The Takeaways:
- Only half (50%) of the US population owned life insurance policies in 2022, down from 63% in 2011.
- The good news is that the “ownership gap” (between people who believe they should have a policy and people who actually own one, sometimes known as “Need-to-Have” gap) for life insurance is smaller (at 18%) than property insurance (up to 54%). The bad news is the gap has been increasing recently.
- There are two fundamental types of life insurance: Permanent vs Term. A term life policy is for temporary coverage over a predetermined length of time, typically no more than 30 years, while a permanent policy covers policyholder’s entire lifetime ending in death.
- All term life policies only cover death benefit with zero cash value regardless of the length of term, while all permanent life policies accumulate cash value to be used for policyholders before death. Term life policies are much cheaper to begin with, but they all have a specific “expiration date,” after which your premium payment is completely gone if you are still alive. Permanent life policies do not expire and the money you saved will be there — for you or your loved ones.
- For policyholders, the most important “must know” concepts are living- versus death-benefits. The former is designed for policyholders’ own welfare before death, while the latter for the named beneficiaries.
- For a long time in the past, life insurance has been largely driven by “altruistic” death benefit in the sense that only proven (or presumed) death of the policyholder triggers benefit distribution. However, annuities for guaranteed post-retirement income, critical care insurance for acute illnesses and long term care for chronic illnesses, these have changed the game profoundly.
Last time the Kingstons talked about inflation and central banks in relation to decentralized finance or DeFi. Today they decided to talk about something more practical and mundane: Life insurance.
Lily: Yesterday we talked about inflation and local reservoirs for holding the flood of money directly from central banks. Kim mentioned household savings as the terminal end of reservoirs, and I talked about life insurance policies as an alternative to household savings. Can we talk more about life insurance today? Part of my job involves marketing life insurance.
Kimberley: That sounds interesting, unless Mom and Dad had something else in mind.
Joy: Insurance is fine with me, especially life insurance, as many people bought auto insurance because the law says they must, but I assume life insurance is not as popular as auto insurance.
Lily: I’m glad you mentioned that. My company invited a knowledgeable speaker from a top life insurance company to educate us last week, and everyone feels they are gaining a lot. The speaker made frequent referral to this website called bestliferates.org during his presentation. Check that site out if you are interested. The only thing is that it covers data up until 2020, not the latest. Anyway, in 2020, only about 54% Americans had life insurance.
Kimberly: So barely over half the people are covered by life insurance in this country.
Lily: Yeah. That 54% is called the rate of “market penetration” for life insurance. Here is the bad news: Over the past decade the penetration rate has been moving downward, meaning fewer and fewer Americans have life insurance coverage today than before. In 2011, for example, 63% Americans had life insurance, but only 54% did in 2020, almost a 10% decrease.
Jason: I wish we knew more recent figures, like from last year.
Lily: We do, actually. This website called Statistica.com tells us that in 2022, based on the LIMRA, which stands for Life Insurance Marketing and Research Association, and Life Happens’ 2022 Insurance Barometer study, the penetration rate was 50%, 4% lower than 2020.
Joy: Hmm. Did the speaker explain why the penetration rate is down?
Lily: He did — at least partially. He talked about insurance “ownership gap” or “need gap,” which is the difference between how many people believe they need life insurance and those who actually own one. Sometimes it’s called the “Need-to-Have” gap. So if 50 out of 100 people believe they need life insurance but only 30 of the 50 actually own a life policy, that gap is 50% – 30% = 20%, meaning life insurance companies have a big job to do to get that 20% to buy life policies.
Jason: Wait, what is a “life policy?” Isn’t a “policy” a rule or regulation like “No gun in school” policy or no racial discrimination policy?
Lily: I don’t know why an insurance contract is called “policy” or “plan.” If I must guess, it may have something to do with the “contract of adhesion,” meaning in an insurance contract only one party, usually the “insurer” or insurance company, fixes the terms of the contract and the other party, usually the “insured” or policyholder, must accept or reject it. So this is like government or authorities make policy and citizens must obey it.
Kimberly: Back to the ownership gap, I just want to make sure I get it. You said if 50 out of 100 people wanted life insurance but only 30 had it, the ownership gap is 20%. Now, let’s say 45, not 30, of the 50 people had a life policy, the ownership gap would be only 5%, right?
Lily: Right. The good news is that compared with property insurance, life insurance has a smaller ownership gap, meaning more people who want a life policy will get one. I remember reading somewhere that says the ownership gap was huge in properties insurance when we look at property losses from natural disasters. We are talking about trillions of dollars there.
Greg: You are right. The most reliable source for that is reinsurance companies, you know, those provide insurance for insurers, or “insurer of the insurers.” I read …
Jason: So why do we need reinsurance companies if we already have insurance firms?
Greg: Well, it’s a way to control or rather to transfer risk for each insurance company. Think of why we buy insurance. We buy a policy because in case something happens to our home, our auto, our health, our income, or our capability to live a normal life, what can we do about it?
Jason: Not much. We just hope bad things don’t happen to us.
Greg: This is a common mindset but seriously, there are several common strategies in handling risks. One is avoiding, meaning if driving is risky of traffic accident, we don’t driving at all. Another is risk retention, meaning we simply accept the risk and swallow the consequences.
Jason: These are not insurance, right?
Greg: No, of course not. If everybody is avoiding and accepting risks, there is no business doing insurance. The idea behind insurance is transferring risk, not avoiding, not accepting. Insurance is basically a deal or a contract between insured and insurer, the insured won’t take the risk by themselves because it’s too much for them to take. So they pay the premium money to an insurer and ask them to take the risk for them, in the sense that insurer will pay money to the insured to cover their losses when bad things do happen.
Kimberly: So in that case, insurers need reinsurance just like we ordinary people need insurer?
Greg: Exactly. That’s why reinsurance is called “insurance for insurance companies,” or a contract between a reinsurer and an insurer. Just like we pay premiums to insurers, an insurer also pay premiums to the reinsurer. Anyway, back to the ownership gap in the property insurance world as I was saying, there is a study by Swiss Re, one of the largest reinsurance firms, that says only 45% of global economic losses from natural disaster were covered by insurance in 2022. That means 55% were not insured, which is a shockingly large number.
Kimberly: 55% is for the world, perhaps the US is lower?
Lily: Not necessarily. I remember reading an interesting article on AP news that says our country is Earth’s “punching bag” for nasty weather because of the unique geography. We are hit “by stronger, costlier, more varied and frequent extreme weather than anywhere on the planet.” We also have the two oceans of Atlantic and Pacific, plus “the Gulf of Mexico, the Rocky Mountains, jutting peninsulas like Florida, clashing storm fronts and the jet stream combine to naturally brew the nastiest of weather.”
Kimberly: Interesting! Now, if we take 55% as the ownership gap for property insurance, what is the ownership gap for life insurance?
Lily: Much better actually. The highest life insurance ownership gap came in 2020 at 16% if I remember it correctly. Jason, could you go to the website “bestliferates.org” please? I want to cite numbers there.
Jason: I just found it. Which numbers are you looking for?
Lily: Search for the words “ownership gap” please.
Jason: Sure. It says in 2011 the ownership gap was 7%. The lowest gap was only 3% in 2013, while the highest, like you said, came in 2020 at 16%. But wait, here is another website called Moneygeek.com that has newer figures. In 2022, 50% of Americans had life insurance like you mentioned earlier, but 68% believed they needed life insurance coverage, so the ownership gap is 18%, 2% higher than in 2020.
Joy: Hmm, I was gonna say that the pandemic finally woke people up for life insurance, but I guess that hasn’t been translated into real ownership figure. Instead of reducing the ownership gap, it increases it.
Lily: That seems to be the case. Life insurers really need to do a better job for reducing that ownership gap to a single digit.
Jason: The same website, I mean “Moneygeek.com,” also tells us that of the 50% owning a life policy, 59% bought on their own, while 23% received a policy from employers. The remaining 18% had life coverage from both sources.
Kimberly: Maybe it makes sense to add that 59% and 18% together: These are the people who actively bought life policies on their own, which is 77% or nearly 80%. The other 23% perhaps don’t count as much because they were given a policy by employers or someone else. After they retire or leave the job, they may or may not have life insurance.
Lily: You are right. Employer provided life policies are a part of employment benefit and are almost always group life policies. Many group life policies automatically terminate once the employee leaves the job. Some companies may offer “portable” policies that continue to cover you after retirement but that’s rare and there is no guarantee. Therefore, if a life policy was given by the employer, the person may not continue after retirement.
Jason: Wait, what is group life insurance?
Joy: It’s a type of insurance offered by employers or organizations to employees or members. There is a single “master” contract between the employer and the insurer, but covers everyone or at least full time members for the employer. Each employee or member receives a certificate of coverage. Because of its coverage to many people, its price is usually lower. This is just like buying stuff from Costco, when many shoppers buy in bulk from the same place the price goes down.
Greg: I wonder whether we should completely ignore group life policyholders. The way I understand it, employer-sponsored group life insurance comes in two types: Basic and Supplemental. Basic group life insurance is a policy offered as an employee’s benefit, typically free or highly affordable. In addition, they are often guaranteed issues, meaning you will qualify regardless of your age or medical history.
Kimberly: That makes sense: If someone is still working, they can’t be too old nor too sick. But why would anyone buy supplemental policy if they have the basic policy?
Joy: Because a basic life policy is what its name says: Basic, in the sense that it only provide basic or barebone coverage. I remember reading an article on Forbes Advisor that says the basic policy typically pays the amount that’s equal to one year’s salary, or a lump sum that is, depending on the employers, typically only around $25,000 according to a survey of compensation. That’s not enough for many if not most people.
Kimberly: So people buy additional supplemental policy to get more coverage for themselves or for someone else?
Joy: Both. They can choose to add additional coverage for themselves, or they can buy additional coverage for spouses and children. It is also called voluntary life insurance and typically bought from the workplace. You obviously need to have basic insurance before you buy supplemental. According to the article by nerdwallet.com, “Maximums typically hover around $500,000 but can reach into the millions of dollars. In some cases, managers or high-level executives have access to higher amounts than rank-and-file employees.”
Kimberly: Basic policies are guaranteed issue, how about the supplemental policy?
Joy: Generally no. At the minimum, health questions or even a life insurance medical exam may be needed. Employees usually will have to buy it with their own money, although for spouse or child the prices are generally cheap.
Kimberly: You talked about having a master contract for the entire group of employees. How does the employer sponsored group life insurance work?
Lily: Most group life are term life policies, sometimes you need to renew it every year, called Yearly Renewable Term or YRT. Other times term life policies last longer, ranging from 5 to 30 years. The most popular term is 20 years, followed by 10 year and then 30 years, according to an insurance survey report. Regardless of the length of the term, it’s still term, meaning there is an “expiration” day when the term is over. In general, all term life policies are cheaper than permanent life, meaning you pay lower premium. A group term life policy covers many people, so it’s even cheaper than individual life policy.
Jason: Other than being cheaper, is there any other difference between term- and permanent-life insurance?
Lily: The most obvious difference is that term life provides temporary or limited time protection while permanent life is “permanent,” meaning the coverage is there for the entire life of the policyholder.
Kimberly: Do they really mean that? What if someone lives to the age of 100? Will her permanent life insurance policy still cover her?
Joy: I’m glad you asked. I was reading this article of Forbes Advisor. It says, “many forms of permanent life insurance issued prior to 2004 have maturing dates of 100,” meaning even a permanent life insurance will expire before death. What is bad is that “the policyholder (and their heirs) get nothing, despite decades of paying into the policy.”
Kimberly: That IS terrible. Are they still doing that?
Joy: Not according to the Forbes article, which tells us that in 2018, there were 94,000 “Centenarians” according to the Census Bureau, meaning people who lives past 100. I won’t be surprised if we now have 100,000 centenarians in this country.
Jason: So how do they fix the expiration problem?
Joy: Interestingly they did it in a scientifical way in 2004 using the so called “mortality table.” If you don’t know, mortality table, which is also called life table or actuarial table, is a statistical table that lists the rate of deaths by ages, or more accurately the probability of death over ages. This table is used not just by insurance but also governmental agencies like the Social Security Admin. For example, when you are before your first birthday in the US, your death probability is 0.005837. But when you are 119 year old, you have a death probability of 0.972793, which is close to certainty. Previously the maximum was 100, but after 2004 it is 121 year old.
Kimberly: The new mortality table would offer extended coverage but what about those who bought the policy much early, before 2004?
Joy: Good question. The answer is provided in the same Forbes article: “Many insurers, in addition to updating their mortality tables beyond age 100, have added a Maturity Extension Rider (MER) to existing policies issued long ago to extend their coverage.” In other words, even though the old mortality table did not have anything above 100, the old policyholders will still be covered by a rider or extension.
Lily: We’ve been talking about permanent life policies and now I want to go back to comparing term and permanent policies. The difference is not absolute because once the term expires when the policyholder is still alive, she can (1) renew or extend it for another term; (2) convert to a permanent policy, or (3) stop the contract altogether. In that case the person loses life insurance, which is not recommended.
Joy: The key difference I believe is that a term life policy gives no value to a policyholder, because it is all about death benefits, meaning the insurance firms pay the beneficiaries money when the policyholder is dead before the term is over. That death benefit is guaranteed. Let’s say you bought a 20-year term life policy and 20 years later if you are still alive, you get nothing back from the policy — unless you switch to a permanent life policy or extend it to another 10 years.
Greg: This is why they say term life is a “using it or losing it” policy. The insurance company that sells 30 year term policy is betting that you won’t die within 30 years, so they get to keep your premium money without paying you anything. This is also why they charge so low a premium, especially for young people, who are unlikely to die in 30 years.
Jason: Sounds like insurance company has good deal: It can collect premium from term life policyholder but not paying death benefit to anyone — unless the policyholder died before the term is over. They should go around finding more people who they believe will still be alive after 30 years and then sell term policy to those people, right?
Greg: It’s tricky to say that insurance companies make money by term life premium. It’s true that term life premium becomes a source of income for an insurer, and if a term life policy paid no death benefit, the insurer would make money from the premiums paid by the policyholder. The same goes to some insurance policies that go unclaimed. Any expired term life policies or unclaimed policies are good news for insurance firms because it means they have collected decades of premiums without paying out any claims.
Joy: I have a feeling that you have more to say on how insurance firms make money. It’s getting late and let’s stop here as we’ve had a long meal today.