Is Term Life Insurance a Scam?
Is Term Life Insurance a Scam?
At a time when we can’t collectively agree on much, a healthy distrust of insurance companies is an opinion that almost everyone can get behind. After all, most of us will spend decades of our lives paying for insurance and, if we’re lucky, never see any tangible return for that payment.
For many, high on the list of products that seem suspicious is the term-life insurance policy—one where you pay fixed premiums for a given term (typically ten to thirty years), and then, when the term lapses, if you’re still alive, either the insurance itself is gone, or you are given an opportunity to renew the insurance, but at a much higher premium.
It’s easy to see where the notion that this is a scam comes from. Most people are sold term policies when they are young, and unlikely to die. Then, twenty years go by, the notion of mortality becomes a bit more real, and suddenly, they’ve paid for something for most of their adult lives that is gone or suddenly becomes cost-prohibitive to keep.
But the truth is, in most financial plans, term life insurance plays a vital role at some point in our lives, particularly if others (like a spouse or children) count on us to provide for them, or if we’ve made joint financial commitments and obligations that won’t evaporate just because we’ve passed away.
Understanding the Role of Life Insurance in a Financial Plan
No amount of forward-thinking financial planning allows us to predict the future. We make financial plans with the understanding that the minute we make them, things will likely start to deviate from the plan. 
In, “The Problem with Plans,” Carl Richards describes this as analogous to a pilot creating a flight plan. Every pilot starts out with a plan for their flight, but almost no flight goes exactly according to plan. There are so many variables that cannot be predicted with precision during a flight, that while the plan is important, it is not actually a map of exactly how the future will unfold. The pilot must be able to adapt to changing conditions, and in some cases even worst-case scenarios, to safely take the plane from Point A to Point B.
Similarly, no financial plan, no matter how good the planner is, or how diligent the clients are, is a map of how the future will play out. So, any good financial plan will not only help clients prepare for small bumps in the road, but also worst-case scenarios. It isn’t just about saving, investing, and watching your money grow, it’s also about thinking in advance about the potential for catastrophic loss, and, where possible, protecting against it.
For most people insurance (not just life-insurance, but all forms of insurance) is one of the most effective ways to protect a financial plan from catastrophic loss. Life insurance protects families from being financially devastated by the loss of their major income providers. And though there’s very little that can protect us from the emotional hardship created by the loss of a loved one, to be able to prevent undue financial hardship alongside that emotional loss is one of the most responsible things we can do to protect those who rely on us as providers.
Why Term Insurance?
Financially protecting our families from our loss is more important at certain times in our lives than others. Our need for life insurance often changes drastically depending on our age and situation.
In many cases, when a couple or young family is relying heavily on the income of one or both partners to meet their financial obligations, it’s extremely important to financially protect against the loss of these income earners. There are often many current and future expenses to consider: mortgage, future college costs for kids, and the financial obligation of meeting basic monthly living expenses on a single paycheck. At this age and stage, a lot of life insurance is likely needed to provide this type of protection.
Once a couple is retired, their kids are financially independent, and their mortgage is paid off, the loss of a partner’s or parent’s current and future earning potential is usually not nearly as impactful to the surviving family’s ability to maintain their current lifestyle.
A permanent, or whole life insurance policy, though it has the appealing feature of not evaporating into thin air at some point ten to thirty years down the road, often does not account for the changing life insurance needs a person has as they age. Further, a permanent policy with a high enough face value to provide real protection for one’s family when they are young and in a wealth-building phase of life is more likely to be cost-prohibitive. For example, the average cost of a 20-year term policy with a $500,000 face value, for a forty-year-old purchaser is $27 per month, but a permanent policy with a comparable face value for the same applicant has an average cost of almost $500 per month. The end result is often that policyholders who will only consider permanent forms of life insurance are often severely under-insured—carrying too little coverage when it is most important, and in some cases, more than they actually need in their later years of life.
Determining How Much Life Insurance You Need
Part of my job as a financial planner is to help clients decide how much and what types of insurance they need. But if you’re trying to determine your life own insurance needs, a good place to start is by asking the question: What do I want to make sure is paid for if I am no longer around to provide for my family? Items like mortgage payoff, kids’ college expenses, and a certain number of years’ worth of salary replacement will often make the list. If you total up what these things would cost, that will tell you roughly how much the face value of a policy should be to make sure your family has adequate protection.
The length of the term should depend on how soon these expenses will be paid for or paid off. For example, a family whose kids are and 14 and 16 with ten years left on their mortgage and nine years until retirement would probably be well covered by a 10-year term policy. But a family that’s just starting out, with very young children, a 30-year mortgage, and 30 or more years until retirement should consider a longer term, like thirty years.
It’s important to remember that while you may have the option to renew at the end of your term, it will likely cost you a lot to do so, so you want to adequately plan for the term you need when you are purchasing a policy.
Where to Buy Life Insurance
It’s a good idea to shop around for multiple quotes, as they can vary widely between insurance companies and agents. If you work with a broker, rather than an agent who is captive to one company, they can often get multiple quotes for you from different companies. It’s also a good idea, when reviewing quotes, to evaluate the underlying financial health and reviews of the companies you are considering. Often paying a bit more for a policy from a company that is well-rated and has a strong underlying financial position will be better in the long run than simply looking for the cheapest policy out there. Typically, an insurance agent or broker should be able to provide you with the ratings from Moody’s, Fitch, and A.M. Best, the three major organizations that review the underlying financial positions of insurance companies. Additionally, it’s always a good idea to check with your state insurance commissioner’s office, as they collect and maintain a lot of data related to claims coverage and complaints.
While many people have life insurance available to them through an employer, this is not always the most affordable or strategic way to purchase term life insurance. Often, an applicant in good health can get better rates by shopping the private market than through a group employer-provided plan. In addition to possibly being more cost-effective, private policies will stay with you if you change employers or lose your job, and many group plans offered by employers have rates that increase as you age, but a term plan will lock in your rate until the term expires. By locking in a rate with a private insurer early and when you are in good health, in the long run you could save a lot of money and ensure your family’s protection even in the event of job change or loss.
What happens when the Term Expires?
For many folks, this is when the feeling of anger at an insurance company can emerge around their term policy. Typically, just before the policy expires, consumers may be provided offers to extend the term, at a far higher monthly premium rate than before. Since ten, twenty, or thirty years may have passed, it’s easy to see how some consumers may have forgotten why they chose their original term and face value amount in the first place. It was because they anticipated that their life insurance need would be far less at this point than it was when they bought the policy. And if their original decisions around term-length and face-value amount were well informed, and their financial situation isn’t too different than they expected it to be, it’s likely at this point that it should be just fine to let the policy go. It did its work, for a relatively low cost, protecting their family for as long as they needed it to. And it was always designed to be more like a subscription streaming service than a comprehensive hard copy of your favorite music collection that you would own forever. That’s why it was so affordable to begin with.