paying $180.00 annually to waive an annual premium of $785.00. This represented 24% of the cost of the death benefit. Clearly, not a good value for the premium dollar when this premium could be used to increase his personal disability insurance coverage or invested elsewhere.
The cost of the Extended Conversion Rider represented 3% of the cost of the policy. Since this client did not have any interest in converting to cash value insurance, it also did not make sense in his situation.
A new $2,000,000 20-Year Level Premium policy was purchased from another carrier, at age 33, with an annual premium of $764.00. He did not feel that $3,000,000 of coverage was needed as he was part of a dual physician couple.
- A $1,000,000 Annual Renewable Term (ART) policy was purchased by a 44-year-old female physician. The (current) annually increasing premium was $664.00 annually. While she ultimately decided to increase her total death benefit and “ladder” her coverage, the annual premium for a $1,000,000 15-Year Level Term Rider was $549.99. Therefore, she was able to reduce her annual premium for this portion of her coverage, as well as, lock into the lower rate for 15 years.
- A $2,000,000 30-Year Level Premium Term policy was purchased by a 33-year-old male physician six years ago. Unfortunately, at that time, he did not qualify for the best underwriting classification. As a result, the annual premium was $2,717.04. Knowing that another carrier would potentially allow him to qualify for the best underwriting classification if he met the criteria, he applied at age 39 for $2,000,000 of 20-Year Level Premium Term Insurance. The policy was approved with an annual premium of $1,094.54. Since he was also part of a dual physician couple and 24 years remained (of the original 30 year) on his existing term policy, he and I no longer felt that a 30-Year Level Premium Term policy needed.
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As you can see, there are a number of reasons to potentially review your existing coverage to make sure it still meets your needs, goals, budget and individual circumstances. In many cases, a lower premium rate might be obtained – especially if your situation has changed since the time the policy or policies were originally purchased.
I admit I was very naive when I bought my life insurance and have no idea if I got taken or not.
I did purchase a 30 yr level term insurance. I remember the insurance agent having me get a return of premium rider (have no idea what extra that cost but I believe it meant if I did not use the policy prior to the 30 yr term lapsing I would get all the premium refunded to me). What are your thoughts on something like this?
This seems like a great service to have your policy individually reviewed. Does the review itself carry a cost or do you typically get money only if something better is found and it is switched?
I also wish I had thought of the laddered insurance policies. That seems like a great idea with higher coverage early when you likely don’t have a nest egg to support loved ones and decreasing as you are about to retire when hopefully your nest egg is sufficient policy enough.
Right now I know I am over insured as I am about to hit my FIRE number at age of 47 (I know definitely by 53) and yet my 30 yr term was designed to take me to 65, but I guess my heirs can view it as more of a bonus lottery win then if it does go into effect.
Also just to confirm, insurance policy pay outs are considered tax free, correct?
It’s not a scam but it is a gimmick:
https://www.whitecoatinvestor.com/return-of-premium-term-life-insurance-friday-qa-series/
Thanks for the link. Where were you in 2006? Lol. Well it looks like it was a bad decision to go along with the insurance salesman (go figure), but I guess in the scheme of things not an end of the world disaster.
Yes, insurance proceeds are nearly always income tax-free. An exception is if you receive interest, such as part of an annuity’s payouts, from an insurance company, which is taxable.
I was never a fan of Return of Premium (ROP) Term Life Insurance as you had to keep the policy for the entire guaranteed premium period in order to have your premium returned. This means that if premium rates for the coverage you purchased decreased, you were forced to keep your policy and you could not replace it in order to potentially obtain a lower premium rate. Additionally, if you no longer had the need for the death benefit, again, you had to keep the policy in order to have your premiums returned.
Here is an example using today’s marketplace for a 35 year old male in New York State in the best underwriting classification (Preferred Best) purchasing a $1,000,000 30-Year Level Premium Term policy from a well-known insurance carrier. The annual premium for Return of Premium Term is $1,817.20. The annual premium for a regular 30-Year Level Premium Term Life insurance policy is $805.00, representing an annual difference in premium of $1,012.20.
If the total premiums of $54,516 were returned in 30-years, this represents an annual return of 3.55%. I would assume over that period of time, you can likely achieve a higher rate of return without committing to those higher premiums for that timeframe.
No, there is a complimentary review of one’s disability insurance and/or life insurance. Yes, if there is a better option available and one chooses to move forward with an insurance purchase, I would be paid a commission based upon the annual premium. However, in many cases, it may make sense to keep what the insured already has for a variety of reasons. While it certainly can generate sales, I also use it a means to generate “goodwill”, showcase my expertise and gain referrals.
Yes, life insurance death benefits are income tax-free but can potentially be subject to estate taxes if an individual exceeds the $11,200,000 or $22,400,000 estate tax exemption for a couple.
Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation.
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Great post, Lawrence. I always thought that disability products were more difficult to understand because of the definitions required and the various riders that can be purchased. It’s interested to know the nuances of life insurance as well.
If the rider is purchased to waive premiums in the instance of disability, how specific is the “disability” definition within those products? I know that is an issue in the disability world, and so I imagine the same probably applies for the disability rider in life insurance products.
As you mentioned, this rider matters more for those who are pursuing whole-life insurance (which most reading this site should not purchase), but was curious to know none the less.
TPP
Generally, the Waiver of Premium Rider will contain an “Own-Occupation” definition of total disability for two, five or seven years. Meaning, the insured is considered disabled and the premium would be waived if they are not able to perform substantially all of the duties of the insured’s regular occupation at the time disability begins.
However, after the “Own-Occupation” period, total disability means the insured is not able to perform substantially all of the duties of any occupation for which the insured is or becomes fitted by education, training, or experience. This can vary by company and/or by state or the age of the insured.
Clearly, this is much more restrictive compared to an individual disability insurance policy that contains an “Own-Occupation” definition of total disability for the entire benefit period (typically, to age 65 or longer). The Waiver of Premium rider also adds a nominal premium charge in additional to the term insurance premium itself.
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Oy, Dunning–Kruger effect in action over here in my brain. Last night I was looking at life insurance policies online. I was comparing rates and nothing else. Didn’t even know about most of what was in this post! Thanks for the lesson.
This is a question for both WCI and Larry.
When (if ever) is the right time to no longer carry term life?
This is a question I have been toying with recently. Very soon I will be completely debt free and my net worth will be more than triple what my term life policy is worth. While carrying the policy at this point seems unnecessary (or very soon will be), it is now so cheap in relation to my income that I have no reason to stop paying the yearly charge. Surely my kids and wife could use some extra kicker money should I croak tomorrow.
For now I have definitely decided to keep the policy, but at what point is it just silly. When I have 10x what the policy is worth? 100x? I don’t know the answer to this question. I don’t really feel like increasing the policy even though I could afford it, since my wife and kids could currently live very comfortably without it. WCI, with your rapidly growing net worth and income (congrats on the success!) surely you have thought about this. What is your plan?
Thanks,
I don’t know of any way to answer this question other than to get morbid and say, “Ok, I’m dead. What does my family need?”
If what you have now (taking into account market volatility) is enough to meet those needs, why would you carry and pay for insurance you no longer need? I don’t why you would unless you are using it as insurance against a catastrophic market collapse/event at the exactly wrong time (close to when you died).
For what it’s worth, that’s my $0.02.
I think Military Millions has it right. Imagine you were hit by a bus today, and do some stone cold math on what the people who depend on you would be facing.
It’s a bittersweet day when you no longer need life insurance, ha ha 🙂
P.S. I bought a disability insurance policy from Larry and found working with him to be an honest and positive process. I’m happy with the results.
Maybe I didn’t communicate the question well enough. The point I am trying to make is that my family would already have enough right now to do just fine. From a strictly financial perspective I could die tomorrow and my family would be fine even without my current life insurance policy.
However, term life is so cheap compared to my current level of income that I don’t even think twice to continue it. The older I get the more likely I am to die and more likely they will get some extra slush money to donate, or buy whatever they want with. It’s not so much an insurance policy at this point, but an extra winning lottery ticket for my family. So why not continue it….the 1200 bucks a year it costs to pay for it is not going to affect my net worth if used elsewhere. Why would I stop it?
Especially when you buy a level term policy. In some ways, you’ve already paid part of those later years’ premiums, so might as well keep it. I agree it’s a little harder to drop than a disability policy. With disability, it’s worth less each year because it only pays to age 65. But with level term life, you’re more likely to die each year and it costs you less in inflation-indexed dollars.
Tell me what I am missing here plz. If you increase your coverage the insurance company is not taking a loss. Your premium should take into account the number of insured and your cumulative likelihood of dying. Your insurance “should” always be a losing bet (at least from a population perspective.) Carrying coverage that is no longer needed should be on average for a population a net loss. So my vote is drop it and invest or spend your money on you current values. Am I wrong?
I guess I just think that paying for insurance (or anything else) you don’t need is a waste of money, but to each his own.
It nearly always is a waste in my estimation as well unless your privy to pertinent information that the insurance company isn’t (e.g. you’ve been diagnosed with terminal cancer and have less than a year to live).
I continued our level term policies until the level price ended, basicly as a lottery ticket, then quit as the price tripled and more. I’d never considered the point that I’d prepaid for the current lower cost.
This was only a few years after we no longer needed them since they were meant to get the kids to a certain age, and retirement/ FI just ended up coming a few years before then.
My quip was, when we no longer needed the policy, it might just be temptation for murder… I’d’ve ended the policies earlier if our marriage had seemed shakier 🙂 , or if the pay off was so huge it might be tempting (but if your insurance payout would be as unexpected and spectacular as a lottery win, maybe you’re carrying more than you need).