Life Insurance

You can learn the nuts and bolts of buying life insurance.

Life insurance, like other kinds of insurance, is a kind of gambling proposition. You bet that something bad will happen to you, while the insurance company bets that it won't, at least not until it's made enough money to cover its losses if you win your bet. Of course, with life insurance, if you do win, you're not around to collect on your wager. The proceeds of your policy will be given to whomever you name in the policy as your beneficiary.

Life insurance comes in a bewildering array of variations. There's whole life insurance, variable life insurance, and universal life insurance, all of which are collectively known as cash value life insurance policies. With these policies, a portion of the premium you pay goes to purchase insurance coverage, while another portion is used as an investment. Taxes on the investment portion of the policy are generally deferred until you collect the proceeds.

Insurance companies love to sell cash value policies, since the amount they pay you on the investment portion of the policy is always less than what they expect to make on the investment of your money, and their salespeople will almost always try to convince you that a cash value policy is the best way for you to insure your life. But no matter how persuasive they may be in this regard, it's important to remember that insurance salespeople rarely have your best interests as their sole motivating factor. They are paid a commission on the policies they sell, and they receive their highest commissions when they sell you a cash value policy.

To defray the costs of those commissions, the insurer simply builds higher costs into the premium you pay, or credits you with less interest during the early years of the policy. With some whole life policies, for example, you don't get any of the investment portion of the premiums returned if you cancel the policy during the first two or three years of ownership. And even after ten years of paying premiums, the accumulated cash value of your policy will be just about the same as the total of your premium payments.

Of course, you will have had life insurance coverage for the entire period of time. But there's another way to get good life insurance coverage to protect your loved ones at a much lower cost, one that leaves you with plenty of money to invest in higher yielding investments than a cash value policy.

For a premium that's about one-eighth to one-tenth of what you'll pay for a cash value policy, you can purchase what's known as term life insurance. In fact, because the premiums are so low, you can afford a term policy with a much larger death benefit than what a cash value policy offers. Most term insurance premiums rise a bit each year you own your policy, but the increase is usually minimal, and since your income will most likely have risen as well you probably won't even feel the increased premium.

In some cases, you can buy what's known as 5 or 10 year level premium term life. Since the premiums don't rise every year, you pay somewhat more in premiums at the beginning, but you may end up paying less at the end of the term than you would if you had purchased an annual term policy.

Although term life insurance policies are generally a much better buy than cash value policies, there are some kinds of term insurance coverage you should try to avoid. One such policy is mortgage-life insurance. A mortgage-life policy pays off the mortgage on your home. But your beneficiaries may have enough income to meet the mortgage payments and would be better served if they could put the proceeds of the policy to some other use, such as paying for educational or medical expenses, for investments, or merely to help pay everyday living expenses. With a mortgage-life policy, they get no say in how the proceeds are spent.

On top of that, consider the fact that most mortgage-life policies are what's known as "decreasing" term insurance. This means that as the balance you owe on your home decreases, so does the amount of insurance coverage you have. For the same amount of money or less, you could buy a regular term insurance policy and know that if you died while covered the policy would pay a specific amount to your loved ones.

For the same reasons, buying credit-life insurance to pay off a car, a boat, or some other personal debt if you die before you make the last payment is usually a mistake. You can get cheaper insurance coverage elsewhere without limiting how your survivors can spend it.

You should also avoid life insurance policies sold by companies through television advertisements that prey on the elderly by suggesting that they won't be able to afford a decent funeral for themselves or their spouse without some extra coverage. These policies cost much more than policies bought elsewhere, and they pay very limited benefits for the first several years of coverage -- usually, all you get is the refund of premiums paid.

There's no hard and fast rule about how much life insurance coverage you need. An adequate policy is one that will allow your surviving spouse and other dependents to keep up the lifestyle they have now. If your spouse works outside the home, you may need to purchase less coverage than if he or she has no independent source of income.

In fact, some people don't need to buy any life insurance at all. If you are young and single with no dependents, there's no need for you to own a life insurance policy. If you're retired, your children are on their own, and your pension, investments and Social Security benefits will adequately provide for your spouse, you probably don't need life insurance either, unless you have so much money that the policy would be used to pay off your estate taxes. And don't forget that your employer may provide group term coverage at no cost to you as an employee benefit. If the amount of this coverage is adequate, there's no need to buy additional life insurance.

If you have life insurance, in most cases you won't be around when it comes time to pay off. However, some insurance companies have begun to offer policies that allow you to collect at least some of the death benefit on the policy before you die, but when you're faced with an expensive terminal illness, such as full-blown AIDS.

Otherwise, it will be up to your beneficiaries to collect the death benefit on your policy. Of course, it will be much harder for them to do so if they don't know where your policy is, so be sure to let your spouse or the person you designate as the executor of your will know where to find it.

To file a claim, the beneficiary will need to notify the insurance company's claims department. The claims department then sends a form for the beneficiary to complete and return to the claims department along with a certified copy of the insured's death certificate and the policy itself. Always remember to keep a copy of the policy, and mail everything to the insurer by certified mail, return receipt requested.

Always be sure to name a beneficiary on your life insurance policies. When you do, the money passes to the beneficiary free of any probate delays or expenses. If you don't name a beneficiary, or if the beneficiary died before you did, the policy's proceeds are considered part of your probate estate, and it could be months before they are distributed. It's another good reason to take a day every year in order to review your affairs and make sure that everything is up to date.

In most cases, your beneficiary will receive a check in the mail for the lump sum amount of the death benefit, unless he's indicated that he wants the money converted into an annuity which pays a specified sum every year. However, some companies make a point of having a company representative deliver the check in person. While insurers claim that this is evidence of how much they care about their customers, in fact it's just one more way for the insurer to try to convince you to buy one of its products.

As the beneficiary of a life insurance policy, you don't have to accept a visit from a salesman in order to get the death benefit paid to you. When the salesman calls to schedule an appointment, thank him politely for his concern and interest and then tell him to mail the check. If you want to buy something from him later, fine, but you shouldn't make any financial decisions while you're under the stress of a recent death, or feeling obligated to the insurance company for its "generosity."

Although most life insurance claims are paid without much fuss on the part of the insurer, there are times when a claim may be delayed or even denied. The most common problem occurs when the insured person dies within what's known as the "contestability period," typically the first two years that the policy is in force. During this period, if the person named in the policy dies, the company has the right to investigate the cause of death to be sure that the person insured didn't misrepresent his health in order to obtain the policy. For example, suppose you died of cancer within eight months of buying your policy. You knew you had the disease at the time you bought the policy, but you lied about your health on the policy application. Your beneficiary wouldn't be able to collect on the policy because of your failure to disclose the disease, which amounted to using fraud to get the coverage.

Unfortunately, some insurance companies use the contestability period to deny payment of death benefits when they have only the slightest evidence (or even no real evidence at all) of a misrepresentation by the insured. They may refuse to pay, hoping that the beneficiary will simply not pursue the claim, or they may agree to settle the claim for a smaller amount by suggesting that a court battle to make them pay the full amount will take years. If the beneficiary needs the money, he may decide to settle and take the smaller amount just to meet mounting expenses.

An insurance company that refuses to pay a legitimate claim is acting in bad faith, and it can be liable not only for paying the benefit but also for punitive damages for its intentional failure to honor its contract. For a more thorough discussion of what constitutes bad faith, you should visit the next section, where we discuss insurance companies in more detail.

Like other kinds of insurance companies, most life insurance companies are regulated only on the state level. If you have a question or complaint about the tactics used by a life insurance salesman, or if you have a problem with the way a life insurer handles your claim, you should contact your state department of insurance.

You'll find the addresses and telephone numbers of your state's insurance regulators in the government listings of your white pages telephone directory. But be aware that some state insurance departments are less than zealous in guarding the rights of consumers. You may have to file a lawsuit to collect on a life insurance claim that was denied for no legitimate reason.