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Author: TTRoberts Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 76418  
Subject: All Life Ins. is Term Insurance Date: 2/11/2004 1:54 AM
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(long post)

For the people in this forum who just don't like whole life or any from of cash value type of life insurance for one reason or another (most often due to a lack of understanding of just what it is and how it actually works), I thought I might throw out some information that may prove helpful. Please understand this is not to try to convince anyone to like it or that they should have any of it. This is simply help with a better understanding of it and how it works. I felt compelled to do this, as what I just saw published in the Motley Fool section about life insurance is full of misinformation, which I feel can lead people to incorrect ideas as to how it all works.

First let me point out that what life insurance is NOT designed to replace lost income as it's so often said. Life insurance is designed to pay immediate cash out to a beneficiary in the event of an insured's death. Please look at that sentence closely again. While it's obviously that a great majority of the time such cash is needed to replace income and so that's what life insurance is used for most of the time. But there are many other situations where there may be a need/want for immediate cash at the time of someone's death. And life insurance can do that because that's what it's designed to do.

Now here's something that might take you a little getting used to until you understand what's going on with life insurance. ALL life insurance is really term insurance. Many of the issues we argue about really have to do with how we may want to pay for that term insurance and/or how long we should need or want it.

You see, what you really pay for each year is akin to yearly renewable term insurance. And as you get older, that cost/premium for that term insurance (yearly mortality and expense costs) gets higher and higher like an exponential curve. As you keep your insurance over whatever period, you can pay each premium directly from earned income or from your investments. You also have a choice too of whether to use enough of your after-tax dollars to pay for the insurance, or . . . .you can pay for some of it with pretax earnings on amounts you choose to deposit with the insurance company.

Almost everyone chooses the latter these days. If you think not . . . just ask around and see who actually buys yearly renewable term insurance. Very often, if not most often, you'll find people buying 20 yr. level term, which has much higher premium than the yearly renewable term. They pay excess premium to the insurance company, which goes into the company's general account and is set up as reserves, to keep premiums level and the insurance company invests that excess premium to help pay for the higher cost of insurance as it rises over the years. So, why are they doing that when they might do better to buy yearly renewable term and investment the difference?

Whole life and other types of permanent life insurance work exactly the same way. One of the main differences of course is the length of time the coverage is to last. The longer the level premium payment period is the higher the premium (just like in level term contracts), because you must deposit more with the insurance company to pay for future cost of insurance. You're over paying in the early years, the reserves compounding on a tax-free basis, as those premiums become insufficient to pay for the insurance in later years.

Because permanent life insurance contracts are collecting so much in the early years, provisions are made to return what's held in the reserves should the policy be surrendered, as those reserves are no longer needed to pay for future life insurance costs at that point. While the policy is in force the value of those reserves that will be returned is what's called the Cash Value. It is not a “savings account” and it is not a cash value “account” – though it's often thought of in those terms. And you really don't make “deposits” to an account or to the insurance company, you PAY a premium, which is used as I've described.

Now that I've got to the Cash Value aspect, let me take a side step to explain a little what happens to this excess-amount/Cash-Value upon death. Another facet of keeping the premium level is that the actual amount of pure insurance coverage decreases as the Cash Value increases (particularly in a whole life type of contract – in universal life contracts there is an option to keep it level, but I won't get into that here). The amount of actual insurance coverage is referred to as “amount at risk.” The Death Benefit actually consists of two parts, the Cash Value plus the amount at risk. So, if or when you hear the non-sense that the insurance company “keeps your money,” what you're hearing is really something ignorant of how it really works. The insurance company always pays out “your money.”

As the reserves are compounding to pay future costs of insurance, they are afforded special tax treatment in our tax code. And it's the tax advantages of both the policy's reserves as well as the death benefit that can make permanent policies very effective and attractive in many situations.

And since a certain amount of reserves must be maintained to cover the future costs, insurance companies also provide liberal loan arrangements against the reserves of the policy. Since amounts received from “loans” are never taxable, the liberal loan provisions in these policies can be used in a very low cost and effective way . . . much like other types of collateralized loans might. There are no immediate payback requirements for such loans, you don't have to try and qualify for such a loan, and the loan does not show up on any credit report.

The better you understand how and why life insurance contracts work as they do, along with the associated tax and legal rules associated with them, the more ways one can find where they become a very effective financial tool. Which is why there's certainly many more uses than just replacing lost income – particularly as you get older and you're financial situations become more complex.
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Author: telegraph Big funky green star, 20000 posts Top Recommended Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 39153 of 76418
Subject: Re: All Life Ins. is Term Insurance Date: 2/11/2004 10:15 AM
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You also have a choice too of whether to use enough of your after-tax dollars to pay for the insurance, or . . . .you can pay for some of it with pretax earnings on amounts you choose to deposit with the insurance company.

Almost everyone chooses the latter these days. If you think not . . . just ask around and see who actually buys yearly renewable term insurance.


I'd venture a lot more people get life insurance through their company plans, and don't have 'whole life' insurance.

You're trying to tell us, that for the first umpteen years, you pay in extra, out of taxable dollars, and let the insurance company invest it, at below market rates, to fund your insurance partially later?

Heck, you could just as easily invest it in a tax friendly mutual fund, or your own IRA, and do a lot better.

Many people who get suckered into whole life at 25, with 30 or 40 year term, often don't need the life insurance after the kiddies are gone, or if they already have a nest egg of multi=millions...it is simply a big drain on their income, with little return. Anytime there is a middleman (or lots of them in the case of life insurance), they are going to take their cut, and take it each year. Now, just how much does a life insurance salesmen get each year? for at least the first five or ten years? Is that why many life insurance salespeople can essentially retire after 15-20 years collecting the residuals on all the pollicies they have sold?

Most folks get life insurance through work. It is term. Part is often paid for by the company, and the rest is available at very low group rates.

Many singles get the pitch to 'sign up young'. For the 1/3rd that don't get married, or stay married, it is a total waste.

Life insurance is an oversold product, often mis-sold, and wrapped in all sorts of 'mystery' to sucker in gullible folks with scare tactics in many cases. It's marketing.

A lot of insurance policies sold 30-40 years ago, after inflation, are essentially teeny weeny things....with the 15% inflation in the early 80s, you would up with $10,000 equivalent life insurance....

t.






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Author: IndecisiveFool Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 39155 of 76418
Subject: Re: All Life Ins. is Term Insurance Date: 2/11/2004 10:40 AM
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Most folks get life insurance through work. It is term. Part is often paid for by the company, and the rest is available at very low group rates.

Not the best idea. If a person become hard to insure (medical reasons) during their employment, that person may find it hard to find a life insurance policy if they leave their employer for another job.

IF


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Author: tmtrad9 One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 39159 of 76418
Subject: Re: All Life Ins. is Term Insurance Date: 2/11/2004 11:30 AM
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t,
Did you even read TTRoberts post? Did you understand the intent? He was not trying to convince anyone to buy any certain type of policy. He was explaining (very well, I might add) the mechanics of these policies. Obviously the first decision is whether or not you need life insurance. Once the answer is yes you certainly should try your best to understand how they work and choose the right one for your situation. I don't think it's as cut and dry as you are trying to make it seem. If you conclude that long term tax-advantaged growth of reserves in an insurance policy with the inherent insurance and tax-free access to the money can always be "out-performed" by "buy term, invest the rest" then so be it. I think it's a narrow point of view that clearly is not best for all.
tt

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Author: TTRoberts Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 39162 of 76418
Subject: Re: All Life Ins. is Term Insurance Date: 2/11/2004 11:39 AM
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telegraph, askes:

<< You're trying to tell us, that for the first umpteen years, you pay in extra, out of taxable dollars, and let the insurance company invest it, at below market rates, to fund your insurance partially later? >>

They don't invest at “below market rates.” In fact, because of the size of their investments, they can actually get better deals on their investments than individuals, which results in higher returns.

<< Heck, you could just as easily invest it in a tax friendly mutual fund, or your own IRA, and do a lot better. >>

If one can actually do “a lot better,” then one should buy yearly renewable term and do just that. (what ever “better” might mean)

<< Many people who get suckered into whole life at 25, with 30 or 40 year term, often don't need the life insurance after the kiddies are gone,

After the kiddies are gone, there may be other issues to address . . . . or for many, they may never be gone due to some special circumstances.

<< or if they already have a nest egg of multi=millions...it is simply a big drain on their income, with little return. >>

For a great many who've reached such of affluence, my experience over the last 30 years has shown me that they find it's a very useful tool and not a “drain” on their income at all. In many cases, it doesn't even affect income.

<< Anytime there is a middleman (or lots of them in the case of life insurance), they are going to take their cut, and take it each year. Now, just how much does a life insurance salesmen get each year? for at least the first five or ten years? Is that why many life insurance salespeople can essentially retire after 15-20 years collecting the residuals on all the pollicies they have sold? >>

Life insurance salespeople don't get much in the way of “residuals” or trails (renewal commissions). If they would get as much as P&C agents, their book of business what have some resale value in the same way. But that's not the way life insurance is set up. And the life insurance agent much continually sell product in order to produce enough income and like other's must set up and contribute to a retirement plan to retire.

Yes, there is great potential for make very good money . . .just as it is in many other industries. But most life insurance salespeople don't make all that much as it's a very difficult job and a long process of education and understanding how life insurance works.

Cutting out the salespeople doesn't help much in the case of life insurance, if at all, in reducing the insurance company's expenses. Since life insurance is something the few people like to think about, it takes heavy marketing of some time in order to sell it. You look at those life insurance company's products who don't use salespeople, you'll find that their products tend to be a little more expensive. There's always a marketing cost and just where the insurance company puts their money depends where that money be more efficient.

<< Most folks get life insurance through work. It is term. Part is often paid for by the company, and the rest is available at very low group rates. >>

While group life insurance is indeed quite available through many employers, group life insurance rates actually tend to be higher than what can be bought separately by those who are in good health. Group life coverage has particularly good rates for those who's heath history doesn't allow them to purchase life insurance at a good rate otherwise. If you're young and/or in good health, looking for an individual life policy outside of group coverage will most likely cost you less (one should definitely shop and compare).

Also, depending on group life insurance for NEEDED life insurance can wind up a very big disaster if one cannot afford to convert all the need coverage if one should lose their employment or the employer decides to cut expenses and limit what they'll offer.

<< Many singles get the pitch to 'sign up young'. For the 1/3rd that don't get married, or stay married, it is a total waste. >>

. . . .apparently so, in some people's opinion.

<< Life insurance is an oversold product, often mis-sold, and wrapped in all sorts of 'mystery' to sucker in gullible folks with scare tactics in many cases. It's marketing. >>

Life insurance may indeed be “oversold.” But does such a fact make it any less useful?

Yes . .. life insurance is often “mis-sold.” But does that fact make it any less useful?

Yes . . . life insurance tends to be a “mystery” to people. Who's teaching people about it so that it's not such a mystery. Though I try my damndist, there's always those who just don't listen. (such is life <sigh>)

And yes . . .there's a lot of “marketing” just like there is in any industry.

<< A lot of insurance policies sold 30-40 years ago, after inflation, are essentially teeny weeny things ....with the 15% inflation in the early 80s, you would up with $10,000 equivalent life insurance....v >>

Hmmmm??? And what does this say about the idea that the amount of life insurance needed declines over time???

33 years ago I was married and intended to start a family and bought a 4-bedroom house with a mortgage of $26,000. 15 years ago I bought a 3-bedroom house with a $225,000 mortgage. I remarried and started a family 17 years ago. I recently built a new 4-bedroom home with a mortgage of over $800,000. Would this suggest my need for life insurance has been declining??? Except for the high priced area I live in, I don't think this kind of thing is very different than most people.


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