Using life insurance to protect yourself and your family

Not everyone needs life insurance. Children don’t need it. Neither do couples with high incomes, where the surviving spouse could maintain an acceptable standard of living from his or her own earnings, nor retired people who receive pensions and investment income, nor wealthy people with enough assets to support their dependents.

This is because life insurance is something you purchase not for yourself but for your loved ones, who may suffer economically in your absence. When you buy life insurance, you are, in fact buying an instrument that will give your loved ones protection against important risks such as:

• Your early death, if you have dependents who would suffer;

• Major medical bills–a long, serious illness can cost a fortune in medical bills; and

• A serious disability–for instance, if you lose an arm in an accident and are unable to work.

How Much Insurance To Buy?

In general, it is better to buy more life insurance rather than less.

The most common way to determine how much to buy is to multiply earnings with the number of years you expect to be productive.

For example, if you expect to earn an average of P1 million a year and expect to work for another 20 years, you will need at least P20 million in insurance to index the value of the payout roughly in line with inflation.

You can also calculate your major obligations and add to it a sum of money that would generate sufficient annual income for your family to live on. In the event of payout, your family will have enough to pay off debt, finish schooling, and having income for their day-to-day needs.

Another way is to multiply your after-tax annual income by the number of years of the term of the policy. This can be adjusted to reflect that your debt may dwindle over time. As you get older, you may actually need less cover because your assets would have grown while your liabilities would have gone down.

Yet another method is to estimate the amount of annual income you think your family will need and subtract any pensions or other benefits they would receive. Then, estimate how many years your family will need this income for–for example, until your spouse retires–and multiply the two figures, adjusting for inflation.

All these methods produce only an approximation of what your family may actually need. It is important to discuss the matter with your spouse and other dependents and, in particular, to remind them that, in the event of your untimely demise, they should invest the large cash payout for income-generating activities and not dip into it for unnecessary purchases.

Types Of Insurance

There are two major types of life insurance:

Term life insurance is a pure insurance with a fixed term, usually for 10 to 25 years. There is no savings element or any guaranteed payout unless you die while you are covered. This makes term insurance much cheaper than other varieties and, for most people, it is a good option to choose, provided that you appreciate that the premium you pay for the insurance you pay are for insurance only.

• Whole life insurance commands a higher premium because part of your premium payments go to fund savings or investment schemes instead of just the insurance cover. Whole life insurance can be further subdivided into non-participating (fixed payout) and participating (fixed payout plus a share of the profits from the company’s life fund). Participating policies from good companies can produce moderately good returns as long as you maintain the policy until it ends. They require a very long-term commitment to making a stream of payments.

There are also endowment policies, which are essentially savings vehicles with a small amount of life insurance cover. You receive premiums for a given number of years and receive an assured sum at the end, plus bonuses, or it is paid to your beneficiaries if you die before the term expires. If you die on the day after you buy the policy, the assured sum will be paid out.

When you have decided what type of insurance is the right one for you, shop around and compare prices. Remember that the cheapest cover is not necessarily the best. You must make sure that the insurance company is financially sound and has a good reputation for making prompt payments on legitimate claims.

Also buy insurance that covers as wide a number of scenarios as possible. Don’t insure against just one type of accidental death, but all types. Don’t insurance against one kind of serious disease, but all of them.

Encashing Your Policy

If you have a life insurance policy and are thinking of encashing it, make sure you understand company policies regarding policy surrender. Usually, if you surrender your policy within the first five years from purchase, you will receive less money back than you paid in because charges are higher in the early years. You may even receive nothing at all.

Instead of surrendering your policy, check if the following are possible at the outset under the terms of your policy.

• You can surrender only a part of the policy and keep the rest.

• You can make the policy paid up, which means that you do not have to pay any more premiums. This has the effect of reducing the assured sum and may affect your cover.

• You can borrow against the policy, usually at low interest. This can be worthwhile towards the end of the policy. For instance, you can use the borrowed money to pay the premiums and eventually receive a reduced payout (adjusted down because of the borrowing).

• You may be able to transfer your investment into a variable annuity to avoid surrender penalties. An annuity is an investment, not an insurance product. Essentially, it is a bet between you and the provider. You pay a lump sum in return for a guaranteed income until your death. If you live longer than the provider expects, you will have made a profit. If you die sooner, the provider may not return any money to your beneficiaries, although some annuities guarantee to return the whole sum invested to a beneficiary if you die before withdrawing any money or a part of it if you have already made withdrawals.

Do not hesitate to seek out an experienced financial professional to understand how much insurance you need and how you can protect your loved ones and yourself. Be very circumspect in searching for a professional, for there is a great difference between an experienced and knowledgeable one and one who is new to the job.

(For more information on how you can build your personal wealth or to schedule a free financial check-up, you may call Citibank at 894-7162.)