What to Review in Your Life Insurance Policy
A catastrophic loss is sure to throw any financial plan off course. In our portfolios, we protect against uncertainty through diversification. In our daily lives, we protect our assets with property and casualty insurance (home, auto, boat, etc.). To protect our families against loss of income, we purchase disability and life insurance.
Many young couples recognize a need for life insurance when they take a loan for their first home, or when they have their first child. They should carefully consider cost, amount, and type of insurance coverage at that time. Once in place, the policy should be reviewed regularly since the need for life insurance is likely to change over the years. A family may grow, mortgages may eventually be paid down, and children may go off to start their own families. Because of the dynamic nature of our families, life goals, and market conditions, we need to be aware of how these risk reduction mechanisms are designed to work for us. Here are some of the things you should review in your life insurance policy on a regular basis:
Family dynamics change. Dependents are created as our families grow, and in divorce situations, dependents may be lost. Review your beneficiaries as your life changes. Ask your advisor the meaning of per stirpes, a type of beneficiary designation. You may choose to edit your beneficiary designations based on this information alone. If you construct a trust as part of your estate planning process, your estate attorney may also guide you towards updating your beneficiary designations.
Market conditions can affect your life insurance policy depending on the type of policy you have purchased. Interest rates move up and down, and if your policy is based on prevailing interest rates, they may underperform relative to the illustration given at the time of purchase. In a down-market situation, the underlying subaccount performance may jeopardize certain types of policies as well. When a policy underperforms relative to the premiums being paid, it may lapse or fail. Imagine discovering too late, in the face of a crisis, that your life insurance policy has lapsed! Also, acquiring a life insurance policy later in life, especially if your health has deteriorated, may be cost-prohibitive. Policy performance review is important because there are steps you can take to salvage your policy before it lapses.
A good acronym used to justify insurance coverage is L.I.F.E.
Liabilities – If your dependents were to lose your income, which debts would you like to eliminate? This is an important question because mortgages are a common debt. Hopefully, at some point in time, the mortgage will be satisfied and your need for life insurance will decrease. The review process should include recalculating the current debt load and comparing that amount to the existing coverage. This process might reveal that you have too much or too little life insurance coverage.
Income Replacement – If your significant other or children were to suddenly lose your income, could they survive without it? Would their lifestyles be compromised? Would they need to go back to school in order to provide for themselves? Generally speaking, this component is calculated by multiplying your annual income by the number of years you may require income replacement.
Final Expenses – This is self-explanatory, but it should be noted that even your final expenses are likely to change over time.
Educational Needs and Estate Planning- Children grow up far too quickly. As their dependence on you diminishes, they graduate college and move on to start their own families. If their educational goals have been met, you may no longer need life insurance to cover those expenses. However, estate planning and the transfer of wealth may be another good reason to retain (and in some cases, increase) the amount of life insurance coverage that you carry.
Your financial situation is unique to you, and so are your life insurance needs. Obviously being underinsured is a bad thing, especially if you happen to meet an untimely demise. Being overinsured is not good either, as you could be using the additional premium payments to reach other goals, such as retirement or education. Since it’s always better to be safe than sorry, I would advise you to continually review, review, review your life insurance policy.