Life Insurance Explained
Al Waller: In theory, having life insurance can be a means of helping to protect our loved ones and is typically a vital part of everyone’s financial planning. However, according to LIMRA, a leading life insurance trade association, half of American adults — representing 129 million people — say they don’t carry life insurance. Like so many financial topics, life insurance can also be confusing, resulting in consumers having misconceptions about it.
Welcome back to ClearPath – Your Roadmap to Health & WealthSM. I’m your host, Al Waller. With me is Catherine Collinson, CEO and president of nonprofit Transamerica Institute®. Catherine is here to explain life insurance.
But before we get started, I want to remind you that we would love to hear from you and learn what topics you would like us to cover. Please drop me or Catherine a note at [email protected].
Catherine, could you begin by providing us with a brief explanation of what life insurance is?
Catherine Collinson: A basic definition of life insurance is that it’s a financial protection product that pays a death benefit when someone passes away.
Al Waller: Fair enough. However, it's been my experience that this field tends to become more complicated as you start peeling back the layers. So, I'm hoping you'll be able to gently help our listeners get a better handle on life insurance today.
Catherine Collinson: Let's start by acknowledging that life insurance is a difficult topic for many people because it involves conversations about the unthinkable – about death. Of course, the whole point of life insurance is to provide money to an individual’s loved ones should they die, however, it doesn’t make these conversations any easier. For this reason, I am pleased that we are talking about life insurance today, so we can share helpful information and encourage others to have an open a dialog with their family and with their loved ones.
Today, I’d like to cover three broad topics:
- Who should have life insurance and why
- Main types of life insurance
- Where to obtain life insurance
Al Waller: Perfect – I'd like to start by identifying who should have it because it does seem like it would be a pretty wise move for people in various life stages and circumstances to have at least some form of life insurance, right?
Catherine Collinson: Generally speaking, Al – yes, you are right. The question of who needs life insurance is highly personal.
A somewhat simple or straightforward way to think about it is to pose the question “if a person were to pass away, would anyone suffer financially.” If the answer is “yes,” then there’s a good chance they should consider life insurance.
Al Waller: I think that helps frame the question. If you wouldn't mind, could you provide examples of some real-world situations where life insurance might just prove to be appropriate and beneficial?
Catherine Collinson: Of course, two examples are couples and parents and let me take them one at a time.
Many couples rely on each other's income to share expenses, and not all of those expenses would be less if one or the other were to pass away. Housing, in particular, is quite expensive and a fixed expense, whether it's a mortgage or rent. If one were to lose their spouse or partner, would they be able to manage that expense on their own? If the answer is no, they may need life insurance. It's also even important to consider how practical it would be to find a place to live. Could they afford it on their own?
The second example is parents. Parents may want to consider life insurance to help cover the cost of raising their children and supporting their education in their absence. Single parents are particularly vulnerable and should take care in considering the needs of their children if something were to happen to them, so that their child could be provided for.
Even stay-at-home parents need to value their parenting and household management efforts because as awful but practical as it is – there's a cost associated with paying for or obtaining those invaluable services if they're not here or able to provide them.
Al Waller: Good points – especially, ones I want to highlight are relating to college tuition expenses. Those costs are astronomical across the board.
Another one that comes to mind is the cost of childcare, which can be really significant, and chances are folks may just be overlooking the value of unpaid childcare in their planning. That could place you even further behind the eight ball under some already challenging circumstances.
Now, what about the other ends of the age spectrum – should retirees or young people for that matter carry life insurance?
Catherine Collinson: Again, I need to underscore that these decisions are so personal – and vary widely. So, my answer is “it depends.” Let’s go back to the question we posed earlier – that big framing question – would someone suffer financially if you were to pass away?
Suffer financially could be loss of income, but it could also include unpaid caregiving, which is typically even more expensive than childcare – and particularly relevant for older individuals who are more likely to need some form of caregiving, especially later in life.
Also, you need to check whether or not you have adequate resources to cover funeral and burial costs, which is another potential reason to obtain life insurance.
An example of people who may not need life insurance includes a family in which the parents are financially set, and the adult children are fully grown and self-sufficient and on their own and everyone can afford burial costs. So, this is an example of those who are less likely to need life insurance, but there are examples out there that I wanted to point out.
Al Waller: Well, Catherine, I'm glad we're having this conversation because I think talking through examples definitely helps paint a picture and provides us with some valuable food for thought.
Now, you alluded to your second topic in terms of types of life insurance. So, could you delve into that for us?
Catherine Collinson: Yes – indeed. There are a number of different types of life insurance and with variations and nuances. For this podcast, I’m going to focus on the two most common types of policies – term life insurance and permanent life insurance.
Term life insurance is the type of life insurance most people are familiar with. It pays a cash benefit to your loved ones (also known as your “beneficiaries”) if you pass away during the term of the policy. The term is the duration of the policy – how long the policy lasts. Typical terms are 10, 20 or even 30 or more years.
For example, if someone obtains a 20-year term life policy when they are age 30, that means the policy will continue until age 50 – or twenty years later. Some people pick a milestone for the term of their policy, such as what year they anticipate their children will graduate from college or maybe the year their mortgage is fully paid off and they are getting ready to retire. So, terms can be very personal based on your own financial situations and needs.
Something important to note about term life insurance – it's typically the least expensive type of life insurance. And Al, as obvious as it may sound – you have to make your premium payments to term life policies for them to remain in force. Premium payments are typically made on a monthly or yearly basis. If you stop making those payments at any time and the coverage lapses, then you're no longer covered.
I'll point out – once that policy lapses, if you later on, try to go get life Insurance, it may cost more, simply because you're older. Life insurance is typically more expensive for older people – even if they're in good health.
Al Waller: Well, you're spot on there, Catherine. And beyond the age differences, there may be health issues one might encounter along the way that could significantly bump up the cost of buying insurance. So, by all means you want to make sure your policy premiums are paid in a timely fashion.
Now, given that there are tradeoffs and types of policies and their respective costs, then what type of life insurance could provide coverage for someone's entire life?
Catherine Collinson: That would be permanent life insurance, the most common of which are whole life and universal life insurance. Like term life, which we just talked about, these policies offer a death benefit, and they have several additional features.
As its name implies, permanent life insurance covers you for your whole life. These polices also build a “cash value” over time by directing a portion of your premium to investments. Some types of permanent life insurance investments provide a fixed rate of return, while others are variable because they are invested in the market.
Al Waller: Good to know. Are there any other features that would be offered within a permanent life insurance policy?
Catherine Collinson: Once someone has built up their cash value, they can “borrow” from it to use in any way they like. However, if they don’t pay themselves back, their death benefit could be reduced.
These policies also require that people pay their premiums. And as a reminder, these policies can be in force a long time because they are permanent to age 90, 100, or even older, depending how long the policy holder lives.
However, because policy owners have built up a cash value, some policies have a feature that enables people to use the cash value to make their premium payments. Also, something I want to point out – if for any reason, someone no longer wants or needs their policy, they can surrender it and be paid out what they have accumulated in the cash value.
These features make permanent life insurance more expensive than term life insurance. As I said, there are several types of permanent life insurance, and they all can include lots of variations in features. I've just touched on some of the high points, but there's even more to them than what we're talking about.
Al Waller: Well, thank you for walking us through these two types, and as you've noted, while the purpose to protect and provide for one's loved one remains consistent, there is clearly more than one way to achieve that end.
Now in terms of where to buy life insurance, I can tell you that having been engaged in employee benefits, many employers typically offer term life insurance to their employees as part of the overall benefit package.
So, I'm curious, did your annual survey among employers explore this prospect?
Catherine Collinson: Indeed, it did. In our most recent survey of employers, we found that 36 percent offer life insurance to their employees, and I want to point out that larger companies are much more likely to do so than smaller companies. For example, seventy percent of large employers (500+ employees) offer life insurance.
Al Waller: Well, is there anything specific we should know about employer-offered life insurance? I guess what I'm really driving at is if someone is offered it, can they simply check the box and feel they're done thinking about the subject?
Catherine Collinson: Al, I wish it were that simple. There are actually several scenarios in which employers offer life insurance. Let me unpack it, and we can delve into it a bit.
One scenario – some employers offer their employees the ability to purchase life insurance during the annual benefits enrollment period. This enables employees to take advantage of the group rate that their employer has negotiated, and it can be a really cost effective way to get insurance.
Another scenario – some employers provide their employees with a term life policy which is usually equal to 1 year salary and the employer pays the premiums for it. A third scenario is some employers do both which enables their employees to increase the death benefit above and beyond their annual pay.
Al Waller: I think you bring up an important point, specifically that policies that companies pay for typically translate to just 1 year's salary. In my mind and especially in this day and age, that just doesn't sound like enough for someone needing to provide for their family, does it?
Catherine Collinson: Al, that’s right. Experts advise having a benefit of 10-15 times your annual salary, according to LifeHappens.org. Again, personal situations will vary. But the most important thing is that people who are fortunate enough to have life insurance paid by their employer still need to do their homework to determine how much coverage is right for them, and if they need to have additional coverage above and beyond their employer’s policy.
Some other ways to get life insurance that I want to touch on – outside of the workplace – if you're looking for and considering life insurance, you could work with a licensed insurance agent, financial advisor, or directly with an insurance company. Ask family and friends for referrals or check with the financial institutions that you're already doing business with.
Al Waller: Well, judging by the amount of coverage your sources suggest, I'm glad to know I'm in the right ballpark.
Is there anything else you'd like to share regarding life insurance?
Catherine Collinson: There are 4 vocabulary words that I think are important for our listeners to know as they're considering life insurance.
- Medical exams: It’s important to know that many policies require a medical exam, which is used to determine an individual’s premium, or their cost for the policy. Generally, healthier people pay lower premiums. Some policies do not require an exam, and instead rely on a few health-related questions.
- Portability: This applies to employer-sponsored or employer-offered life insurance. Some employer-offered policies are “portable,” meaning that an employee can retain the policy, even after they leave the employer. This involves the employee paying the premiums directly to the insurance provider. Keeping the policy may not necessitate a medical exam.
If you are considering changing jobs or maybe you've changed jobs and you want to keep your life insurance policy, it's super important to check with your HR Department and benefits provider to see if your life insurance is portable, and you can do this. It is offered in the industry, but not all employers offer it as part of their life insurance benefit
- Age: I've touched on this a couple of times, and as our listeners may have expected, policies are generally less expensive for younger people – particularly permanent life insurance.
- Riders: These are add-ons for optional coverages that can be bought and “ride” on the basic policy. Common riders include accelerated death benefit riders that provide payments for people with terminal illnesses or critical illnesses while they are still living. Another common rider is spousal insurance that extends someone’s policy to also cover their spouse.
Al Waller: Well, there you have it – a whole new vocabulary to navigate the field. Catherine, where can folks go to learn even more about life insurance?
Catherine Collinson: I mentioned LifeHappens.org – it has educational content about many types of life insurance, disability, and long-term care insurance, as well as annuities.
Another source is the Insurance Information Institute at iii.org. There are so many providers offering life insurance, types of policies, variations in terms and benefit amounts – this is an area where you really need to do your homework and do some comparison shopping as you’re out seeking to obtain life insurance.
Al Waller: Catherine, thank you very much for sharing all these valuable details and at the same time boiling it down and making them a lot more comprehensible.
In case listeners want to review what we covered today, I want to remind them that the full transcript of this and all past episodes are available on wypr.org. There you can also check out episodes on “Medicare Enrollment 2023 Explained” and “Four Generations Emerging from the Pandemic.”
Don’t forget that we really want to hear from you with ideas for future episodes, comments, or feedback. Email me or Catherine at [email protected].
Until the next time, I’m your host Al Waller. Stay safe, be well and thanks for listening.
ClearPath – Your Roadmap to Health & Wealth is brought to you by Transamerica Institute, a nonprofit private foundation dedicated to identifying, researching, and educating the public about health and wellness, employment, financial literacy, longevity, and retirement. You can find our weekly podcast on WYPR’s website and mobile app, wherever you get your podcasts, and at transamericainstitute.org/podcast.
ClearPath – Your Roadmap to Health & Wealth is produced by the Transamerica Institute with assistance from WYPR.
The information provided here is for educational purposes only and should not be construed as insurance, securities, ERISA, tax, investment, legal, medical, or financial advice or guidance.
