The (Sort of Made Up) History Of Life Insurance

This post is part of the TermLifeInsurance.com blog tour, which helps spread awareness of the importance of providing financial security for your family. September is Life Insurance Awareness month, so learn more with LifeHappens.org and how life insurance can protect your family and your finances.

People get all melodramatic about life insurance. They either hate it so much that they refuse to even look at it, or they’re so afraid something might happen to them that they’re bleeding insurance premiums.

Where’s the middle ground?

Here’s a thought: maybe there is no middle ground.

Huh?

What if, instead of looking at life insurance through a bunch of truisms and rules of thumb, we actually looked at life insurance from an individual point of view. Could it be that all types of life insurance policies might be good….but for different people?

I’m sure that’s the case. In fact, I’m so sure that I’ll show you, using a handy dandy made up story I’ve called:

The (Sort of Made Up) History Of Life Insurance

One thing that is true: the life insurance industry has always been reactionary. Initially, insurance policies were simple contracts: you paid money into a company and when you died, your heirs took money out. It was easy, but expensive.

Why was insurance expensive? Simple. Every year you had a birthday, that meant you were one year closer to death. So, the insurance company made you pay more money. Why? Because insurance firms are in the profits business and to stay profitable, they had to jack up the rates on older people.

If you wanted to stay insured into your 50’s and 60’s, you were going to have to pony up a lot of money.

In fact, that’s still the case now. This type of insurance (one year term) is fantastic for young people but horrible for anyone who needs insurance later in life.

What would insurance companies do for these people? One day an insurance company thinker had an idea. What if we created a product that would subsidize the enormous costs of insurance late in life with bigger premiums when the person was young?

Brilliant. Whole life insurance was born.

The creators of whole life insurance developed this new tool inside of life insurance called “cash value.” Here’s how it works: you pay in extra money every year into the “cash value.” The owner of the policy could take this money out whenever he wanted, but they were advised to leave it there. Why?  That cash paid in during the insured’s younger years would be used later in life. So, instead of putting in $10 at age 25, you might invest $50. The extra $40 was an investment now that would pay the extra money required to pay the huge costs down the road. It was brilliant….and expensive.

People who rip whole life insurance do it because they say it costs too much. That depends on a variety of factors. Do you need insurance late in life? Probably not, but if you do, whole life insurance isn’t expensive. It’s efficient as long as you keep it your entire life.

Of course, the problems with whole life insurance came around when people decided they were “savings accounts.” Insurance as a savings account! Why would someone do that? Easy. People weren’t buying the whole life policies, so companies said that you could use the money later if you decided you didn’t need it.

Innovative…and confusing to most people.

Because whole life insurance is expensive, new types arrived on the scene. Universal and variable universal policies meant to keep up with different trends:

• Universal policies allowed owners to flex their policy. Instead of a guaranteed interest rate and set death benefit, people now could change their death benefit and the interest rate it paid depended on prevailing rates in the market. This was great in the late 70’s and early 80’s but is horrible now.
• Variable Universal policies replaced the set interest rate cash value with accounts meant to operate like mutual funds. These separate accounts could give a saver potentially bigger gains as the market increased. Of course, they also were susceptible to the downs of the market, too, which is why many people who didn’t understand “cash value” got crushed by down markets. How? They thought that putting less money into their life insurance was a good idea. It’s a brain bender, but more money into the cash of a variable universal life policy is a good thing. It keeps the policy stable, makes sure it lasts a long time, and it allows people to invest in mutual funds….which over longer periods of time increase in value.

Do you follow all that? Probably not, but that’s the point. Insurances can be confusing and are very specifically designed to meet the needs of specific situations. The only way to know which type is for you is to actually dive into your situation, how much insurance you need, and how long you’ll need it. At that point, pick your best type, instead of starting with a type of insurance “that’s best” and ending up with the wrong type.