Insurance is often a misunderstood asset. I have heard people say how they just pay and pay with nothing in return. Let’s try to cut through myths and go for the truth.
Insurance is a Contract
Insurance is a building block of financial security – it is a Risk Management tool. A contract between a purchaser and an insurance company that allows the purchaser to offload financial risk they can’t bear alone onto a company that can – in return for premium payments.
How do insurance companies do this? It is called risk pooling – selling many policies and using statistical estimates to set premiums – which are then invested in a manner that allows companies to pay their contractual obligations. It is thus of major importance to examine the financial strength of the insurance company.
Insurance Categories: Life/Health/Accident and Property/Casualty
Property/Casualty is dealing with damage and liability stemming from cars, homes to professional liability and even Kidnap and Ransom. We are not licensed to deal with this type of risk, but we have ability to refer you to agencies that can provide you with suitable contracts.
It is a subject that is always difficult to approach because we don’t like to think about our mortality. The beneficiaries are those who are left behind – the dependents.
This is one of the most important aspects of life insurance to understand – the benefits go to dependents and they are tax free. The basic purpose of Life Insurance is to provide for those left behind who are now without financial means provided by the deceased.
The most basic type of Life Insurance is Term Life. In exchange for paid premium, the insurer promises to pay an agreed upon sum (“death benefit”) should the insured die within the term of the policy. Thus this is a time limited policy, once term expires it is no longer in effect.
On the other end of the spectrum there is Whole Life. This is a policy that lasts for the entire life of the insured. The premiums are substantially higher than for Term policies because in addition to death benefit, these policies provide for a cash value. A part of the premium is deposited into Insurance Company general account and the Insurance company credits the policy with an interest rate that is declared annually (or guaranteed for a few years). It is essentially like having a CD with some tax protections.
In between there are Universal Life policies. They still have cash value and thus premiums higher than Term Life, but they have various levels of flexibility in terms of payments as well as how the interest on the cash value is credited – based on an index or a portfolio of mutual funds.
Permanent policies offer some additional benefits – they can be used in estate planning as a means to provide for estate tax on large estates especially those that consist of illiquid property. Properly structured permanent policies can also be effectively used as a tax free retirement vehicle. Finally many offer riders that can help with Long Term Care as well as accelerated death benefits in case of terminal illness.
What is the best policy for you? That is entirely dependent on your life situation and has to be examined on a case by case basis.
This is an often neglected provision especially for the self employed. These policies provide for income replacement should the insured gets injured and is unable to work. There are short term disability policies and long term disability policies – and yes you need both. The reason for this is that a male in his 20s is 4 times more likely to be disabled in his working life than to die. Many companies and certainly large employers offer these policies as a part of the benefits package – which explains why people don’t think too much about them. However if your company doesn’t offer one, it would be prudent to obtain such policy.
No conversation about Insurance is complete without discussing annuities. There are sharp differences among financial professionals about their usefulness. Annuity is a contract between a person and an insurance company where the company promises to pay a lifetime of income to the beneficiary in exchange for a premium payment.
Usually there is an accumulation phase and a distribution phase. It is true that annuities carry higher fees and can be opaque – and as always they are not suitable for everyone. But they do promise the lifetime stream of payments which is an important safety net and can mitigate the sequence of returns risk for retirement funds.
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