The FIRST Life Insurance Decision (It’s not term vs. whole life.)

The FIRST Life Insurance Decision (It’s not term vs. whole life.)

March 15, 2019

The personal-finance principle of “Protection First” is frequently referenced in this publication; preserving the value of assets you already have is one of the most effective ways to achieve long-term financial security. Among those assets, arguably the most important is one’s Lifetime Economic Value, the potential to produce income through one’s work. For most of us, for most of our lives, our Lifetime Economic Value is our primary engine for wealth creation. Among all our assets, it is the one we most need to protect.

Insurance, where small amounts of money are collected from many policyholders to pay for the few losses that might occur in a given period, is an efficient method to provide this protection. Specifically, life insurance and disability income insurance are two ways individuals can protect their Lifetime Economic Value.

The logic of Protection First and Lifetime Economic Value is fairly simple and straightforward. But when it comes to execution, the details of insurance can sometimes distract consumers from adhering to a Protection First approach. This is particularly true with life insurance, where protecting Lifetime Economic Value is often derailed by a discussion of whether you should use term or whole life insurance. A more relevant first conversation is how to determine Lifetime Economic Value, and how to insure it.

Lifetime Economic Value and Life Insurance

Insurance companies have underwriting parameters for how much life insurance they will consider offering an individual, and these guidelines can be used as a rough estimate of one’s Lifetime Economic Value. This table, from a highly-rated American life insurance company, “reflects general life insurance guidelines equal to the present value of potential future earnings which would be lost at the death of the insured.”

The declining multiples as applicants get older reflect shorter time periods; a 51-year-old has 20 fewer earning years than a 31- year-old counterpart. And as people move into retirement, the criteria switches from their future economic value as earners to the future economic value of the assets they have accumulated.

 Using this table as an estimate of Lifetime Economic Value, a 35-year-old with an annual income of $50,000 qualifies for $1.5 million of life insurance ($50k x 30), a 40-year-old with an annual income of $150,000 qualifies for $4.5 million ($150k x 30), and a 45-year-old with an annual income of $250,000 qualifies for $5.0 million ($150k x 20).

“Do I Really Need That Much Life Insurance?”

For some consumers, seeing their maximum life insurance number can be unnerving. “Do I really need that much life insurance?” they ask. “After all, I’m (fill in the blank), and I don’t have (fill in the blank).” Regardless of how you fill in the blanks, the answer is the same: the maximum amount represents an insurance company’s estimation of your Lifetime Economic Value. And the question that follows is: do you want to insure your full economic value, or just a fraction of it? It’s interesting to note that while some financial experts recommend obtaining the smallest amount of life insurance that will keep a spouse and children from poverty, insuring other assets for full value is the norm. We insure our homes for their replacement value, as opposed to what it would cost to buy a pop-up camper (“because I just need a place to live, right?”). Same thing with our cars; even as their value declines with use (sort of like how maximum life insurance goes down with age), most of us continue to insure our vehicles for their current replacement value. If you’re going to do Protection-First, you ought to look at ways to insure your full Lifetime Economic Value today.

Buy Lifetime Economic Value Protection Now

If you understand and agree with the Protection-First approach, you should consider securing maximum life insurance protection now. That statement may seem like hyperbole, but there are two compelling reasons to see it as true.

First, future insurability is not guaranteed. Second, insurability tends to decline with age. For healthy individuals, there may be significant advantages to obtaining the maximum amount of life insurance as soon as possible. Consider the 35-year-old with an annual income of $50,000 from the previous list. Using rates from the insurance company whose maximum life insurance guidelines were shown above, a 35-year-old male no-tobacco user with a health profile that merits a “Preferred NT” rating could secure a 20-year level term policy for $1,410/yr. This policy includes a conversion privilege, which allows the insured to change some or all of the insurance benefit to a whole life policy at any time during the term. However, if the same individual is in excellent health, (defined as “Elite” by the insurance company), the annual premium drops to $975/yr. – a 30% reduction – for all 20 years. A 35-year-old female with an Elite risk profile would realize an even greater discount of 34%. (see chart below).

A convertible term policy for the maximum amount of life insurance locks in a Lifetime Economic Value benefit today, with options to change the coverage in the future, including the ability to keep the protection in-force for a lifetime. And many insurance companies offer convertible 30-year level term policies, which is not only a longer period of protection with fixed premiums, but plenty of time to determine how to best integrate a permanent life insurance benefit with the rest of your financial plans. The key is having protection equal to your Lifetime Economic Value now, when you are most insurable.

Protection-First Makes Sense

Is this more life insurance than you need? Maybe, probably not, who knows? Both you and the life insurance company believe your death is a long way off. Because you can’t anticipate how much life insurance will be needed in the future, it’s prudent to apply for the maximum today, then take as much as your budget will allow. A Protection-First approach to personal finance doesn’t dismiss or de-emphasize the accumulation aspect of wealth building. It just recognizes the importance of protecting the asset that makes all accumulation possible: your Lifetime Economic Value.

Lifetime Financial Growth, LLC is an Agency of The Guardian Life Insurance Company of America® (Guardian), New York, NY. Securities products and advisory services offered through Park Avenue Securities LLC (PAS), member FINRA, SIPC. OSJ: 244 Blvd of the Allies, Pittsburgh, PA 15222 (412) 391-6700. PAS is an indirect, wholly-owned subsidiary of Guardian. This firm is not an affiliate or subsidiary of PAS. 2019-75477 EXP 2/21

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