Life Insurance: Who Needs It?

Just about everyone needs it, but there some important decisions to be made.

Life insurance is a complex and often misunderstood financial vehicle. In order to make an informed decision about the type and amount of life insurance to purchase, the insured’s personal and financial goals, available resources, and tolerance for risk should be evaluated. When considered in the context of an overall financial plan, life insurance can be used to accomplish a variety of goals:

Amount of Coverage: To determine the amount of insurance needed, analyze anticipated expenses and consider sources of income available to meet those costs. Life insurance needs change over time -- the age of the insured will impact the amount of coverage. A reassessment of insurance coverage would be prudent following events such as a marriage, birth of a child, changes in children’s needs, and growth in personal wealth. Common formulas or "rules of thumb" to consider when determining how much life insurance to buy include

Of these three methods, the needs approach is the most accurate for determining the amount of insurance needed to provide for future financial requirements.

Term Insurance: There are two basic types of life insurance -- term and permanent insurance. Term insurance provides a death benefit during the life of the policy, but there is no buildup of cash value (term insurance is considered "pure insurance"). Premiums for term insurance are significantly lower than those for permanent insurance when the insured is young or during the early years of coverage; however, premiums escalate over time. Term insurance is generally most appropriate for specific short-term needs.

There are a several term insurance products available. The most common is Annual Renewable Term; even though premiums increase each year, these policies can generally be kept in force without requalification until the insured reaches an advanced age (for example, 75 to 80). Level Term policies have a fixed (guaranteed) amount of coverage for a specific period of time (usually 5, 10, or 20 years). In Decreasing Term insurance, the level of coverage declines gradually over the term of the policy, but premiums remain at a constant level. Renewable Convertible Term insurance provides renewable coverage and the option to convert to permanent insurance at any time.

Permanent Insurance: This type of insurance is generally appropriate for long-term needs (for example, estate and retirement planning).There are two basic types of permanent insurance -- whole and universal life. Whole Life insurance is a cash value policy with a fixed death benefit that endows at age 100. Premiums usually start higher than term insurance premiums, but payments are at a fixed level for the insured’s life. A minimum cash surrender value is usually guaranteed, and the insured can borrow against the cash surrender value. In some cases, the insurer pays dividends to policyholders (which can be used to purchase additional coverage).

Universal Life insurance is also a cash value policy; however, these polices permit the insured to adjust premium payments (within limits) and increase/decrease the death benefit. A universal policy’s death benefit can also increase or decrease with changes in the policy’s cash value. There is usually a guaranteed minimum schedule of cash values and death benefits. Because the insured earns market rates of interest on the policy’s cash value and shares investment risk with the insurance company, universal life premiums are generally lower than whole life premiums, but higher than premiums for term insurance.

Variable Option: Variable insurance (whole or universal) allows the policyholder to select investment vehicles (for example, stocks, bonds, money market funds) for the insurance contract. Consequently, cash values of variable policies are not guaranteed and will fluctuate with investment performance (that is, the insured absorbs the investment risk).

General Guidance: Following are some guidelines for selecting life insurance products. As discussed above, life insurance decisions should be tailored to specific goals and financial needs (including time horizon and risk tolerance).

Risk Tolerance	Short-Term Need (up to 10 years)	Medium-Term Need (10-25 years)	Lifetime Need
Aggressive	Term	Variable Whole Life or Universal Life	Universal Life or Variable Whole Life
Moderate	Term	Whole Life or Universal Life	Whole Life
Conservative	Term	Whole Life	Whole Life

Accelerated Death Benefits: Enacted as part of the Insurance Portability and Accountability Act of 1996, certain policyholders can receive tax-free accelerated death benefits. Proceeds from the sale or assignment of a life insurance contract to a licensed settlement provider (or an individual who meets certain insurance regulations) will be tax-free. Accelerated payments are available for two types of policyholders: (1) terminally ill patients (physician certified illness reasonably expected to cause death within two years), and (2) chronically ill individuals (generally, a person who cannot perform at least two activities of daily living -- eating, toileting, transferring, bathing, dressing, continence). These rules became effective Jan. 1, 1997.

These are some thoughts to consider regarding life insurance coverage. Your Deloitte & Touche LLP financial advisor can provide additional information and should be consulted before any action is taken. Our guide Insurance Against the Unknown can also provide additional information.

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	Life Insurance: Who Needs It? Personal Finance Advisor by Deloitte & Touche OnLine July 7, 1997