Tag: Death benefits

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Life insurance

Why Do I Need Life Insurance?

The Takeaways:

  1. You don’t have to buy life insurance, but the first reason to consider it is when you have a big and long term financial responsibilities for you or your loved ones, it is to your great advantage to own life insurance.
  2. Everyone talks about “death benefits” from life insurance because that is often the largest payment from your life insurer, who paid $100 billion to the beneficiaries of policyholders who died in 2021, the highest amount in a single year.
  3. You don’t have to have a child to buy a life insurance. Living benefits of a life policy give anyone reasons to have a life policy for unpredictable future events for oneself, like accelerated death benefits & secured mortgage payments when one lost job.
  4. Life insurance involves very personal choices, where a long term oriented mindset matters more than demographics and liabilities. Cultures play a big role especially between American parents and Chinese parents.
  5. Next to the long term mindset is the long term financial responsibilities one faces, like raising children, saving money for college education of the youth, leaving a legacy in personal cause, mortgage payments, owning a business, and senior long term cares.

Do I must Have Life insurance?

I have heard that question many times in my life. I myself also wondered about that. But the short answer is “No” because, let’s face it, life insurance is not for everyone, or in a flip side, not everyone needs a life policy.

To avoid sounding negative, the safe and sound answer should be “It depends.”

Unlike auto liability insurance that is required by the law, no one will force you to buy life insurance. The urge to own life insurance may come from inside more than outside.

That said, let’s change the question to this: “Why would anyone want to buy a life insurance policy?”

Reasons for Owning a Life Insurance

With the new question we will have a more constructive, more positive answer. We are not talking about why anyone must have life insurance. Instead, we ask for reasons why someone would choose to have it.

Let’s begin from ChatGPT and see what the chatbot would have to say (with my edit).

Here are some reasons why you might need a life insurance policy:

  1. Demographic Reasons to Protect Your Loved Ones: If you have anyone financially depending on you (spouse, children, or aging parents), life insurance can ensure that they are financially protected in the future when your pass away, allowing your loved ones to maintain their standard of living.
  2. Business Continuity Reasons to Protect Your Brand or Endeavor: If you are a business owner, life insurance can ensure that your business continues and that your family is protected in case of an untimely passing. Both whole life and term life insurance options should be considered for the reason of protecting your business.
  3. Funding for Future Expenses: Life insurance can be seen as an investment for future expenses, such as college tuition for your children.
  4. Peace of Mind: Having life insurance can give you peace of mind, knowing that your loved ones will be financially protected in the event of your passing. It can also provide a sense of security and stability during uncertain times.

The above is just a start, and I’d say it missed at least two things: It does not cover the particulars or specifics of why you should have life insurance and it essentially skips the “living benefits” for policyholders. Let’s get into details below.

Life Insurance Is Very Personal

The first thing ChatGPT missed is your personal choice for life insurance. To be sure, all insurance decisions are based on personal choices, even for auto insurance. The law says every driver must have a liability auto insurance to protect other drivers involved in an accident that is your fault. At the minimum, all California drivers must have:

  • $15,000 for injury/death to one person.
  • $30,000 for injury/death to more than one person.
  • $5,000 for damage to property.

However, you don’t have to have a comprehensive and/or collision coverages that are designed to protect yourself and your autos. Whether you choose to buy those coverages is totally up to you or is your personal choice.  

Personal choice matters especially for life insurance because no law says one must buy life insurance. Just because you have a demographic need (a wife, children and/or grandchildren) does not necessarily mean you will buy life insurance. Let me illustrate with real life examples.

Americans Do Not Always Pass Wealth to Heirs

According to an article published in New York Times, “Two-thirds of Americans who have at least $3 million in investable assets have not talked to their children about their wealth or never will.”

Another article by the Atlantic discusses how many grandparents offer some sort of financial support to their grandchildren. Some may choose to keep their wealth private from their own children. This could be due to a variety of reasons, such as not wanting to create conflicts among siblings or not wanting their children to become complacent with the idea of inheriting wealth.

Let me use a hypothetical example. Sam owns a small business with a net worth of $6 million. Sam was divorced with one son, Simon, and three daughters, Ashley, Dawn and Kelley. Sam has decided to pass his wealth not to the offspring but to an estate, which starts from a will, an executor who is in charge of the estate after Sam dies, a guardian for Kelley who is currently only 14 year old, an inventory or an account for distribution of heirs, among other things.

ChatGPT offers several reasons why a life insurance policyholder, like Sam, might name their estate as the beneficiary of their policy (with my edit):

  • Simplicity: If you name your estate as the beneficiary, the distribution of the death benefit is determined by the terms of your will. This can simplify the process of distributing the funds to your heirs, as it’s all managed through the probate process, which is the legal process of administering a deceased person’s estate, including identifying, valuing, and distributing the assets, settling debts and taxes, and transferring the remaining assets to the beneficiaries.
  • Flexibility: By naming your estate as the beneficiary, you retain control over how the death benefit is distributed. If your circumstances change, you (or the court in California) can update your will to reflect your wishes.
  • Protection: If you have debts or liabilities that may not be covered by your assets, naming your estate as the beneficiary of your life insurance policy can provide additional protection for your loved ones. One way is to establish a trust, a legal arrangement where you transfer ownership of your assets to a trustee who manages them for the benefit of your beneficiaries. When you establish a trust, your assets are no longer considered your property, so they cannot be seized by your creditors or debtors.

However, naming your estate as the beneficiary may also delay the distribution of funds to your heirs. Additionally, if you have a large estate, naming your estate as the beneficiary could increase the overall size of your estate, potentially triggering estate taxes.

That said, Sam and his heirs do not need to worry about that because the IRS will charge estate tax only for estates with a value above certain tax exemption threshold. For individuals passed away in 2021, the exemption amount is $11.7 million, meaning any estates valued at or below $11.7 million are not subject to estate tax. Sam’s net worth was only $6 million, way below the tax threshold.

Chinese Want to Pass Every Penny to Heirs Top of Form

On the other end of the spectrum and unlike many American parents, many (mainlander) Chinese parents will treat their children as the most important people in the world, literally more so than their spouse. They will do everything in their power to make sure the children get all the wealth they created, which has been their life goal to begin with. For these parents, one of the favorite way to pass wealth to the next generation is to open an irrevocable life insurance trust (ILIT) account.

This is obviously the topic for another day but briefly, an irrevocable life insurance trust (ILIT) is a type of trust that is commonly used to manage life insurance proceeds. It is called “irrevocable” because, once the trust is established, the grantor (the person who creates the trust) cannot change or revoke it without the consent of the beneficiaries.

In other words, an ILIT is permanent and not meant to be changeable. You really must have made up your mind to pass the wealth down to the trust, otherwise you may get into a lengthy process to reverse it — if possible at all. Some states allow for modifications if all of the beneficiaries consent to the changes. In other cases, the court may have the authority to modify or terminate the trust based on certain circumstances, such as a change in circumstances that makes the trust’s purposes impractical or impossible to achieve.

But Chinese parents are unlikely to change their mind on their children, so this is not really a risk factor for them at all.

There are several benefits to using an ILIT, including:

  • Estate tax savings: Since the life insurance policy is owned by the trust, it is not considered part of the grantor’s estate for tax purposes, which can reduce the amount of estate tax that must be paid. Say a Chinese businessman named Mr. Lin owns a net worth of $50 million. He can put $11 million into an ILIT for his 15 year old son, Ben, which is just below the lifetime gift tax exemption that allows individuals to make gifts up to $12.06 million as of 2023 over their lifetime without incurring a gift tax for Ben to pay.  
  • Asset protection: Because the ILIT is irrevocable, the assets in the trust are protected from the grantor’s (e.g., Mr. Lin) creditors and from any legal claims against the grantor. In other words, even if Mr. Lin owed $2 million debt to the bank, bankers cannot take money from the $11 million in ILIT, which is off limit to all creditors.
  • Control: The grantor like Mr. Lin can specify how the life insurance proceeds will be distributed, which can provide greater control over how their assets are used after their passing.

The American example of naming an estate as the beneficiary versus the Chinese example of using an ILIT to pass the wealth down help illustrate how different people choose to work with life insurance differently, which in turn is affected by different cultures and preferences.  

Why Death Benefits Matter

Like I pointed out earlier, the ChatGPT answer listed above also missed the living benefits of a life insurance policy. This is understandable as when it comes to life insurance, the thing called “death benefits” quickly come to our mind. This makes total sense as they are typically the biggest chunk of money from the insurer, and will only be sent out after the policyholder is no longer alive.

Not only are death benefits the primary payment from a life insurer but they are not generally taxable income for the beneficiaries.

For example, you have a daughter named Chloe who is the beneficiary of your life insurance policy and when you passed away, leaving a death benefit of $100,000, Chloe gets to keep that lump sum without paying income tax. In fact, Chloe does not even need to report that $100,000 on her income tax form for the year she received the money.

Only under unusual circumstances would Chloe have to pay taxes. One scenario is when she decides to let the life insurance company keep the money to generate interest, Chloe then needs to pay tax on the interest part. For example, say Chloe keeps the $100,000 on the account with the insurer and one year later it generates $500 interest, Chloe would have to report that $500 as income and pay tax on that.

Another scenario is when Chloe’s father bought the life insurance policy through a group life plan, which is typically paid by pre-tax dollars, then Chloe would have to pay taxes and her death benefits will not be $100,000 after paying taxes. Another (unusual) scenario is when Chloe decided to sell the policy (with $100,000 death benefits) to someone else.

Why Living Benefits Also Matter

When prompted, ChatGPT offers the following answer:

Life insurance provides financial protection through death benefits for your loved ones, but it can also offer living benefits while you’re still alive. Here are some listed by ChatGPT (with my edit):

  • Cash value accumulation: Many whole life insurance and universal life insurance build cash value over time, which policyholders can use the money anyway they see fit, with the following uses or advantages:
  • Tax-deferred growth: The cash value of certain life insurance policies grows tax-deferred, meaning you don’t have to pay taxes on the growth until you withdraw the money. Being able to pay taxes later rather than now saves you money because money has more value today than tomorrow.
  • Supplemental retirement income: You can use the cash value of certain life insurance policies to supplement your retirement income. This can be especially useful if you’ve maxed out other retirement savings options, such as 401(k)s or IRAs. This means in addition to the money saved though 401(k) and IRA, plus social security, you have an extra source of income when you retire.
  • Collateral for loans: The cash value of a life insurance policy can be used as collateral for loans, such as a home equity loan or business loan. When you need money today, banks can look at your cash value from the life insurance policy and say “Okay, we see you have $100,000 cash value from your life policy and we can loan you $150,000 using that $100,000 as the backup.” Banks won’t say that to someone with no life policy, or with a term life policy that carries no cash value.
  • Estate planning: Life insurance can be used as part of an estate planning strategy to transfer wealth to your heirs. Life insurance proceeds are generally tax-free to your beneficiaries. We say “generally” but more specifically the death benefits will be tax free, while the beneficiaries do pay taxes on the cash value that is more than the paid premium. Say Sam has paid a total of $250,000 in premium and the cash value comes out at $400,000 at Sam’s death, due to insurance company investing the $250,000 in the financial market, that extra $150,000 (=$400,000 – $250,000) will be taxable income for any beneficiaries of Sam’s life policy.
  • Long-term care benefits: Some life insurance policies offer long-term care benefits, which can help cover the costs of long-term care if you become unable to care for yourself due to an illness or disability.

The above list misses one thing: accelerated death benefits, which allow policyholders to receive a portion of their life insurance payout in advance if they are diagnosed with a terminal illness or critical condition.

Say John has a life policy with a death benefit of $250,000. At the age of 55 John was diagnosed with Lewkemia and will be treated by chemotherapy, radiation therapy, and/or bone marrow transplantation. John is never married and has no kid, but he can talk to his life insurer about getting a portion of the $250,000 death benefits out for his terminal illness.

Accelerated death benefits are typically included as a standard feature in many (whole) life insurance policies so you don’t need any special rider or add-on terms. That said, you do need to meet a few requirements, such as medical documentation of your condition, and other requirements such as minimum age and time since the policy was issued.

Only whole or permanent life but not term life insurance, which covers typically from 10 to 30 years, will offer accelerated death benefit. That said, some term life insurance policies may offer other riders, such as accidental death and dismemberment riders or waiver of premium riders.

Life Policies Are for People with a Long Term Orientation

In my view, life insurance is ultimately for people with a long time orientation. It is one of those things where mindset matters more than demography, liabilities or specific life circumstances.

What do I mean by long time orientation? It means one must think in longer terms like decades rather than years, months or days. The longest term we can think of is cross- or inter-generations like many if not most Chinese parents do.

Sometimes long time orientation comes to us or forces itself upon us. Mortgage protection insurance is a perfect example. It is a type of insurance that pays off your mortgage in the event of your death, disability, or job loss. The most typical term of mortgage is 30 years, which means even if you don’t want to think long term, mortgage payment will force you to act in a long term manner.

Here are some reasons why someone might consider getting mortgage protection insurance:

  • Peace of mind: Knowing that your mortgage will be paid off in the event of your death or disability can provide peace of mind for you and your loved ones.
  • Protection for your family: If you pass away, mortgage protection insurance can help ensure that your family is not left with the burden of paying off the mortgage on their own.
  • Job loss protection: Some mortgage protection policies also include coverage for job loss, which can help cover mortgage payments if you lose your job.
  • Simplified underwriting: Compared to traditional life insurance policies, mortgage protection insurance typically has a simplified underwriting process, which means you may be able to get coverage without undergoing a medical exam or providing extensive medical information.
  • Affordable premiums: Mortgage protection insurance premiums are often more affordable than traditional life insurance policies, which can make it a good option for people who want protection but may not be able to afford higher premiums.

Final expense insurance is another long-term consideration, where life insurance payment can provide funds to cover your own funeral and burial expenses, which can be quite costly.

Leaving a legacy is another long term concern, where you can leave a charitable donation or other legacy to a cause or organization that is important to you.

Locking in insurability and low insurance cost, this requires a long term mindset to look into the future. If you are young and healthy, purchasing life insurance now can help you lock in a lower premium rate while you are still insurable.

The final scenario that a long term mindset provides motive for life insurance is a business owner, who can pass the business to their heir or heirs through a variety of methods, such as a will or a trust. This is known as succession planning and is an important consideration for any business owner, especially those who want to ensure that their business continues to thrive after their death.

The question is if business owners can pass the businesses to heirs, why would they have life insurance? ChatGPT offers the following answers (with my edit):

  • To cover estate taxes: When a business owner passes away, their estate may be subject to federal or state estate taxes, which can be significant, up to 40%. Life insurance can help cover these taxes, so that the heirs don’t have to sell the business or other assets to pay them.
  • To provide liquidity: Even if the business owner plans to pass the business to their heirs, there may still be expenses that need to be paid upon their death, such as funeral expenses or outstanding debts. Life insurance can provide the necessary cash flow to cover these expenses without requiring the heirs to liquidate assets.
  • To equalize inheritances: If a business owner has multiple children who will inherit the business, life insurance can be used to provide an equal inheritance to children who are not involved in the business. For example, if one child is going to take over the business, the business owner may choose to purchase life insurance to provide an inheritance of equal value to their other children.
  • To provide a buy-sell agreement: If a business has multiple owners, life insurance can be used to fund a buy-sell agreement. This agreement ensures that if one owner passes away, their share of the business will be sold to the remaining owners at a predetermined price. The life insurance provides the necessary funds for the remaining owners to buy out the deceased owner’s share.
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Did You Know? Life insurance

Insurance for Properties & Protecting Life

The Takeaways:

  1. Property insurance and life insurance are two major categories with different purposes, for different people, and covering different things.
  2. A trend of late is to see property insurance rate moving up, while real life insurance rate going down.
  3. One important but little known way of predicting insurance cost is to look at reinsurance cost insurance firms pay to reinsurance company.
  4. More competition, advanced technology for underwriting, increased life expectancy, better risk management and more informed consumers, these all contribute to a lower cost of life policies.

Property Insurance vs. Life Insurance: An Overview

Did you know one way to divide insurance business is to separate them into property insurance and life insurance? Yes that’s true and property and life insurances make up the biggest categories, in addition to a few other “biggies” like commercial insurance, liability insurance and health insurance.

Property insurance is about protecting physical assets (e.g., personal homes and personal belongings, businesses building and business properties, vehicles) against financial losses from covered perils (i.e., direct causes of loss that your insurer will pay you for) like fire, theft, weather damage and natural disasters. They differ from life insurance in two ways: What they cover and for whom. Simply put, (1) property insurance is always protecting properties while life insurance is always protecting loss of human lives; and (2) property insurance is always designed for property owners, while life insurance is mostly designed for the loved ones of the policyholder, occasionally for the policyholder themselves.

Note property and property insurance are not always the same. It is easy to think of property insurance as for autos and homes. After all, for most families the biggest asset is the house. But insurance terminology does not always work that way. Strictly speaking property insurance does not cover everything related to your house or autos. Remember property insurance only protects property owners? That means whenever your insurance pays money to someone else, that part of coverage belongs to liability insurance, not property insurance.

Consider an easy example: Say you were driving under influence, and you hit Joe’s car, your auto insurance will pay Joe for his bodily injury and his car damage. That money received by Joe is not strictly from your property insurance but rather your liability insurance, even though the same (comprehensive) auto policy of yours will cover both.

Life insurance, on the other hand, protects financial loss caused by the loss of human lives, not physical properties. While property insurance protects property owner(s), life insurance mostly protects others — your loved ones — although it can protect oneself (i.e., the policyholder, see more details below).

Because life insurance mostly protect your loved ones, “death benefits” is a big term that appears in all life insurance policies. This is for a good reason: Death benefits often are the biggest chunk of insurance payment. It is called death benefits because they must be paid after the policyholder is dead, only to beneficiaries (i.e., recipients of insurance payment).

But death benefits are not the only benefits in a life insurance policy. Sometimes we can receive “living benefits” that are unique in two ways: They are paid to policyholders themselves rather than to their loved ones, and they are paid when policyholders are still alive.

This is a topic for another day, and I will not get into details in this post. What I will say is a quick fact that term life insurance can have living benefit as well, contrary to a misconception some may have. For example, a terminal illness rider is typically included automatically on term life policies, providing a lump sum payment if the policyholder is diagnosed with a terminal illness and has a life expectancy of 12 months or less.

Insurance vs Reinsurance

One of the reliable ways for predicting how much premium you and I will pay for our insurance policies is to look at reinsurance cost for the insurance companies like in this report of January 2023.

Many if not most of us have never heard the word “reinsurance” before, or have but did not bother to dig deeper into it. It sounds more complicated than insurance and yet seems to be one of those things that we can afford to ignore in our lives.

In truth, reinsurance has lot to do with how much you and I will pay for our insurance premium. Let me explain. Reinsurance is simply insurance of the insurances, and only insurers or insurance companies can and will buy it, not individuals. That said, the way it works is the same: We pay premiums to the insurers for the right to receive insurance payment in case we have financial loss due to the agreed perils or direct causes of loss. Insurers also pay premium to a reinsurance company so that if during catastrophic events there are more claims than the insurers can pay, they will ask reinsurer to pay it.

Reinsurance is especially important for catastrophes like earthquakes, hurricanes, floods, wildfires, and volcanic eruptions. Human-caused catastrophes can include industrial accidents, terrorist attacks, wars, and pandemics.

Catastrophes could be disasters for any particular individuals, businesses and governments alike. But they are especially bad news for insurance companies as they bring significant financial losses for insurance companies that are unable to cover the costs of claims made by policyholders.

Insurance industry has a quantitative threshold for an event to be designated a catastrophe “when claims are expected to reach a certain dollar threshold, currently set at $25 million, and more than a certain number of policyholders and insurance companies are affected.” According to this article by Triple-I.  

You probably think insurance companies all have a deep pocket that can survive any catastrophes with no problem paying insurance claims. In truth, some insurance companies are pretty vulnerable to disasters, which is why you often hear the news that some insurers got themselves into insolvency, meaning they run out of money to pay the claims from their policyholders or clients.

By buying reinsurance, insurance companies transfer some of the risk they have taken on by insuring their customers to another insurer.

From Reinsurance Cost to Insurance Cost

Here is what ChatGPT has to say about how reinsurance premium is related to our own insurance premium to be paid to our insurer.

“Yes, generally higher reinsurance costs can lead to higher insurance premiums for customers… When reinsurance costs are higher, it means that the insurance company is paying more to transfer its risk to another company. To make up for this added cost, the insurance company may pass on the cost to customers in the form of higher insurance premiums.”

Of course, there are many factors that can affect insurance premiums, like the level of risk being insured, the insurer’s expenses, and competition in the insurance market. But reinsurance cost is one of the major factors because it is the cost for the insurers to do business, which is always significant just like in any other business.

But how does reinsurance firm determine how much it will charge insurers? It is not much different from how an insurer determines our premium. The key factors are risks involved, past frequency and severity of claims made, plus industry trends and the overall cost of risk across insurers, allowing reinsurers to set more accurate prices for their coverage.

ChatGPT tells us the following: “If reinsurance rates are high, it may indicate that reinsurers are pricing their coverage more cautiously, which suggests that the overall cost of risk in the insurance market is high. This can lead insurance companies to increase the premiums they charge customers to compensate for the increased cost of risk.”

“Overall, while reinsurance rates are not the only factor that insurance companies consider when setting premiums, they can be a useful indicator of the overall cost of risk in the insurance market and may play a role in determining the prices that customers ultimately pay for insurance coverage.”

Property Insurance Rate Goes Up, Real Life Insurance Rate Down

ChatGPT tells us the following that “it appears that property insurance rates are indeed on the rise in the US. A report by Gallagher Re shows that property catastrophe reinsurance rates for loss-hit US accounts increased by between 45% and 100% at Jan. 1 renewals, indicating a significant increase in rates for property insurance policies in some areas. This trend of increasing property insurance rates is also supported by a recent analysis by Bankrate.com, which found that the average homeowner spends about 1.91% of their household income on home insurance, a figure that has been rising over time.”

This report in Business Insurance cites a report from Amwins Group Inc as saying: “Property markets will remain hard with no softening in the foreseeable future.” “Due to the challenges in the property market, however, reinsurers are being ‘extremely cautious’ with all their capacity.” The reason for property insurance market getting tough is “the combined effects of a major hurricane making U.S. landfall in five out of the last six years, wildfires engulfing thousands of acres, unprecedented winter storms and Midwest flooding. All ‘have played a major role in hardening the insurance marketplace.’”

What about life insurance premium? ChatGPT tells us that the trend of premiums for life insurance policies has remained relatively stable in recent years. This may not sound exciting but wait for taking inflation into account: Life insurance prices remained relatively the same throughout 2021 despite inflation and an increase in death claims. The average monthly cost of a $250,000 policy only increased by a small amount from January 2021 to December 2021.

Combining the above I’d say the “real” (i.e., inflation adjusted) life insurance premium has gone down.

While there is no specific data provided for California, it is likely that the trend of stable premiums applies to the state as well.

It should be noted that while the cost of premiums may remain relatively stable, they can still vary depending on factors such as age, gender, and health status.

Explaining the Decreasing Real Life Insurance Cost

ChatGPT offers several reasons why life insurance rate may go down (with my edit):

  • Improved Health: One of the primary factors that influence life insurance premiums is the health of the policyholder. If you have made positive lifestyle changes that have led to improved health, such as quitting smoking or losing weight, then you may be eligible for lower premiums. Note this is an individual specific reason, although modern medical technologies can certainly benefit anyone.
  • Increased Competition: As more insurance companies enter the market, there is greater competition to offer more affordable policies. This can lead to lower prices for consumers as companies try to attract more business.
  • Lower Risk: Insurance companies base their premiums on risk factors such as age, health, and lifestyle. If these risk factors decrease over time, then insurance companies may lower their premiums accordingly.
  • Advances in Technology: With advancements in medical technology, it has become easier to diagnose and treat various illnesses. As a result, life insurance companies may be more confident in their ability to predict the life expectancy of policyholders, and this can lead to lower premiums. The other reason is the use of technology in underwriting, such as using Google Maps for homeowner policies and wearable devices for monitoring personal fitness.
  • Economic Conditions: Finally, economic conditions can also impact life insurance costs. If interest rates are low, for example, insurance companies may need to lower their premiums in order to remain competitive and attract new policyholders.