Buyers Of Life Insurance Face Complicated Choices

December 17, 1990|The Washington Post

Little in life is more complicated than life insurance. Few people outside the industry, and possibly not everyone inside it, understand all the ins and outs of choosing the right size and type of policy.

On top of that, life insurance is expensive. So if you make the wrong choice, you may be out a lot of money, and your beneficiaries may not get the protection you expect.

All insurance is complicated, of course. Indeed, it has become synonymous with fine print and escape clauses that somehow always seem to let the insurer off the hook.

One company is even advertising that it will not sell you a policy until you understand it. What this suggests about the way other companies -- and perhaps this company in the past -- market their products is not exactly reassuring.

But for many people, life insurance represents a prudent way of protecting loved ones against financial hardship in the event of the person`s untimely death. So they need to address the question of how much insurance they should buy, and what kind of policy or policies they should have.

This discussion is not meant to take the place of expert advice; it is intended, rather, to give a general picture of needs and options.

The first question is whether you need life insurance at all. You may not. If there is no one depending on your earning power -- no young children, for example, who will be needing college money -- and your estate is not so large and illiquid that your heirs need instant cash for taxes, you probably do not need a policy.

If your death would mean economic hardship for someone, you do need insurance. But what kind?

Insurance can be divided several ways. There are group policies and individual policies. There are term policies and cash-value policies.

To understand the differences, look first at the way insurance works. Basically, insurance is a bet. The insurance company bets that if you give it some money, either all at once or over a period of time, it can invest that money and make enough to pay the promised benefit when you die.

Plainly, the company does not always win. People who take out policies and die a year or two later cost the company money. But in the aggregate, the company thinks that enough policyholders will live out their life expectancies to provide a profit.

Policies that offer only a death benefit and cover only a specific period of time are called term insurance. These policies usually offer the most death benefit per premium dollar, and they make excellent sense for consumers who need insurance, but only for a limited time.

For example, a term policy could be used to ensure that money will be there for college.

``But eventually the kids get out of school, so you don`t need that money anymore,`` said William G. Brennan of the accounting firm of Ernst & Young.

Likewise, a term policy could fill in for your salary if you die, protecting your spouse. But ``pension plans kick in`` after you reach a certain age, and if yours provides an adequate survivor benefit for your spouse, you probably do not need insurance, Brennan said.

But there are some drawbacks to term insurance. Premiums often rise with age. Renewal may require a physical examination, which you cannot be sure of passing. So for longer-term needs, Brennan suggests a cash-value policy.

In such a policy, part of the premium goes to cover the death benefit, just as in a term policy. But an additional part of the premium goes into some sort of savings or investment vehicle.

With traditional whole-life policies, this is a savings plan, and the insurer guarantees to pay a certain interest rate to you. This feature allows the company to keep the premiums level as the policyholder ages.

As time passes, this money, known as the ``inside buildup,`` accumulates, creating a fund that the policyholder can borrow against or get returned if he or she cancels the policy.

Whole-life policies were widely criticized for providing inadequate returns on the investment portion of the premium. Such criticisms helped lead to the development of other, more investment-oriented cash-value policies.

One such type is called universal insurance. These policies promise a higher rate of return, at least initially. However, the return is usually reset at intervals and may fall in later years.

Another relatively new type is variable life insurance. Generally, the policyholder is offered a choice of investment vehicles -- mutual funds, money-market funds and the like -- and can allocate the investment portion of the policy. The investment risk falls on the policyholder -- that is what they mean by variable -- but for the person who thinks he or she can beat the returns offered by other policies, variable life can be attractive.

Two other developments in life insurance also are worth noting.

The first is called ``survivor life`` or ``second-to-die`` policies. These cover two lives, usually a husband and wife, and pay on the death of the second.

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