Introduction
So you want to have life insurance. Like many people, you may have determined that this type of coverage is an important strategy to provide adequate resources for your surviving dependents in the event of your premature death—and perhaps even to serve as an investment vehicle. But choosing the right policy requires more than just deciding to buy one. Evaluating life insurance policies is a critical step, involving the careful selection of coverage type, benefit amount, and insurer, as well as periodic reviews to ensure the policy continues to meet your needs over time. The decision to purchase life insurance is only the beginning of a more detailed process of research, comparison, and ongoing management to protect both your loved ones and your long-term financial goals.
Evaluation and comparison
If you’re just starting out, your first step is to pick both a good insurance company and the particular policy that’s best for you. In general, you can select a company based on such factors as its reputation in the industry, the opinions of others, and ratings information. The choice of a policy, however, will be a little more involved and will require considerable research. It’s crucial to choose a policy that offers both the right type(s) of coverage and the appropriate coverage level for your needs. Among other things, you should take into account your age, health, financial situation, and family circumstances. For information on the types of policies from which you can choose, ranging from term life to whole life to variable universal life, see Policy Types. Additional resources, such as your financial planner and insurance agent, can help you narrow the field and make the right decision.
To do so, these qualified professionals may employ complex mathematical formulas. One of the pitfalls in comparing and evaluating life insurance policies is that it’s often difficult to find reliable information that lets you objectively assess a policy from either a cost-benefit standpoint or an investment standpoint. As a result, you may end up purchasing a policy that’s simply not right for you. While not the final word, many of the formulas used in the industry help solve this problem. If used properly, they yield concrete data that can give you insight into the true value of a given policy. This will allow you to compare and evaluate in greater detail the different policies you are considering. See Evaluation and Comparison Methods.
Replacement and conservation
Even after you’ve finally settled on a policy, there will be work to do on an ongoing basis. While you may have complete confidence in the policy you selected, you still need to periodically review the policy to make sure it’s right for you. If your premium skyrockets, or especially if any of your coverage needs or circumstances change, you may want to consider replacing or exchanging your existing policy for another one. See Factors in the Decision to Replace or Exchange a Policy. On the other hand, it may be wiser to just keep the policy in place. See Reasons to Keep Existing Policies.
The decision whether to conserve your existing policy or replace/exchange it is complex and involves a variety of considerations. A middle ground course of action that may be appropriate is to change the level or amount of death benefit coverage on the existing policy. See Changing Levels of Coverage. Another strategy you may want to consider under certain conditions is transferring ownership of your policy. See Transferring Policies. If you exercise this option, be aware of the transfer-for-value rule. See Replacement and Conservation Considerations.
Evaluation and comparison techniques: mathematical methods
Baldwin method
The Baldwin method enables you to determine the annual rate of return you are receiving on the investment component of a permanent life insurance policy. It takes into account the tax ramifications of the return received as well as the consequences of borrowing against the policy. It also allows you to determine the value of the protection provided by the policy. See Baldwin Method.
Belth methods: yearly price of protection and yearly rate of return
The Belth yearly price of protection method enables you to determine whether a given life insurance policy is competitively priced based on the annual cost per $1,000 of protection. Simply put, it weighs costs against coverage. The Belth yearly rate of return method allows you to determine whether the rate of return on the investment component of a given policy is good, fair, or poor. See Belth Yearly Price of Protection Method and Belth Yearly Rate of Return Method.
Cash accumulation method
The cash accumulation method allows you to compare both similar and dissimilar types of policies (e.g., term with permanent) with different premiums. If comparing two particular policies, it tells you which is the better value in terms of a complex relationship between premium and cash value. See Cash Accumulation Method.
Equal outlay method
Used to compare both similar and dissimilar policies, the equal outlay method allows you to find the policy with the highest death benefit coverage and cash value. It assumes that you pay the same premium for both policies being compared and that you purchase the same death benefits every year. See Equal Outlay Method.
Interest-adjusted cost method: the net payment index and the surrender index
The net payment cost index allows you to determine approximately how much $1,000 of coverage will cost you per year and offers a valuable means of assessing the protection value of a given policy. The surrender cost index assumes that you will surrender your policy at some point, determines the cost of the policy based partly on its cash value, and offers a way of evaluating the policy from an investment standpoint. See Interest-Adjusted Cost Methods.
Linton yield method
The Linton yield method provides you with the average rate of return on the investment component of a policy over a given period of time and offers another way of evaluating policies as investment vehicles. See Linton Yield Method.
Evaluating and comparing insurance companies
In general, a life insurance policy is only as good as the company that wrote it. For this reason, choosing a good insurance company is at least as important as selecting the right policy. Fortunately, it’s not quite as complicated a decision. The criteria that you should use to evaluate and compare different companies range from the qualitative to the quantitative. You can rely partly on word-of-mouth references from friends as well as various written resources that attest to a company’s standing in the insurance industry.
You can also obtain a rating of each company you are considering from a ratings service agency. Organizations that will perform this service for a fee include A. M. Best, Standard & Poor’s, Fitch (formerly Duff & Phelps), Moody’s, and Weiss. Generally speaking, these ratings are based on such factors as a company’s financial soundness, its record of paying claims in a timely fashion, and the percentage of policies canceled in a given year. Most of these agencies rate the insurance companies they have evaluated on a letter-grade basis. For more information, see Finding Insurance Company Rating Information.
Replacement and conservation considerations
Factors in the decision to replace or exchange a policy
There may be times when it’s appropriate to replace or exchange an existing life insurance policy. Replacement involves switching to a new policy with an entirely different insurance company, while exchanging involves trading in your existing policy for a different one with the same company. Factors in the decision to replace/exchange might include dissatisfaction with your company as well as any changes in your financial situation and/or coverage needs. Because replacement/exchanging can be expensive and disadvantageous in other ways as well, you should generally only consider this option if you have pressing reasons. See Factors in the Decision to Replace or Exchange a Policy.
Reasons to keep existing policies
In many cases, it’s best to just leave your existing policy in place without making any changes. There are a number of reasons why you might want to consider keeping a policy. If you’ve been happy with the company and the policy, if your financial circumstances have remained basically the same, and if your coverage needs haven’t changed dramatically, it may in fact be foolish to switch to another policy. Moreover, there may be tax issues, replacement costs, and other considerations that come into play. See Reasons to Keep Existing Policies.
Changing levels of coverage
If you feel that your circumstances warrant a change as far as your life insurance coverage goes but that replacing/exchanging your policy would be too drastic a measure, you may want to consider changing your coverage level. To do so, you simply modify your existing policy by either increasing or decreasing the amount of the death benefit. This usually results in a correspondingly higher or lower premium. Reasons to alter your coverage level include, among others, marriage or divorce, new children, and employment and financial changes. See Changing Levels of Coverage.
Transferring policies
A policy transfer occurs when you assign full or partial ownership of your policy to another party. In some cases, a transfer may be a viable option for you and may make sense from a tax standpoint as well. Read your policy first, however, as it may be subject to restrictions concerning transfers of ownership rights. See Transferring Policies.
Transfer-for-value rule
The transfer-for-value rule is an exception to the general rule that life insurance death benefits are exempt from federal income tax. Basically, if you assign ownership interest in your policy to another party and receive valuable consideration in return, the death benefit proceeds payable under the policy will become subject to income tax to the extent that such proceeds exceed the consideration paid for the policy by the transferee, plus any premiums paid by the transferee after the transfer. This is an important consideration in terms of policy transfers. See Transfer-for-Value Rule.
Conclusion
Choosing, evaluating, and maintaining the right life insurance policy is an ongoing process that requires both careful research and periodic review. By understanding how to assess policies through objective methods, comparing companies for stability and service, and revisiting your coverage as your needs change, you can ensure that your policy remains aligned with your financial goals. Whether you keep your current coverage, adjust benefit levels, or consider a replacement, each decision should be made with a clear understanding of the long-term implications. With a thoughtful approach, life insurance can serve as both reliable protection and a valuable component of your overall financial strategy.
Scarlet Oak Financial Services can be reached at 800.871.1219 or contact us here. Click here to sign up for our newsletter with the latest economic news.
Source:
Broadridge Investor Communication Solutions, Inc. prepared this material for use by Scarlet Oak Financial Services.
Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on individual circumstances. Scarlet Oak Financial Services provide these materials for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
