Should You Hurry to Buy Life Insurance?

Life insurance costs have recently climbed after falling for more than a decade. Salespeople say if you’re thinking about buying you should do so now before rates move higher. Of course, salespeople just about always say that. What do the facts say about buying now versus waiting?

For life insurance, historic price information is sparse. The best source might be sitting on the hard drive of Byron Udell, who sold insurance on his own from 1986 to 1994 before founding AccuQuote, which attracts online shoppers looking to compare policy prices. Udell has recorded policy prices each month since 1990. In January 1994, he says, the cost to a healthy, 40-year-old male for $500,000 of term coverage with prices locked in for 20 years first dipped below $1,000 a year. (“Term” means the policy has only insurance value, not investment value.) By 1999, the same policy sold for an average of $425 a year. At the beginning of this year it went for $360. That has been great news for policyholders, since they can “refinance” any time. The insurer covers the costs, including a new medical exam. Since January, though, the same policy’s cost has crept back up to $400.

The long-term price decline is owed mostly to longer life expectancies. Today’s 40-year-old man is forecast to outlive his 1980 counterpart by more than four years. Longer lives mean more years for insurers to collect premiums, and more customers who will drop coverage before they die. The reasons behind this year’s price increases are almost but not quite as clear. Tighter credit plays a big role. Insurers face strict requirements on cash reserves when they sell new coverage. To meet the requirements, they can lay off risk on another insurer (called a reinsurer), pay a bank for a promise to come through with funds in a pinch (called a letter of credit) or package existing policies into investments for resale (called securitization). A tightening of credit hurts insurers ability to do all three, making the coverage they sell more expensive.

Lower interest rates have also played a role. Since June 2006, the Federal Reserve has lowered core interest rates from over 5% to almost zero. The premiums insurers charge depend in part on the return they can achieve when they invest the money. But then, most insurers buy corporate bonds rather than Treasury bonds, and the spread between the two has stayed fairly wide. John Nadell, a stock analyst who covers life insurers for Sterne Agee, an investment bank, says interest rates might have played less of a role than the near-collapse of insurer AIG a year ago. AIG lost big on mortgage bets and ultimately needed a government bailout. Nadell says that before then, the company’s life insurance division, American General, was able to beat competitors on price, thanks to the pristine credit rating of its corporate parent, which allowed the company to raise funds cheaply. With AIG humbled, American General has had to raise rates, allowing other companies to raise them, too, reckons Nadell.

The common theme here is macroeconomics. Life insurance rates are rising because of broad economic troubles, not because people are suddenly dying sooner. If you foresee the economy worsening, you should expect life insurance costs to rise, too.

Now I want you to forget about price trends, because in truth, they have nothing to do with whether you should buy insurance. Here’s my philosophy:

The ideal amount to spend on life insurance is zero, ever. That’s because the probability math built into the stuff is pretty much the same math casinos use. Some customers win, but the average customer loses. At a casino, you get free drinks and maybe camaraderie while you lose money, adding entertainment value, so it’s OK to knowingly blow a little cash on dice and cards, if that’s your thing. But life insurance isn’t entertaining. Avoid it, unless both of the following statements apply:

1. Your death would put someone you care about in a financial bind.

2. You’re not rich enough to set money aside for that person now.

Note that caring about someone isn’t enough of a reason, because insurance is a money-losing proposition, making it a poor gift versus simply saving. The purpose of insurance is to turn the unknowable (the probability of financial disaster brought on by your death) into the known (the cost of premiums today). Buy only enough so that your loved ones don’t suffer financially, not enough to make them feel like they’ve hit the lottery. They’ll feel like lottery winners anyhow after seeing your savings and brokerage accounts stuffed with all the money you saved on insurance. Buy only cheap term insurance, not expensive whole life or anything else that builds investment value, because you can build investment value in your brokerage account with more control and lower fees.

Pay for insurance only until either of the above two conditions no longer apply. The more you pay, the longer you can lock in prices, up to 30 years. But you’d have to be a pessimist to buy a 30-year policy. Twenty years should be more than enough time to become rich enough to not need insurance.

There are special circumstances I’m ignoring under which the old and rich might find life insurance worthwhile. Suppose you own $20 million worth of convenience stores, which, despite the name, aren’t the least bit convenient to sell in a hurry to cover inheritance taxes. Insurance might help your heirs cover the tax bill. To learn more about that, find an estate planning expert who charges a fee for their time, not a commission for their financial products.

For most of us, rising premiums are no reason to buy life insurance. You either need it or you don’t, and market timing has nothing to do with it.