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Life Insurance & Common Sense

Common sense is overrated isn't it? It has to be, I think, because the world has gone slightly mad - along with today's so-called financial professionals. As soon as someone mentions “life insurance”, it seems as though there is suddenly a room full of experts (or an Internet full of them). One of the first issues you will have to look at is which kind of life insurance policy will be the most beneficial for you. This is not as easy as it sounds, and unfortunately, even life insurance agents don’t make it easy.

Life insurance is a financial product – a contract – that leverages your future savings. When you purchase an insurance policy, in effect you are saying “I don’t have $500,000 (or whatever the death benefit happens to be), but I do have $100 every month”. Fortunately, the life insurance company does have $500,000 that they can give to you under certain circumstances. The major circumstance is that in order for the contract to pay, you have to die. Not exactly an attractive option, as you’ll never see the money.

This places life insurance into a unique classification. It is a form of savings, but the death benefit is not the type of savings you will ever be able to access under normal circumstances (although many insurance companies do offer special provisions in which you may have early access to the death benefit and the instances when you can actually do this tend to be rare).

So, why would someone buy life insurance? We are often told that life insurance is for those that we leave behind. It is to make them “whole” for their loss – economically speaking. This sounds pretty catchy, and there are lots and lots of charts and graphs and fancy software to back that up. But, you don’t need to pay any attention to any of that because, honestly, it’s all marketing material designed to sell more life insurance.

Many agents and financial advisers will use these fancy software programs to show you that you need to buy 10, 20, even 30 times your income. All of these projections will, of course, fluctuate over time. However, they are mostly based on arbitrary premises. The amount of life insurance that one “needs” – although carrying the appearance of legitimacy - often times has little or no connection to reality when you use these software programs or “rules of thumb”. It’s a guessing game, and it quickly becomes highly subjective.

The first time you buy life insurance often initiates a cycle of buying. The financial adviser or insurance agent has your name and your policy anniversary so that they can continue to sell you more life insurance. The question is: do you need it? Does it help you accomplish your financial goals and solve your financial problems? You could keep buying insurance until you have very little money for anything else.

The alternative to becoming “insurance poor” is to take an objective approach to calculating the amount of life insurance you need. To do this, you’ll need to think about what life insurance really does for you and the people you care most about in your life.

My view is that the fundamental principle underlying life insurance is self-responsibility. Each individual is responsible for his or her own life. This self-responsibility ends when the individual dies, but any outstanding financial obligations do not suddenly disappear. Therefore, the responsible, rational, individual will be forward looking and purchase life insurance to cover any financial obligations that they leave behind when they die. This completely solves the dilemma of “how much life insurance should I buy?” by deferring the question to reality. The answer is: you buy enough life insurance to cover your personal financial responsibilities. This would include dependent children and spouses as well as any payment agreements, loans, mortgages, and other financial contracts that stipulate you (and only you) as a debtor to another individual or business.

Nothing else, aside from financial responsibilities you've accepted, needs to be factored into your life insurance plan.

This entry was posted on June 30th, 2009 by David C Lewis, RFC. Edits may have been made to keep this entry current. · 6 Comments · Insurance & Savings

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