Who Needs Insurance, and When

"If anything should happen to me..." With that idea planted in a man's head, he is an easy mark for a life insurance policies salesman. This vague phrase gets around the ugly word "death"; and combined with pleasant phrases such as "security" and "building an estate," it develops the impression that life insurance is the ideal protection against almost any conceivable difficulty that a family might encounter. The great majority of American families are paying for some life insurance, but it is a rare person who has more than a foggy notion of what his policy will and will not do for him, or any notion whatever of how the cost and provisions of his policy compare with other available possibilities.

Life insurance policies are in their pure form a simple idea, but the companies selling them seem to have decided that the way to build up a large volume of business is to make life insurance so complicated that nobody can understand it without devoting an unreasonable amount of time and effort to the task.

Now let us try to clear away some of the fog. Pure life insurance policies are actually death insurance. It is a means of arrang­ing, in advance, to offset or reduce the bad financial effects that may result from a person's death. A life-insurance policy is a contract between an insured person and an insurance company. At regular intervals the insured person pays a charge, called a premium, and in return for this, if he dies, the company pays the specified face, or death, value to the person named as beneficiary. These are the easily understood essentials of life insurance policies.

From the standpoint of investing, life insurance is a sub­stitute for lack of capital. At moderate expense it enables a young man to leave money to his dependents, even though he dies without owning any capital. But the expense naturally increases with an insured man's age, although insurance-company practices may conceal this fact. In middle age and later, the expense of continuing a sizeable amount of life insurance on either an old or a new policy is great enough to use up considerable of the money that an insured man might otherwise add to his savings.

For a beneficiary, the death value of a life-insurance policy is a fixed-dollar investment. This makes an estate composed all or mostly of life insurance a poor substitute for one con­taining a large portion of well-chosen diversified equities. For an informed investor, life insurance is an unsatisfactory and temporary expedient, to be replaced as soon as possible by his own accumulated capital.

Paying the cost of life insurance policies is a plain waste of money, unless the death of the insured person will hurt somebody financially. A reader's reaction may be, "That's obvious; why mention it?" But for many premium payers it is far from obvious. Presumably because a life-insurance policy has or will have some cash surrender value, they assume that it is practically the same as a savings-bank deposit. They do not understand that part of a premium must pay the company's selling expense, and another part must pay the cost of pro­tection against death of the insured person, regardless of whether anybody needs that protection.

Insuring the life of a baby is a common practice. One company offers more than fifty different policies, with rates starting at "age zero." Premium amounts are suitable to all sizes of pocketbook, on some types of contracts as little as five cents weekly, while on other types minimum premiums run to several hundred dollars.

In insuring the life of a baby, surely it is a rare parent who aims at receiving a substantial cash settlement in case the child dies young. So apparently parents look on child insurance as a method of investing for the child's own future benefit. But when a parent bothers to examine the results of investing through a juvenile insurance policy, he is likely to find that his child has little chance of collecting from the policy as many dollars as the parent has paid into it. Even on the best policies, with the premium always paid annually in advance for twenty years and dividends always reinvested, the results are equivalent to about 2 per cent compound interest, well below an E bond's performance.

Passing on from childhood, the mere fact that a man is earning an income is not a reason for having insurance on the whole of life. Neither is his being married, provided his wife can earn her own living if he dies. But a father, not owning much capital, may justifiably feel that life insurance is nec­essary as a safeguard for completing the rearing and education of his children.

When children's schooling has ended, insurance on the husband-father's life again becomes more questionable. For a couple with substantial capital available for whichever spouse survives the other, the need for life insurance is re­duced or eliminated. On the other hand, when a married couple have reached middle age with little or no savings, life insurance may still be needed. Whether it can be obtained then at a reasonable cost is something else.

An unbalanced pension plan may be improved by life insurance in middle age. Under some pension plans, when an employee has worked for a required number of years and has reached a certain age he acquires a vested right to pension benefits, starting when he retires. Suppose he intends, at retirement, to choose the "joint and survivor" option, thus giving his wife an income lasting as long as she lives. But if he dies before actually retiring, his employer will not pay a pension to his widow. So it might be sensible for him to carry life insurance to protect his wife against the risk of losing him and the pension together.

Under many pension plans, benefits are paid to no one except a retired employee, as long as he lives. Even in the generally sensible Social Security program of the Federal Government, when a retired worker dies, his widow's pension is cut to half of what the two were receiving. In principle, the effect of such pension rules can be improved by life insurance policies, but after age sixty-five the cost is prohibitive.

Mere male egotism can create a need for life insurance. During the years a husband is earning a living, all of the family income passes through his hands. When he retires, he refuses to allow cash to reach the family except in his name. He uses his capital to buy annuities all on his own life, so that if his wife survives him, she will have no income. Life insurance might help here, except at that age it's too expensive.

Complicated, Hidebound Customs

The multiplicity of prices and refunds quoted by a life insurance policies company on policies for individuals is something that has to be examined to be believed. For just one company, in 1956, the Unique Manual lists seventy-six basic policies. On $1,000 death value, the premium rate varies for each year of age of a person starting a contract, and the annual sum of premium rates also varies with the frequency of payment, all the way from once a week to once a year. This company seems to have about 12,000 premium prices on basic policies, and onto these prices some eighteen different amounts can be added for extra provisions in the policy. The manual does not show the scale of extra premiums added as a penalty for low medical or occupational rating of an appli­cant for insurance. Cash surrender values, per $1,000 death value, vary as premiums do with the kind of policy and the beginning age of an insured person; they also vary with each year that an insured person continues a policy. The company seems to have something like 200,000 cash-surren­der rates.

But it is on dividends that a mutual life-insurance company really shines. In one-year dividend rates per $1,000 death value vary about as much as cash values do. A dividend is supposed to reflect a company's actual experience each year, especially the difference between the excessive mortality rate included in the premium and the actual rate. So if a company carries out the theory, it refigures all these dividend rates every year.

The amount of death value in a policy also affects all these charges and refunds. Taken by itself, this is sensible variation, but when applied to hundreds of thousands of rates per $1,000 death value, it multiplies the mess. And, of course, a buyer of life insurance pays for all this red tape.

With life-insurance rates as complex as they are, nobody is going to try to understand them unless he is something of a statistician and has lots of time available. Normally a cus­tomer depends on the word of an insurance agent as to what policy to apply for, in what amount and in what company. In the jungle of rates, an honest agent is quite unlikely to under­stand what he is selling, and a tricky salesman finds it easy to mislead and overload his customers.

On request, a policyholder probably can obtain from a company an annual financial report showing the amount of its various classes of income and expense and of assets and liabilities. But he has no way of knowing whether the premium he personally pays is a fair share of all the premiums collected by the company. And a mutual company tells him nothing as to the relationship between its net gain from operations and the amount it pays him as a dividend. In effect, a company says to a policyholder: "Just trust Papa, and everything will be all right."

Much of the confusion is due to the practice of combining pure insurance in the same contract with a savings plan. Each slight variation in the savings plan is the excuse for a policy with a different name, and another set of premiums, cash values, and dividends, although the policies all have the same death value.

The complexity and mystery of life insurance policies, as practiced, are reasons for avoiding dealing with it, if an investor can find a satisfactory alternative.

Death-Settlement Options

When an insured man dies, the beneficiary named in his policy is guaranteed to receive the face or death value of the policy. An actual settlement amount may be slightly in excess of the guarantee. Because a life insurance policies company keeps almost all of its assets in bonds, mortgages, and other loan types of investment, it is practically certain of being able to pay the dollars it has guaranteed to policy-holders, and it is equally certain of not paying much more than those low guarantees.

Several options on the manner of paying a death settlement are usually offered, and a choice can be made while the insured person is living, or it can be left for the beneficiary to choose. The usual options are these:

1. The company pays the entire death value promptly in one lump sum.



2. The company keeps the entire death value until the beneficiary withdraws it, and meanwhile it pays interest.



3. A fixed amount is paid at regular intervals until the death value plus accrued interest is exhausted.



4. Payments at regular intervals are spread over a speci­fied number of years, the fixed amount per payment being set at the figure that will exhaust the death value, plus accrued interest, at the end of the stated period of years.



5. An annuity: a fixed amount is paid at regular intervals as long as the beneficiary lives.



6. Combinations of these options can be arranged for one or more beneficiaries.

As far as the scheduling of payments is concerned, these options offer a choice to suit most anyone's desires. The same options generally are available also when an insured person, without waiting to die, surrenders his policy.

The big drawback in these settlement options is that they are all fixed-dollar amounts, and the interest rate included in them is around 2 or 3 per cent. When life insurance com­prises all or most of a man's estate, at his death his depend­ents are going to receive an inheritance that will be badly out of balance, with both a low income and no protection against inflation, either before or after his death. The reasons why a family's capital should not be all or mostly in fixed-dollar investments are discussed in other chapters.

Of course a beneficiary receiving a cash settlement can use it to buy common stock or other equities. But in the chapter called "Easy Payments May Have Advantages" we explain that for fear of a drop in price, a large portion of one's capital should not be put into common stock at one time. It is safer for a stock-buying schedule to be spread over at least 5 years. So the inheritance of a big wad of cash may be a poor substitute for an equivalent amount of money already invested in stock that was bought gradually.

It is possible to arrange for death settlement to take other forms than the options offered by a life insurance policies company. When a home or other real estate is mortgaged, life-insurance proceeds can be used to pay off the remaining balance of the mortgage, thus lifting this worry from a dependent's shoulders. Also, real estate being an equity, this arrangement gets away from fixed-dollar settlements.

Another possibility is to use life insurance to guarantee completion of a program of buying shares in a mutual-fund type of investment company. A stock buyer so desiring can obtain life insurance through the mutual fund. If he dies, his estate receives a certificate for so many shares of stock, including those bought with the proceeds of his insurance.

In general, the life insurance policies company practice of keeping assets almost all in fixed-dollar investments is a reason for an investor's putting less money into life insurance than might otherwise be desirable.

How Much Is Enough?

"A man should have adequately chosen his selection of life insurance policies." That is a standard expression among investment advisers, and it is about as helpful as telling a hard-up man with a large family that he should have an "adequate" income. Assuming that a man's dependents will need considerable financial help if he should die soon, how much life insurance should he have? Before answering that question, he needs the answers to several others:

1. How much of his need for life insurance is already met? What are his survivors guaranteed, under the programs of the U.S. Government, his employer, and organizations of which he is a member? Some of these are discussed in the following chapter on "How to Buy Life Insurance."



2. What is his chance of death in the coming year? As­suming that his physical condition is average and. he takes no unusual risks, his chance of death depends mainly upon his age. Between ages 2 and 32 it is less than 1 in 500; at age 40 about 1 in 250; at age 50, 1 in 100; at age 60, 1 in 40; at age 70, 1 in 20. Women's mortality rates are lower than men's of the same age. For young people of both sexes, the mortality rates in recent years are only a fraction of what they were fifty years ago, and presumably the rates will con­tinue to decline.



3. Thinking about mortality rates brings a man to this dilemma. In youth, his chance of dying is almost too slight to worry about, but life insurance then has a comparatively low cost. From middle age on, his chance of dying increases rapidly, and so does the cost of insurance, on either an old or new policy.



4. How badly would his family be hurt by his death, in comparison to other financial troubles that may strike them? Especially after men and women reach middle age, their main financial problem of the future is probably not premature death but the opposite, the risk of living too long after earned income stops. For any difficulty except death, pure life insurance is useless, and money put into an insurance policy with a savings combination will not grow into as large a fund as if placed in other well-chosen investments.

Looking on life insurance policies as a temporary substitute for capital a man intends to acquire, what is a sensible re­lation between the amount of life insurance and his program for accumulating capital? To simplify the answer to this mean question, let us start by assuming that whenever a man dies, he wants to leave an estate of the same dollar amount. At first, when he has no capital, his estate will contain only
life insurance; but as his savings grow, he will gradually replace the insurance with accumulated capital. To carry out this idea, the original value of life insurance should not be a larger amount than he can match by capital accumulation within a reasonable time.

Remembering that, in middle age and later, the cost of maintaining life insurance is high enough to interfere seriously with saving from salary, let us say that a young man had better plan to eliminate life insurance by the time be reaches fifty years of age. Suppose a man twenty-five years of age has life insurance of $25,000 death value. To eliminate this by age fifty without cutting the value of his estate means that during the next twenty-five years he must save and invest enough to accumulate $25,000 of his own capital. Let us assume that his average annual income rate, after deducting income tax, will be 4 per cent and will all be reinvested. Then the annual saving needed from earned income is about $600 a year. According to these figures, $25,000 is a reason­able amount of life insurance to carry at age twenty-five, provided a man is actually saving from salary and investing $600 a year, has reasonable expectation of being able to keep up this rate of saving, and will reduce the death value of his insurance as his capital grows.

Suppose that another man, on reaching age fifty, is still carrying a $25,000 choice of life insurance policies. To establish a sensible re­lation between insurance and capital, he must act fast. By saving $2,000 a year from salary and reinvesting as above, he can replace the insurance with capital in about ten years. If he can't save that much, he had better cut his life in­surance now, and save more.