Federal Employees Should Review Their Life Insurance Needs and Choices

This column is the first of three columns intended to help federal employees and retirees understand their choices and needs when it comes to life insurance.

The topics to be presented in this column are some of the important reasons why individuals purchase life insurance, the types of life insurance policies that individuals can apply for, and the ways that individuals can buy individual life insurance.

SEE ALSO:

• Understanding the Different Types of Term Life Insurance
• 10 Most Common Mistakes to Avoid When Purchasing Life Insurance

Why Individuals Purchase Life Insurance

Like any other financial asset that individuals purchase, applying for life insurance should have a purpose or reason. Among the reasons why individuals purchase life insurance are:

• Provide financial security for the named beneficiaries

• Provide for estate liquidity, equalization of inherited assets for heirs, and wealth transfer

• Fund repayment of a specific debt such as a mortgage

• Satisfy spouse’s claims in a divorce settlement, and

• Use an investment, such as single premium life insurance policy.

Types of Individual Life Insurance Policies

Life insurance policies can be broken down into two major categories, namely:

(1) Individual or group-sponsored; and

(2) Term or permanent (cash value). Both are discussed.

Individual Versus Group-Sponsored Life Insurance

• Individual life insurance policy. An individual applies for an individual life insurance policy from an insurance company which offers individual life insurance policies. The individual most qualify for the insurance, as the insurance company among other things will be checking the individual’s medical records and the individual will likely have to go through a medical exam.

• Group-sponsored life insurance policy. An employer sponsors a life insurance plan for its permanent employees, in which the employees are eligible to join the plan when they are initially hired. An example of a group-sponsored life insurance plan is the federal government’s Federal Employees Group Life Insurance (FEGLI) program. The advantage of a group-sponsored life insurance plan is that the insurance is “guaranteed issue” meaning that the individual applying for coverage need not furnish evidence of insurability. All employees – young and old, smokers and non-smokers – are eligible to apply. There is no checking of individual medical records nor any medical exams.

Term Life Insurance Versus Permanent (Cash Value) Life Insurance

• Term life insurance. Term life insurance offers pure protection (in the form of a death benefit) against financial loss resulting from death during a specified period of time. Term life insurance is usually the most appropriate and the best buy for an individual needing life insurance for a relatively short period – less than 30 years. In short, term life insurance offers the most coverage for the least amount of cost (premiums). It is not designed to meet a permanent need for life insurance.

• Permanent (cash value) life insurance. Permanent (cash value) life insurance is life insurance that does not expire, provided that the life insurance policy owner pays the premiums or does not exchange an existing cash value life insurance policy for another cash value life insurance policy. The three primary types of permanent life insurance policies are whole life, universal life and variable life, are discussed.

(1) Whole life insurance. A whole life insurance policy provides a death benefit protection at a level premium for the entire lifetime of the insured. A whole life policy is sometimes called a “straight line” policy. A portion of the premium earns a fixed interest resulting in cash savings within the policy.

The advantages of a whole life policy include:

(1) Protection for the insured for a lifetime;

(2) Cash value accumulation based on the savings element accumulates tax-free; and

(3) Can provide a sufficient amount of cash accumulation which may be borrowed against.

The disadvantages of a whole life policy are:

(1) Usually more costly than term insurance for the same amount of death benefit; and

(2) Rates of investment return on the savings element are not disclosed.

(2) Universal life insurance. Universal life insurance combines a death benefit protection (in the form of term life insurance) with a cash value fund that accumulates tax-free as long as the insurance remains in force. With a universal life insurance policy, the insurance company deducts certain expenses and the first month’s pure insurance protection (the death benefit) from the initial premium paid. The balance of the premium paid earns market rate interest in a cash-value fund, normally a high-yielding government securities fund. Each month thereafter the cost of an additional month’s death benefit plus expenses is deducted from the cash value fund.

The advantages of a universal life policy are:

(1) The policy earns interest at current market rates

(2) The policy provides loan values which may be borrowed against;

(3) There are flexible premium payments;

(4) The policy has adjustable benefits as a policyholder can increase or decrease the face value of the policy according to needs; and

(5) The policy investment and mortality expenses are separately defined.

The disadvantages of universal life are:

(1) The policyholder has a life insurance policy which is neither the most competitive life insurance coverage nor the most competitive savings vehicle; and

(2) The future investment yield potential is uncertain due to inflation.

(3) Variable life insurance. Variable life insurance combined the tax-free deferred savings functions of life insurance together with the growth potential of equities (stocks). Like traditional life insurance, variable life policies have fixed premiums and a guaranteed death benefit. But unlike other cash value life policies such as whole life, the cash value is not guaranteed and will fluctuate with the performance of the portfolio selected by the insurance policyowner.

The advantages of variable lie are:

(1) Earnings compound tax-free within the policy;

(2) Several investment options with tax-free exchanges that are available;

(3) Professional asset management; and (4) provides loan values which may be borrowed against.

The disadvantages of variable life are:

(1) Cash value is not guaranteed – both the death benefit and cash value increase or decrease based on the investment performance of the underlying asset; and

(2) Tends to be more expensive with higher premiums compared to other types of life insurance policies

There are also offshoots from these three types of life insurance policies including:

(1) Single premium whole life insurance;

(2) Variable universal life insurance;

(3) Indexed universal life insurance;

(4) Guaranteed universal life insurance;

(5) Joint and survivor life insurance (“first to die” or “second to die” life insurance);

(6) Final expenses (“pre-need”) life insurance, used for paying funeral expenses; and

(7) “Split dollar” life insurance.

How Individuals Can Buy Individual Term Life Insurance

There are two ways in which individuals can purchase an individual term life insurance policy. One way is through a licensed life/health insurance agent or broker. The other way is to use insurance-quote firms that provide computerized analyses, listing as many as five lowest cost policies in their databases. These national services include:

www.AccuQuote.com
www.Insure.com
www.QuickQuote.com
www.ReliaQuote.com
www.SelectQuote.com

A word of caution for individual life insurance policy purchasers: The “cheapest” policy in terms of premium cost is not always the best value. Life insurance policy purchasers are advised to use one of the services above to select a few policies that appear to offer the best premium rates and values. Once obtained, the purchaser is encouraged to contact an independent licensed life insurance broker who would provide premium quotes from several life insurance companies in order to see if the premium quotes provided by the broker can beat the premium quotes from one of the services.

Also, the Consumer Federation of America (Phone: 202-387-6121) or http://consumerfed.org will analyze (for a fee) whether it is cost effective to drop and then replace an existing life insurance policy. To do so, go here.

With respect to the amount of life insurance needed there are a number of “life insurance needs” calculators available on many financial and insurance websites. One such website is: Bankrate.

Those employees and retirees who may be in the market to buy life insurance are highly encouraged to contact their financial advisors to determine which type of life insurance is most affordable and suitable for them.