We all know the reality: Term insurance is cheap. By comparison, permanent insurance is expensive.
It’s difficult enough to get clients to take action and buy the amount of life insurance they really need — much less get them to pay five to 10 times as much for permanent life as they would for term. As we in the life insurance industry know, term insurance is at its best when it provides families and businesses the protection they need for a specific and defined period of time.
We also know that families rarely have enough of that protection. The other reality is that when it comes to lifetime solutions, term doesn’t work; it’s neither mathematically nor actuarially designed to be affordable for a lifetime.
Here’s an example. Typically, the 11th year’s guaranteed renewal premium of a 20-year term policy is 15 to 20 times the initial period of guarantees. And it rapidly increases from there on an annual basis.
We always would attempt to underwrite the client for a new policy (albeit with a new contestable period), but sometimes it’s not possible. As a result, the client is stuck in a a term policy that quickly becomes unaffordable. And that may be all we can do. For many in our economy, insuring for a lifetime comes with financial and timing challenges.
Many of our clients start out with large protection needs and significant potential for increasing their income over their working lives. As their income grows, the typical insured client will face a number of options to begin allocating their resources toward the objective of “retiring in the style to which I will have become accustomed.”
How do we advise this type of client and facilitate a schedule to convert their term coverage gradually? How do we customize the coverage to the client’s budget and resources to obtain a portfolio of insurance policies that will cover their lifetime needs?
In addition to the other diversification choices, clients will want to consider their unique risk tolerance, investment experience and time horizon. I advocate a custom-designed portfolio that begins with insuring the client’s core needs with convertible term and participating whole life.
Perhaps the portfolio may be topped off with additional styles of permanent insurance that — in addition to covering human life values — also conform to the client’s needs and expectations for value, annual outlay, accumulation of cash values and death benefit. I describe this as making efficient choices.
A Couple Considers Converting Their Coverage
Let’s consider Paul, a 40-year-old man earning $80,000 a year as a middle manager with a regional auto parts wholesaler. He is married to Sharon, a 35-year-old paralegal making $30,000 working half-time until their 12-year-old daughter and 10-year-old son enter high school.
Although their combined income is above the national median, it has been difficult for them to balance all the current needs of running a household. Saving for retirement has been restricted to less than $8,000 a year withheld from their salaries in 401(k) accounts.
Fortunately, this couple “gets” the difficulty of maintaining a reasonable standard of living if either of them were to become disabled or die prematurely. They are in the 11th year of 20-year $1 million and $400,000 term policies on him and her, respectively. They also have acquired disability income policies offering $4,000 and $1,500 per month of income protection, respectively.
Paul and Sharon are ready to reprioritize their budget to increase their annual retirement savings significantly. They have been able to free up $10,000 now. They expect to have an additional $20,000 a year available when Sharon returns to work full time during their younger child’s freshman year in high school – five years from now. Paul and Sharon also have determined they want to maintain their combined $1.4 million of death benefit protection until each of them turns 50 — with progressive reductions to a lifetime amount of $500,000 on Paul and $200,000 on Sharon. They consider this as the legacy that — at a minimum — will give their children more flexibility when planning their own retirement.
Here’s the strategy we would discuss with this couple:
With the $10,000 additional savings allocation for the next five years, we would recommend putting up to 50 percent into risk-appropriate mutual funds or exchange-traded funds. At the same time, we would re-underwrite their current term insurance to new, select-age policies that will save money now and allow for eventual conversion to whole life in order to obtain the ultimate amount of lifetime coverage.
When the couple is able to increase their savings in five years, we would draw up a plan to continue converting their term insurance. This would better ensure the long-term affordability of that lifetime coverage with the added benefit of providing a substantial cash reserve to draw upon in retirement.
Focusing on the consumer’s question of “what kind of policy is best for my circumstances and needs?” we find it useful to consider how advisors make strategic asset allocation recommendations to new clients.
Assessing Risk Tolerance
Typically, in the first interview with a client, the focus will turn to assessing risk tolerance in the typical categories of conservative, balanced and aggressive allocations. As we might expect, speculative options will not be attractive to someone with a conservative risk tolerance.
In fact, such a client will be drawn to policies with substantial guarantees, such as participating whole life. Similarly, a client with an aggressive risk tolerance naturally will be drawn to some of the current assumption policies of life insurance, although — surprisingly — we find that the more aggressive the client’s investment style, the more conservative their insurance style!
Remember that universal life-type policies don’t have stipulated premiums. We calculate them in response to the client question “What’s it gonna cost?” The typical problem with calculating UL-type planned premiums is the tendency to assume overly optimistic crediting rates in preparing the illustration.
For most clients, the “pricing” reality of current assumption policies is demonstrated best using the more realistic planned premium calculation rates suggested in the chart on this page. After clients understand that the substantially higher calculated premiums are more likely to sustain the coverage — although that’s still not guaranteed — many will choose participating whole life with its guaranteed premiums and substantial accumulation of tax-advantaged cash value growth (as long as premiums are paid when due).
These are not arbitrary numbers. With today’s extremely low fixed-income returns, an insurer’s bond portfolio cannot reliably support higher than a 3 percent UL projection for the foreseeable future. For indexed universal life and variable universal life — policy styles whose crediting rate depends on direct or indexed performance of the stock market — extensive volatility research with sophisticated software tools provides the “safe” initial illustration rates indicated in the chart.
The slogan “Buy term and invest the difference!” largely has been discredited. One reason is that it’s human nature to want to spend the difference on more attractive and immediate things. Another reason is the actuarial and mathematical construction of term insurance: It’s not designed for a lifetime.
And although that’s a catchy slogan, advisors and their clients will appreciate the fact that life rarely imitates cliché. When lifetime needs or the uses of life insurance seem indicated by a factual pattern, are supported by financial resources, and address the client’s desire to provide for their family or heirs, a more sophisticated approach must be taken. That approach must consider risk tolerance and the opportunities for additional asset accumulation with specific tax advantages from life insurance designed for a lifetime.