Beware Life Insurance

Life insurance is bought more because it sounds like a good idea than because it is actually needed. In fact, most people who buy life insurance never actually get paid when they die:

Almost 85% of [US life insurance] term policies fail to end with a death claim; nearly 88% of universal life policies ultimately do not terminate with a death benefit claim.  In fact, 74% of term policies and 76% of universal life policies sold to seniors at age 65 never pay a claim. …

We document the following core facts about the U.S. life insurance industry, which has over $10 trillion of individual coverage in force …:

  •  A death benefit is not paid on most policies. For “term policies” that offer coverage over a fixed number of years, most are “lapsed” prior to the end of the term; a majority of permanent (e.g., “whole life”) policies are “surrendered” (i.e., lapsed and a cash value is paid) before death.
  • Insurers make substantial amounts of money on clients that lapse their policies and lose money on those that do not. Insurers, however, do not earn extra-ordinary profits. Rather, lapsing policyholders cross subsidize households who keep their coverage.
  • Real premiums decrease over time (i.e., policies are “front loaded”) rather than increasing with age in a manner more consistent with either actuarially fair pricing or optimal insurance in the presence of reclassification risk where new information about mortality risk is revealed.
  • As an industry, insurers lobby intensely to restrict the operations of secondary markets. In other markets (e.g., initial public offerings or certificates of deposit), the ability to resell helps support the demand for the primary offering. …

While consumers correctly account for mortality risk when buying life insurance, they fail to sufficiently weight the importance of background risks. … Since consumers do not anticipate the need to lapse, this front-loaded policy appears to be cheaper than a policy that is actuarially fair each period. … The introduction of a secondary market undermines this cross-subsidy by offering lapsing households better terms relative to surrendering. (more)

We cryonics patients are hopefully an exception – we really do need the money to pay for the cryonics treatment. More info on cheating insurance agents:

We construct a rich dataset describing individual insurance agents operating in Texas. We match licensing data with company affiliations and detailed sales practice complaint records from the state regulator. From the company affiliation data, we identify two types of experts: monitored agents from large, branded companies, and unmonitored agents working as independents. We fid that the odds of monitored experts from large, branded companies taking advantage of their customers are 21 to 98% greater than the odds for unmonitored independent experts. In a supplemental analysis, we use national sale practice complaints data to confirm our results. Finally, we find that more experienced agents are significantly more likely to mislead their customers. … Company agents may earn 50 to 70% of the gross commissions of their sales, depending on the type of insurance product. (more)

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  • This is a feature, not a bug.

    “I paid for all this homeowner’s insurance, and my house didn’t burn down! I’m outraged!”

  • John B

    If your children are grown and you have saved for retirement, it’s reasonable to no longer see a need for life insurance.

    I used term because I needed it during the time I had minor children and not much saved. 

    •  The numbers are still weird. Ok, so if 85% of term life policies never pay out, then 15% do pay out. But the annual death rate by age is generally well below 1%, is it not? So does this imply that too many term policies are paying out? If so, why? Inertia in people just carrying term to death (even as term renewals cost more each time)?

      And if people are letting term lapse for rational reasons like no longer needing coverage for dependents (as I understand term policies were designed for, temporary coverage), then why do permanent whole policies have even *lower* payout rates? If 88% never pay out, then just 12% pay out – so a term policy is more likely to have the subject die than a whole life? Why are they surrendering whole even more often than term?

      Maybe the paper explains all this since some of the bullet points touch on these questions, but it’s paywalled…

      • John Salvatier

        Imply and ye shall receive.

  • Dean Jens

    I shopped around for 20-year term insurance when my wife got pregnant, but what I ended up with is kind of an odd policy.  Assuming I’ve understood it correctly, I could actually pay according to an increasing schedule, but early overpayments effectively accrue 3% interest; the salesman simply presented me with the fixed monthly payment that, made for 20 years, would lead me to build up an excess balance that would then exhaust itself in the 240th month.  I’m just going along with that.  Because of this, though, I’m pretty sure that if I quit making payments, the policy wouldn’t actually lapse until the excess had run down; there’s no benefit to them from my potential lapse on this policy.

  • Bobreednz

    See Comment by John B.  That is also my plan.  I’m thinking that somebody who suggests that life insurance isn’t a good idea because most people don’t cash in is kind of missing the point of “insurance.”

  • Most life insurance policies are investment vehicles as well as insurance policies, so your statement that “most people who buy life insurance never actually get paid when they die” doesn’t bother / surprise me.  In one sense the earnings of the insurance carriers represents the well-being that, for instance, a Term life insurance holder may receive for knowing that her family is well taken care of in the event of her death during the term (e.g. while the kids are not yet in college).  Note that of course I’m pretty biased.

  • Lukas

    Generally speaking: Isn’t ANY insurance policy a lot like sports gambling?

    Yes, you might theoretically understand the odds better than those trained, experienced and well equipped actuaries (unlikely though that is…), but then again, there probably wouldn’t be any insurance companies if they didn’t usually make money on their clients.

    Alright, there still might be some benefits to getting a policy as an investment (not because insurers are so great at investing, but because there might be some guarantee by the government to keep the companies hopelessly inflated payout promises if needed), or because compensating a LOSS has inherently a greater utility than making some gain (as in “normal” gambling).

    But still, wouldn’t it make a lot more sense to just save your money, invest it when stocks are low, and then sell those when needed?

    • PLee45

      The article above should already shed light on the financial health of an insurance carrier. Those who buy Term Life policy and those who surrender universal life policy early help pay for those who fully fund their policy and carry them to maturity. Those who maximize death benefit on a policy will more likely lapse or surrender the policy compare to those who minimize death benefit and maximize cash grow.

  • Realize that life insurers pay out 1.5 billion dollars every day!

    Cyronics maybe one of the strangest, but most applicable examples for buying permanent insurance. If you plan on being preserved after death, you have a need for a big lump sum when you die that doesn’t lessen over time, like a mortgage or raising kids would.

    Other reasons for Whole Life are to insure business partner or loan, bequeath a charity, pay estate taxes, or leave a legacy to heirs.But that is not most people. the typical profile of a Term Life insurance owner is someone who is a family breadwinner and has minimal savings. It is critical protection and too many people don’t have it.Choose term for covering specific needs that will disappear with time, such as: Income replacement, Financial security for dependents, Mortgage protection, College funding, Final/burial expensesUse a free online quote engine to compare term rates from hundreds of top-rated companies to see how affordable it is. (I’d recommend QualityTermLife’s site because they don’t ask for your phone or email to get quotes.)

  • mgoodfel

    I’m interested in cryonics (have no philosophical objections), but I can’t afford it as a cash payment.  I am disabled and uninsurable.  And I live alone, which means I could be dead for days before anyone noticed.

    Is there any way cryonics is practical for me?

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  • Robert Wiblin

    Sounds like you could do well by buying and holding a life insurance policy until death (if you think you will so).

  • The life insurance agent makes money on the commission of the sale but when the policy holder die then they get the life insurance check for beneficiaries. So I don’t think there is any kind of need to beware before purchasing insurance. Yes there are also very rare chances where adviser can’t make this better for you.

  • williamwalker91

    I am glad that you gave a warning like this for health insurance. You have to get your insurance from someone you can trust. I am just glad that I already have health insurance.

  • Mickey James

    Insurers make substantial amounts of money, Congratulations guys quality information you have given!

  • PLee45

    The Index Universal Life product has flexible premium and normally there is smaller premium that is required to keep the policy active and when the client can afford to pay more then more cash will go to the investment portion to grow the cash value. There is a grace period of time that the policy would still be active after the client missed the monthly payment and if the client can catch up with the payment then the policy would continue as written. I believe there is a non-payment gap of 2-3 years that the client could get back to the same policy if the client can retroactively make up all the rear payment. Life insurance has evolved quite a bit and death benefit is just one components of the total package. To me, Term Insurance is just a waste of money for the client and a good revue for the carrier. A well structure universal life policy should cost the client nothing over the long run, let alone there could be substantial cast value to supplement retirement income. Most people think of life insurance as a cost item so they chose Term Life to minimize premium; however, those who understand life policy well would prefer Index Universal Life for the cash value, accelerate benefit, and death benefit. One critical advantage for the client is too buy the policy as early as possible when one is still young and healthy. Build a larger cash value early on to take advantage of compound interest over many decades to