Understanding Life Insurance
Layering
In some situations you may find that the amount of coverage you need changes over time – specifically we may assume it declines. The solution to this is to structure a policy with different types of coverages or classes within it. Layering different terms, or term and permanent, can give you an insurance policy that has decreasing coverage.
Lets say you need $1MM of coverage for the next 20 years, and then $250K for the next 10 years (for a total of 30 years). A $1MM term 20 policy doesn’t last long enough, and $1MM of term 30 is overpaying for the last 10 years where you only need $250K. The solution is to purchase a policy that combines $750K of term 20 with $250K of term 30. This gives you:
First 20 years: $750K term 20 + $250K of term 30 = $1MM of coverage
Last 10 years: $250K of term 30 = $250K of coverage
You want to compare prices on layering vs level coverage as often layering term doesn’t save you that much money. For example, it’s unlikely that layering a term10 and term 20 would be that much cheaper than a straight term 20 policy.
Perhaps the most common layering technique is to layer term with permanent. I call this the ‘perfect policy’ because it suits many people’s insurance needs over their lifetime. Lets say you need $1MM of coverage while you have a mortgage and kids. When you retire, you don’t need $1MM any more, but would like to still have $50K of life insurance for final expenses. The way to layer this would be with $950K of term 20 and $50K of permanent (whole life or universal life). Now you have $1MM of coverage for 20 years, and for years 21+ you coverage reduces to $50K for the rest of your life.
I mention this case specifically because while many young people assume they want term (because they don’t want insurance later) in practice, many people change their minds as they get older and decide that in fact they would choose some permanent insurance for final expenses.
A Note on Assumptions
If you’re reading this and not quite agreeing with me, read the following. If you’re on board with what you’re read so far you can skip this section.
We’ve made some clear recommendations in terms of policy classes and types above. However, these recommendations are based on a set of common underlying assumptions that haven’t been stated. They work for most people, but do not work for everyone. If you feel that these recommendations are not for you, you are absolutely correct to go with different policy types. As an example,my personal life insurance choices as a broker are different than most of the people I work with – because my assumptions are slightly different.
Here’s three examples – three people with the same situation but radically different underlying assumptions, and who thus end up with completely different insurance solutions.
- Married with kids. They assume that if they pass, Canadian government benefits will be sufficient to keep their family housed, with healthcare, and in school. And that’s true – they could go with housing geared to income, and we all get excellent and free healthcare and schooling. And they are content with that reduction in lifestyle for their family. To them, a drop in lifestyle to that level is not perceived as catastrophic (and in fairness, their family likely will be housed, fed, provided with healthcare, and education). So, the death of this person fails the catastrophic test. Solution? No life insurance necessary.
- Married with kids. They assume that they have an obligation to their children to an exact, if somewhat arbitrary timeframe of either until retirement or until they’re not financially dependnet. The solution? Term life insurance, probably 20 or 30 year term. This is far and away the most common assumption by Canadian families.
- Married with kids. They assume that they have a obligation to their kids over their entire lifetime, and that this obligation doesn’t change at retirement. They intend to help their kids with housing, marriage, and then the same for their grandkids. The solution? Permanent life insurance.
Three identical families. One needs no life insurance, the other needs term, the last one needs permanent. I’ve recommended term in the above sections for this case but if you find your assumptions lead you to a different conclusion then you are correct to do so. My writing here is a guideline more than a rule.
Another common underlying assumption is whether you should purchase life insurance on your children. While we’ll make some suggestions in the following sections, once again if you disagree with the underlying assumptions you are correct to end up with a different conclusion that what I’m going to write.