The Importance of Regular Life Insurance Evaluation
Examining Our Original Life Insurance Decisions
Ideally, our initial choices when it comes to selecting the right life insurance policy will be well considered and at least sensible, if not close to the ideal. When we make these decisions though, we are doing so with a certain set of assumptions though, which can change over time.
The clearer we are on what these assumptions were at the time of purchase, the easier it will be to adapt to these changing conditions. If we are assuming a certain amount of income in our model and this income goes up or down by a significant amount, we will be in a position to adjust our expectations and needs, but only if we have a good enough idea of what they actually are.
If the assumptions of our needs or our capacity to afford the insurance or anything else material to the decision is not accurate, and we do not correct this, any attempt to correct this will be similarly off base. If our needs are understated by 50% for instance, and they are believed to be reduced by 50%, this would serve to balance them if we do nothing, but if we believe that we need less coverage now, this view will be mistaken.
We do need to regularly assess our life insurance needs and all matters related to our being protected here, but the validity of these further assumptions will often depend on how accurate our prior ones were, given that we tend to rely on them in our ongoing calculations.
The right approach here is not to depend on prior analysis but to re-assess from our present perspective, which means that we’re going to need to do all these calculations all over again and not seek shortcuts. If it turns out that our original assumptions were correct, we can verify this, but if we do not seek to, we can be mired in long term miscalculation.
Factoring in Wealth Accumulation Over Time
Ideally, when we do any life insurance needs calculation, we also need to properly account for our own resources providing more and more financial support over time. This assumes of course that we are saving money, and in cases where we are not, we may want to adjust our spending and devote at least some money to saving if we can.
Even if we know exactly what our life insurance needs are at any given point in time, provided that we are saving as well, these savings will over time reduce this need. Life insurance needs are generally pretty dynamic for this reason, and it’s not as if we can select a lesser amount to protect us and compensate for this because we simply do not know if and when we may die.
If, for instance, we need a million dollars’ worth of coverage today, and we have no savings, we can’t just say that we’re going to accumulate savings to reduce this need because this need exists today.
Later on, years down the road, perhaps we have reduced this need, and often times we will, but we did need this much for a time regardless, prior to our own savings making a bigger contribution to our future.
The role of life insurance will therefore tend to go down as we save more and more, and if we are saving a substantial amount over time, this all does need to be revisited every few years. We do not want to be over-insured, because it costs us more than we may expect to get back by devoting our funds to a life insurance policy, where the excess may become better suited to retain and add to the savings component of our financial plan.
The Role of Inflation
Even though we generally have a pretty good idea of how inflation will run over a period of a few years, it’s more difficult to predict this longer term. With life insurance, often we are dealing with pretty long terms, over several decades.
As the information we have changes over time, we may need to compensate for this. Perhaps the outlook for inflation has increased quite a bit since we first started buying life insurance, and we’re going to need more coverage. Perhaps the outlook for inflation has decreased, which has actually happened over the last couple of decades, reducing our life insurance needs and perhaps requiring a re-assessment.
Very often, we don’t properly account for the effect of inflation on our life insurance needs, and will tend to just look at the nominal amount of insurance coverage we receive instead. If we have a million-dollar policy for instance, we tend to think of this million dollars in terms of its present value, where its true value may be reduced significantly down the road due to the effect of inflation.
If we look back to a time in the past, and remember what things, those of us in middle age or older will recall times where money went much further, and when having something like a $100,000 life insurance policy went much further than it presently would. This may have even seemed like a nice sum of money 30 years ago,
While inflation has settled down lately, we can count on money today being worth considerably less down the road. Our $100,000 30 years ago buys less than half what it did back then for example.
There are some rules of thumb here that we can use, where if we’re looking to determine how much we may need 30 years from now, all other things being equal, we can just double what our needs are today and get at least a pretty good idea of how this may end up.
There are also some tables that we can use where others have done these calculations for us to get an idea of the projected effect of inflation, and we’re always going to need more and more as time passes as the cost of things keep going up.
Any projection made today is going to be subject to changing inflation rates though, so if we want to seek out a reasonable amount of accuracy, we’re going to need to run these numbers periodically, looking at updated tables for instance.
Since we don’t know when we may need the policy, we’re going to need to err on the side of caution here, using the longer-term numbers to base our decision on, rather than the reduced shorter-term ones, if we want our coverage to be sufficient for both that is.
Changing Financial Needs
When we decide on a certain figure that we will need if we pass away, this will always involve certain assumptions of need, which are of course subject to change. When we are deciding on a longer-term basis, there’s no real way to know what our needs will be at any point in the future beyond the shorter term.
There are numerous events that may end up changing these needs, like the birth of new children, one of our beneficiaries dying, significant increases or decreases in our net worth, health conditions that may increase our needs a lot, and so on.
When we look to initially assess our life insurance needs, this will involve us acting on the knowledge we have at the time, and as new factors emerge, they need to be accounted for. We may not be able to do very much or we may not want to if these needs decrease, but they tend to instead increase, and we may wish to add additional coverage to compensate for them.
Even though term life insurance does commit us in a real sense to the term, and we don’t just want to cancel the policy and buy an entirely new one, we can purchase additional policies as the needs arise.
When our policies expire, and we still desire to be covered, this is the time where we can both compensate for reduced and increased needs, and purchase less or more coverage if deemed to be appropriate.
Given that the tendency is to have our needs increase, we should be assessing our needs on an ongoing basis during the term of the policy, to ensure that it we maintain our desired level of sufficiency and add to it when appropriate.
Assessments with Permanent Life Policies
When it comes to permanent life, also known as whole life, we’re going to have to decide what to do with both the insurance component of these policies as well as the investment or savings component of them.
The actual life insurance part of whole life policies should be approached the same way as we would with a term life policy, but with the savings part, we need to assess this in a similar way to how we would judge any investment.
While it will be nowhere easy enough to reallocate our funds with whole life policies as it is with any other type of investment, we still need to be aware of how this component of our policies is performing as well as changes to its suitability to our long-term financial objectives.
The fact that you can’t just take this money and put it into something else as easily as you could with a mutual fund investment for instance is one of the real drawbacks of saving or investing with a life insurance policy, but this doesn’t mean that once we’ve bought the policy, all analysis of it should end.
People often buy these whole life policies as a means of looking to be covered by the life insurance part of it over their entire lifetimes, thus the terms whole life or permanent life, but this may not be a good idea in itself, and can certainly change.
You may have saved a lot over the years to pay for the very high cost of insurance when you get older, but just because you have the money to become insured in old age doesn’t mean that you should, and generally you should not in fact.
The goal should instead be to wean yourself off of the need for life insurance in the final quarter of your lives, and even though being insured into old age may have been your objective at one time, this at the very least needs to be rethought later, especially if you find yourself in a better position than you earlier thought you would be in.
There’s also the matter of how well your savings or investments are performing, and while we can have a pretty good idea of what to expect from these policies even at the outset, we always need to look at this performance relative to what else we could be doing with the money.
If we are in a bull market for instance, it may be more appropriate to invest more of our savings, where if we’re in a bear market, these rather small returns that whole life policies generally provide can look pretty good alongside investment losses.
Our investment needs also change over time as well, and while the policy may have seemed to be appropriate at one time, this can change alongside our changing financial situation and goals.
We should never see buying life insurance as a once and done thing, or something that we should only be thinking about when our policies are up for renewal. Instead, life insurance needs do change over time and we should at least be evaluating our needs here every few years and whenever things change substantially.