CHAPTER EIGHT

Insurance 101

This is the lengthiest section in the book, but once we get through it, you’ll probably look at life insurance much differently. To start, we have to get a basic understanding of the machine that is life insurance. An insurance expert shared a story with me that quickly brought me up to speed on the basics when I was training to get my licence. While it’s been some time, allow me to recount the gist of that story …

Let’s go back a few hundred years. Lloyd, a wealthy man, was a frequent visitor to a certain pub. Now, Lloyd was always looking for ways to make more money. Everyone in town knew of Lloyd’s wealth and they would come to the pub to ask for his money for business transactions, for loans, or just to plain beg.

One day, a farmer came to Lloyd and said, “Listen, I have a problem. It’s July and my crops are due to be harvested in August. We’ve had a fantastic year and we’ll earn more selling this year’s crops than for the last 5 years combined.”

Lloyd retorted, “That hardly sounds like a problem, friend!”

“Well,” continued the farmer, “hear me out. I am the only one in the household who can harvest those crops—without me, the crops will sit and die and become worthless. I know that once I harvest those crops I can stop working for life. But I am close to 40 years old [which was really old back then] and I would like to make sure that no matter what happens to me, my family will be taken care of. Even if it costs me money for that peace of mind.”

Lloyd thought for a moment. And then he said to the farmer, “Here’s what I can offer you. I want you to give me 20 gold coins right now. If you die in a month’s time, before the harvest has been gathered, I will give your family 100 gold coins. Of course, if you don’t die, I get to keep your 20 coins. What do you say to that?”

Lloyd had done some fast thinking before he made his offer. This farmer appeared to him to be in exceptionally good health for a 40-year-old. Lloyd knew that for every one hundred 40-year-old men in town, on average, five would die in the next month. Lloyd was willing to bet that this farmer wouldn’t be one of them.

The farmer agreed to this scheme—and he survived to harvest and sell his last crop. He retired wealthy, so the story has a happy ending. Lloyd was happy too: he had 20 gold coins that he did not have before making his “bet” on the farmer’s life.

So much for my story. Now let’s take a look at the math.

The statistical odds of that farmer dying were 5 in 100 (or 1 in 20), which is a 5% chance. ASo there was a 5% chance that Lloyd would lose his bet on the farmer’s life and have to pay out the 100 gold coins. Bearing in mind that he had collected 20 gold coins from the farmer, he would really only be out 80 gold coins. So from Lloyd’s point of view, there was a 95% chance that he would make 20 gold coins versus a 5% chance that he would lose 80 gold coins. He was wealthy enough to come up with the 80 coins if necessary, so he decided to take the risk.

But Lloyd was taking a risk: it was possible that the farmer would’ve died. So, instead of just charging the farmer 5 gold coins (which would be the statistical break-even point), he charged more (20 gold coins). He did this to compensate for the risk he was taking.

Let’s fast-forward 10 years. Lloyd’s scheme caught on like wildfire and other people were coming up to Lloyd with the same, or a very similar, proposition: they wanted to be insured for 100 gold coins in exchange for a fee to be set by Lloyd. Lloyd was shrewd enough to know that if he lowered the fee (or, to give it its familiar name, the premium), he would attract more customers. As he attracted more customers, he could lower the premiums. He knew that one bad bet wouldn’t wipe him out because there would be 20 good bets for each bad one. He knew this because he had studied the population statistics of his town.

So let’s look at this new business Lloyd has set up for himself. This year, 1,000 men (all aged 40) have bought a life insurance policy from him for the next month. He knows that statistically 50 of those men will die and he will have to pay out 5,000 gold coins (50 men × 100 gold coins) in death benefits. He also knows that 950 men will survive. If he wants just to break even, he has to generate 5,000 gold coins in premiums from all 1,000 men, so he could charge them each just 5 gold coins instead of 20.

But being the businessman that he is, Lloyd knows that some months 60 of 1,000 men will die, and some months 40 of 1,000 men will die. He doesn’t want to get caught out. In exchange for the risk he is taking, and to make sure that his time isn’t being wasted (this new endeavour is now taking up all his time), he charges an extra 2 gold coins on top of the 5 needed to break even—and to make sure that he makes a profit. So during the next month, he collects 7 gold coins each from 1,000 men (a total of 7,000 gold coins) and pays out 5,000 gold coins. He now is earning an average 2,000 gold coins per month.

Now let’s look at this from the insured person (or policyholder’s) point of view. They also know that 50 out of 1,000 men like them will die in the next month. By taking out the policy and paying the 7 gold coins, they win—in a manner of speaking—if they die: their family receives 100 gold coins in exchange for 7. It is a morbid way to think about insurance, I know. The insurance company wins if you don’t die, because they keep your premium and don’t pay out a death benefit.

TERM LIFE INSURANCE

Now we are ready to build on some simple concepts. Let’s talk about how premiums rise as you get older. Once we understand this, we will have a lot of the groundwork covered.

Remember how the statistics for a 40-year-old man, way back when, indicated that he had a 5-in-100 chance of dying in the next month? Well, let’s fast-forward a little bit. Let’s say that a 40-year-old man (due to improvements in health care and quality of life) now has a 5-in-100 chance of dying within the next year. As you know, your chances of dying go up with age. So, statistically, a 41-year-old man has a slightly higher mortality rate than the 40-year-old, and a 39-year-old would have a slightly lower mortality rate than the 40-year-old.

But let’s take a closer look. Maybe the 39-year-old has a 4-in-100 chance of dying (4%), while the 40-year-old’s chances of dying remain 5 in 100 (5%). The 41-year-old might have a 7-in-100 chance (7%). In this case, the amount of change between the 39-year-old and the 40-year-old’s chance of dying is less than the amount of change between the 40-year-old and the 41-year-old’s chance of dying.

Another way to explain this is that, all else being equal, you would expect that a 25-year-old in average health has little chance of dying in the next year, while a 99-year-old in average health has a pretty good chance of dying in the next year. As you get older, your chances of dying increase exponentially. The 99-year-old’s chances of dying might be 95 in 100.

The general trend of mortality can be directly translated into insurance premiums. The higher your chance of dying, the higher your premium will be. So in Figure 8.1, you can consider the Y axis as either mortality or the insurance premium amount.

The graph shows how insurance premiums increase exponentially as a function of age. From this we can extrapolate that if someone were to apply for an insurance policy every year, the cost in each successive year would increase, until at some point it becomes unaffordable.

Figure 8.1: Mortality and insurance premiums

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For someone very young, the premiums are relatively inexpensive. I remember a client aged 26 or so requesting a $250,000 life insurance policy whose premiums were around $130 per year. For someone very old, the annual premium on a policy for the same amount will actually approach $250,000 per year: the premium and potential payout are virtually the same. Of course, at this point it becomes pointless to purchase the insurance, because it would be silly to pay $250,000 for the year if you collect only $250,000 if you die.

Let’s break it down a little further. For a 25-year-old, we know the premiums are fairly cheap. If this person could spread out the cost of the insurance over a set time period (say, 10 years), he or she could pay a set yearly or monthly amount for the entire 10 years. Why would they do this? Well, the set payment will be higher than the amount they would have to pay in the first of the 10 years, and lower in the last of the 10 years, so they are averaging it out. The idea is that they are willing to pay a little bit more than they should early on, so that they can pay less than they need to later in the term. This way they keep the cost of insurance affordable as they get older.

Now look at Figure 8.2: we have inserted vertical lines at 10-year intervals. In the beginning, the growth rate in annual premiums is relatively small, but as the person gets older and the premiums increase exponentially, you can see why choosing a longer term becomes desirable. Insurance coverage becomes more desirable as you get older because people realize they have a greater chance of dying as they get older, which is exactly when the costs are greater.

Now we understand the basis of term life insurance. There are different lengths of term available: the most popular are 10- and 20-year terms. (There is also termto-100, which is a bit of an anomaly, so we will cover that later.) Term life insurance is known as temporary insurance because there comes a point at which it is unaffordable (when you are really old). When you are younger, however, it is quite cheap and affordable. It stays in effect for as long as you pay your premiums—if you miss a month, your policy gets cancelled and you get no money back. (There is a provision to pay your late premium owing within a certain period of time to allow for your policy not to lapse.)

Figure 8.2: Term life insurance evens out the cost of premiums

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Term life is most often needed for temporary insurance needs. One example of this is to cover your mortgage: you want the mortgage paid off if you die, so you get insurance to cover the balance. Of course, the balance goes down over time and, all things being equal, one day you are mortgage-free, so the need for mortgage insurance is temporary.

Okay, so the take-home message of this section is that term life is temporary insurance, and for the better part of your life, it will be the cheapest form of insurance coverage you can get. As you get older, however, term life will eventually become unaffordable. Next, we will take a look at permanent insurance. (Whole life and universal life insurance also fall into this category.)

WHOLE LIFE INSURANCE

Let’s start with the basics of whole life insurance. There are certain costs that people would like paid for when they die, but if they are older we know that term life insurance is too expensive. Many companies will not even offer term life once you are around 80. But, of course, even 80-year-olds have some life insurance requirements, namely: funeral costs (if they don’t want to burden their loved ones); inheritances (if they want to make a larger estate available to their heirs); taxes (if they have a large tax liability when they die, they may want to have enough insurance to pay the tax bill).

One of the top reasons cottages go for sale in Muskoka (one of Canada’s most popular recreation areas) is that the owner has died and the next generation can’t afford the tax bill. The only way to pay it is to sell the property.

The solution for these permanent insurance needs is whole life insurance (which is a type of permanent insurance; universal life, which we will cover later, is the other form of permanent insurance). Whole life insurance never expires (as long as you keep paying your premiums) and the premiums never increase. It is much more expensive at first than term life, because you are averaging the cost of insurance over your entire life (as opposed to averaging it out for a limited term of, for example, 10 years), but while it is much more expensive when you are younger, it looks like a real bargain when you are older. Figure 8.3 provides a visual idea of how this works.

Figure 8.3: Whole life insurance becomes a bargain in later life

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When you take whole life insurance, you overpay the cost when you are younger in order to be able to afford it when you most need it—when you are very old. There are a few more ideas we need to discuss in relation to whole life before we get to universal life—in fact, this is where it starts to really get interesting.

Let’s now look at what the insurance companies do with the overpayment in the early years of a whole life insurance policy. We know the monthly premiums in the early years of a whole life insurance policy are much higher than the pure cost of insurance, which is the curved line that increases exponentially with age (see Figure 8.4). People agree to overpay in the early years because this makes it possible for them to afford the premiums later on in life. (Note how the pure cost of insurance indicates the premiums become unaffordable as you get very old.)

Figure 8.4: Premium overpayments and underpayments offset each other over time

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But what does the insurance company do with the overpayments? As you can imagine, they don’t just put it under the mattress. They take the money and purchase a bond portfolio (with some stocks and other investments). Usually the bonds are very long term and very solid (e.g., 30-year government bonds). They invest conservatively because these insurance policies are going to be in place for a long time in most cases, and they need to make sure that they have the money to pay the claims. The proportion of stocks, short-term bonds, and bonds of lower credit quality in their portfolios are kept to a minimum.

Now, let’s look at what happened with whole life policies in the 1980s, which caused a lot of change in the life insurance industry. (I’ll give you a hint: the insurance companies made a lot of money on the bonds and ended up making huge profits.) If you look again at Figure 8.4, you can see that the overpayments go into an overpayments savings portfolio. This investment portion of the whole life policy grows over time, as the investments and the ongoing contributions increase this pool of funds.

The high interest rates of the 1980s created lots of change in the types of insurance that companies offered. So the first thing you might be thinking is, what do interest rates have to do with insurance policies?

If you remember, the overpayment in the early years is directed into an investment portfolio that is predominantly fixed-income in nature. The rate of return on fixed-income investments is closely tied to prevailing interest rates. During the 1980s, interest rates were incredibly high—around 20% at the peak. When insurance companies are figuring out the insurance premiums for whole life, they first factor in the expected death of the life-insured individual along with that person’s current age. This allows them to calculate how much the pure cost of insurance is. If, for example, you are expected to die at 85, are 25 now, and would like $500,000 in coverage, they will calculate how much money they will need from you over the next 60 years so that they will have $500,000 to give you when you’re 85. If you live longer, you lose in the sense that you overpaid for the $500,000. If you die early, you win. They also factor in how fast they can make the money you give them grow.

So with whole life, where you are overpaying in the early years, the insurance company’s investment portfolio’s rate of return needs to be estimated for a very long period of time because once the premium has been determined, the insurance company is stuck with it. And, of course, because the insurance companies are meant to be profitable, they will tack on an additional amount to cover their expenses and to produce a profit for their services. Because of this, they tend to underestimate the rate of return on their investment portfolios when calculating premiums, which means premiums go up in price.

Well, during the 1980s, and specifically after interest rates had started to come back down, the insurance companies were being a little too cautious with their estimates. Whereas the premiums were based on perhaps a 6% long-term rate of return, they were collecting 10% or more on their investment portfolios. So let’s say in any given year that 100 people with policies died, and they all had policies for $500,000. The insurance company was on the hook for $50 million. But they knew that, and using the estimated rate of return for the portfolios (6%) they would have set aside $60 million—enough to pay the claims with something left over for expenses and profit. But since the portfolios grew at 10%, maybe they actually had $120 million, so they had $70 million left over after paying the $50 million in death benefits.

Check the price histories of insurance companies during this period: they were among the best stocks to own because they were money-making machines. So what happened after that? Well, people became wise to their extraordinary profitability and they decided to do something about it.

Let’s now look at the change spawned by infuriated policyholders (infuriated, that is, by the amount of money the insurance companies were making on the investment pools inside whole life policies). People started to “buy term and invest the rest.” That is to say, they would buy term life insurance, paying premiums closer to the pure cost of insurance and much cheaper than the premiums for whole life insurance, and then they would take the amount that would have gone to the whole life premium (less the term insurance premium) and invest it themselves. The underlying rationale for this strategy was that the invested savings would grow at rates that were available in the market (the same rates the insurance companies were enjoying) and it would grow enough so that individuals would become effectively self-insured as they grew older. They would still have the coverage early on through the term policy, but would later shed their insurance coverage (and premiums) as the investment pool grew large enough to cover their needs.

Of course, big companies pay attention only to the language spoken by consumers’ wallets. So “participating whole life” became more popular. “Participating” in this context meant that the policyholders would participate in the performance of the investment pool. If the investment pool grew faster than predicted, then the policyholders would get the extra growth returned to them in a number of different forms. On the flip side, if the investment pool underperformed, the policyholders would not be held accountable for making up the shortfall. This participation of the policyholders in the actual performance of the investment portfolio made whole life insurance more popular again.

Whole life insurance policies (which are a form of permanent insurance) are used for expenses that you incur only when you die, that can’t be avoided no matter when you die. I realize this sounds like a minor point, but let’s look at an example of when you wouldn’t need a permanent insurance solution.

A lot of people buy insurance to cover the mortgage balance, reasoning that if one of the breadwinners dies, the surviving family members will not have to change their lifestyle drastically because of strained financial circumstances. But you might not have a mortgage balance when you die—especially if you live to be 80 or so. Chances are you will have paid it off by then. So this is a perfect example of a temporary insurance need. On the flip side, costs for a funeral can be huge, and sometimes people don’t have the thousands of dollars with which to pay for these costs when they die. This is an example of a cost that necessarily happens only when you die, and therefore is a permanent need. While the costs of whole life insurance are greater than for term life, permanent insurance needs tend to be lower than temporary needs.

When you are younger, you may find that you need more insurance coverage than later on. This is because you have few assets coupled with large obligations. These may include the mortgage and an income for your young family to live on if you are not there to provide it yourself. In this case, you see term policies with coverage in the $1-million range on a regular basis (whereas a whole life policy might be in the $25,000–$50,000 range for an average person). The $1 million policy might cover a $250,000-mortgage balance and the remaining $750,000 could pay for your income replacement for 15 years.

While the amount of term life might be highest when you are starting your family, the cost is still fairly affordable because you are less likely to die when you are young. As you start saving and paying down the mortgage, you increase your net worth and decrease your need for insurance because in your absence your family can use the saved-up assets.

As shown in Figure 8.5, when you die, and if you are lucky enough to live to an old age, you may have sufficiently substantial assets to forgo the need for insurance altogether (assuming you were a good saver). In fact, many people do not need any type of insurance—even whole life—when they get older. I mentioned earlier that one possible use for whole life insurance is to pay terminal taxes. Some people believe that there is no need to cover the tax liabilities faced by their heirs: this is purely a personal choice. Am I advocating that you shouldn’t have insurance of any kind when you get older? Of course not. What I’m saying is that you need to analyze your needs and your personal beliefs on money management and inheritances, and then make up your own mind.

Figure 8.5: As your assets accumulate, your need for term insurance declines.

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UNIVERSAL LIFE INSURANCE

Some people, looking at the relatively high premiums charged for whole life insurance, asked why the insurance companies were not a little bit more aggressive with their investment selections. They figured that the companies’ investment accounts could be structured to grow more quickly and so fund more of the cost of the policy, which ultimately would mean that the premiums would go down. Of course, the insurance companies had to make sure they could weather all types of market conditions and a largely fixed incomebased portfolio was the best way to do this. In other words, the insurance companies didn’t want to have to deal with investment accounts that didn’t grow enough to fund the premium underpayment in later years.

Because the insurance companies didn’t want to take on the risk of an aggressively managed portfolio performing poorly, they created the universal life insurance product. This allowed the policyholder to determine how the investments were structured. If they performed well, it benefited the policyholder. If they performed poorly, the policyholder would be on the hook for the shortfall. The term “universal” came about because you can structure this type of insurance to behave like any other type of life insurance product, if you know what you are doing.

So, as illustrated in Figure 8.6, the insurance company has granted the policyholder the ability to select the investments that go into the investment component in exchange for being responsible for the account’s performance. Many policyholders believed this to be a fair arrangement, and universal life became attractive, especially to those who had an insurance need and some market savvy. Up to certain limits, the policyholder can also “overfund” a universal life policy by adding even more money into the investment portfolio than is required just to keep the policy in force. One reason people do this is because this investment account has some tax-sheltering advantages.

Figure 8.6: Universal life insurance gives the policyholder discretion to direct the investments inside the policy

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To reiterate, a universal life insurance policy is similar to a whole life insurance policy in that there is an insurance component and an investment component. On the one hand, with whole life the goal of the investment component is to lower the cost of insurance over the course of the policyholder’s lifetime by taking the overpayments early on and investing them, eventually growing them enough to pay for the underpayment later on. On the other hand, with universal life the policyholder has the ability to adjust the amount of the overpayment, and also to direct the actual investment allocation of the investment account. There are numerous reasons and strategies for this flexibility.

CALCULATING RISK

Okay, so how much life insurance do you need? I have come across way too many people who have no idea why they have as much insurance as they do. Their explanations range from, “my father told me to get this amount,” and “it sounded like a good number,” to “I really don’t know.” I find that very few people really know why they bought what they bought, and more importantly, how to adjust the amount as time goes on.

A good place to start is with a ballpark figure based on a simple set of calculations. Trust me, they are simple. Once you understand the basic philosophy behind the ballpark calculation, you can incorporate the details to match your own situation and preferences. Many calculations will vary based on your personal preferences, as you will see.

First, we need to realize that we have two types of needs: immediate cash requirements, and ongoing cash requirements.

Immediate Cash Requirements

These are expenses that are incurred upon the death of a spouse. For example, one requirement is to have the mortgage and other debts (such as an outstanding credit card balance) paid off. A funeral would also be an immediate expense. The insured person also may want to make sure the children’s educations are paid for and have a lump sum added to the immediate requirements for this purpose. He or she may also want the surviving spouse to be able to take 6 months off work for bereavement. All of these needs and desires need to be added up.

Ongoing Cash Requirements

Normally, both spouses will have estimated how much household income will be required to maintain their lifestyle if one of them dies. A quick method would be to take the total current household income and multiply by 75%. So if one person makes $100,000 and the other makes $50,000 (for a total of $150,000), then 75% of their combined income ($112,500) would be required to maintain the family’s lifestyle after the death of one spouse. You can also calculate the exact number by subtracting certain expenses that disappear when that spouse dies (e.g., vehicle payments for their car, clothing for work, meals, hobbies, etc.), if you want to be more accurate. But there may be certain items you’ve gotten used to (e.g., vacation with the kids to Disneyland every year) that you want to maintain, and this, coupled with other expenses, may be too much for one income. Depending on whether the surviving spouse wants to work or focus on raising the kids, or whether he or she was the breadwinner, this amount needed for ongoing household income can vary quite a bit.

So now we have talked about immediate and ongoing needs. Next we need to subtract what you already have in terms of assets and estimate the surviving income to find out what the shortfall is. You purchase insurance for the shortfall—not the total amount you require. An easy way to sort all of this out is illustrated in Figure 8.7.

If you read across the top two boxes as if they were a math equation, you take the immediate needs at death and subtract the immediate resources at death. These resources include current insurance (e.g., insurance coverage through your work benefits), savings that you would be willing to use (this may or may not include RRSPs), etc. In the example illustrated in the figure, we see that the current assets and insurance do not quite cover the immediate needs at death—there is a $105,000 shortfall.

Figure 8.7: A simple way to calculate the amount of life insurance you need.

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The bottom two boxes compare the ongoing family income requirement and the survivor’s ongoing income. In this case, the family has decided that once the mortgage and other debts are paid off and the children’s education funds are accounted for, then they don’t require an extravagant amount of money to keep the surviving family members’ standard of living intact. Further, in this case the surviving spouse would like to keep working (perhaps the children are old enough to not need supervision during the day). After we subtract the ongoing family income after death from the ongoing family income requirement, there is a small shortfall of $20,000 per year.

The key to that last sentence is in the phrase “per year.” Twenty thousand dollars in life insurance today will cover the deficit for only 1 year, and naturally the surviving spouse may need to cover that shortfall for many years. Let’s assume now that the surviving partner requires that support for 18 years, until the kids have moved out of the house. At that point, the survivor can live on one income. There are numerous ways to provide for this shortfall, and again it comes down to personal preference, but let’s walk through the options.

The simplest method is to multiply $20,000 by

18 years. (We won’t worry about inflation or the potential growth of the lump-sum insurance payment.) In this case, $20,000 × 18 years = $360,000. Add that to the $105,000 in immediate needs at death and the required coverage is $465,000. After 18 years, there would be no more insurance money, but presumably the surviving spouse would no longer have children at home, potentially has found a new partner, etc.

Another option is known as the “capital retention method.” In this case, you calculate how much of a lump sum invested each year at a conservative rate of return would produce $20,000 per year in interest after tax. Working backwards: $20,000 after tax is equal to $28,500 before tax (assuming roughly 30% marginal tax rate). Suppose the lump sum is invested conservatively in government bonds at an annual growth rate of 5%.1 The desired yield of $28,500 would be produced by a lump sum of $570,000. If you add this to $105,000, you have a total coverage requirement of $675,000. The point to note is that the beneficiary will always have the $570,000 lump sum. Many people like this method precisely because it provides for a retirement nest egg for the surviving spouse as well as providing an ongoing income until that point.

The last main method is the “capital depletion method.” This means that eventually the lump sum will decrease to zero, as it would be used to fund the annual costs. In this case, you would encroach upon the capital so that each year the $20,000 required cash flow would be funded by the interest earned on the lump sum plus the yield realized by selling off part of the lump sum itself. Eventually, at the end of 18 years, the lump sum will have been depleted to zero. Using my trusty calculator, I can tell you that you would need a lump sum of roughly $280,000 invested at 5%, assuming a marginal tax rate of 30%, to provide $20,000 in after-tax income for 18 years. Doing the math: $280,000 + $105,000 = $385,000, which is the total insurance required. Again, at the end of 18 years, you would have no insurance money left.

Note that I have not included the math for factoring in inflation. You can do this easily by subtracting the inflation estimate from the rate of return estimate. For example, if you think inflation will run at 3%, and you think you can get 5% on your conservative investment, then you would use 2% as the real rate of return on your lump sum investment. By dividing by a smaller number you get a larger answer (i.e., a larger lump sum) that will account for inflation. Suffice it to say, when factoring in inflation for the capital depletion method, the lump sum amount increases from $280,000 to about $370,000.

A couple more points to finish off and then we’re done. Which of the three methods we’ve discussed is the best? Perhaps the best way to figure that out is to calculate the premium costs of each. For a 30-year-old male non-smoker:

• $465,000 Term 10 would cost $29.86 per month (18 years × $20,000 + $105,000)

• $675,000 Term 10 would cost $37.25 per month (capital retention method: lump sum invested, no depletion of principal)

• $385,000 Term 10 would cost $25.60 per month (capital depletion method: lump sum invested with depletion of principal)

Personally, I would choose the capital depletion method. It will be the cheaper option, while still providing the proper amount of insurance and it doesn’t give your spouse that much of an incentive to kill you. But it’s all up to your personal preferences.

The last significant calculation is to determine how much goes into term insurance and how much into whole life. Normally, you would match the need to the product (as they say). Term is a temporary solution. Whole life is a permanent solution. The only permanent needs are the need for funeral expenses and perhaps taxes and estate equalization. All the other expenses generally approach zero as you get older (mortgage gets paid off, kids leave home, spouse retires, etc.). But no matter what, there is always a funeral to be paid for. For this, you could consider a whole life policy to cover funeral expenses (say, for example, $15,000) and term for the rest.

Generally, it makes more sense to get the shorter terms (5 or 10 years) because, as you get older, acquire more assets, and pay off debts and mortgages, your need for insurance goes down. You can always adjust the coverage you have downwards by filling out a form, and therefore reducing your costs over time.

It’s important to use an insurance broker who can compare quotes at many companies. It’s not unusual to see a 10-year-term product offered at a cheaper rate than a competitor’s 5-year term. But beyond that, this chapter has been a lot of information to take in. A good advisor can help you run through your own insurance needs analysis in case anything is unclear.


1 5% for a conservative government bond is quite a bit higher than current rates, so make sure to use current rates in your analysis.

EPILOGUE

Well, that’s it. We’ve reached the end. For some reason I always get a bid sad when I get to the end of a book. Parting is such sweet sorrow. But let’s review what we tried to achieve together.

The fundamentals of financial success are easily understood but hard to implement. Set aside some time to reflect on what you want to achieve with your personal finances. You now know the financial equivalents of eating healthy and how to do a sit-up (and all the other basic exercises). It’s up to you to put it all into action. You have the formula for an easy A. And for those of you who are ready, or who soon will be ready, you can start your journey for the harder-fought A+.

And I’m happy to provide some guidance along the way. Please don’t hesitate to reach out on Twitter. You can find me at @preetbanerjee. I look forward to hearing from you!

If you find an error or have any questions, please email us at admin@erenow.org. Thank you!