Oran Hall | Life insurance an important element of personal financial planning
If we see personal financial planning as the process of planning to achieve our goals in the various stages of our lives and how to negotiate the barriers that inevitably arise in the course of pursuing those goals, it is clear that risk management must be a key element of it.
Insurance is a major risk management tool, and although there are several types of insurance, we will focus on life insurance, of which there are several types.
Term insurance is often described as temporary insurance purchased for a specific length of time. The insurance company pays a death benefit to the beneficiary if the insured dies as long as the policy is in force, meaning that all premiums have been paid. Premiums are generally low, and there are several kinds of term insurance policies.
Term policies offer coverage only and thus have no cash value or investment value. Because they are for a set term, if the policy is renewed or extended when the term of the policy is arrived at, the premium is increased because of the higher age of the insured person.
Whole life insurance is intended to be in force for the whole of the insured’s life. The traditional ones guarantee a death benefit and cash value. There are times when the cash value is determined on the basis of a formula linked to the yield of a financial instrument to make it more competitive.
Because the policy is permanent, it ensures future insurability, and premiums are fixed for the life of the policy. The death benefit is guaranteed, but benefits in excess of the sum assured may be paid where there is a provision for the investment value of the policy to be added to the sum assured.
This is relatively expensive insurance, however, and cash values may only be accessed by surrendering the policy or borrowing against them.
A universal life policy is a permanent contract. Premiums are divided into two basic portions: one covers the mortality or death benefit and the other goes into an investment fund.
The mortality portion, in practice, functions as a renewable term policy so that that portion of the premium increases with the age of the insured even though the total premium remains unchanged. If the premium is not able to cover the mortality charge, the shortfall is taken from the investment portion of the policy.
Future insurability is assured because the universal life policy is permanent insurance. Premiums tend to be lower than for other forms of permanent insurance. Lump deposits may be made to the investment fund, and death benefits and premiums may be increased or reduced.
Investment units may be surrendered for cash at current unit values. Although this is useful for providing short-term liquidity, it generally erodes the long-term investment value and thus the death benefit of the policy.
A major downside of such policies is that fluctuations in the cost of pure insurance and administration may seriously impair the growth of the investment fund.
Life insurance is beneficial in that it creates an immediate estate. Claims are payable on an insurance policy even if the insured dies a short time after the policy comes into force. In cases in which estate is designated as the beneficiary, individuals named in the will as beneficiaries receive their payment upon the completion of the process of probate. To avoid complications, the insured should make a will if estate has been designated as the beneficiary.
Proceeds from a life insurance policy are paid quickest when there is a named beneficiary. The liquidity that this provides can facilitate the prompt settlement of the estate of the deceased considering that certain expenses are incurred in the settling of the estate.
Insurance proceeds also allow people who used to be dependants of the deceased to continue their lives as the proceeds serve as a replacement of the income of the insured. Thus, the living expenses of the family can continue to be met and the education of children, for example, can continue uninterrupted.
Life insurance is also a good tax-planning tool as death benefits and the cash values and investment values generated are not subject to tax, and, if the business of the deceased is properly organised, funds should be available to cover expenses such as funeral expenses, mortgages and other debts.
Life insurance is a reliable means for a family to realise its goals when the main bread winner dies, more so prematurely, as it can provide a lump sum to meet its needs – if the coverage is adequate. It may also provide funds to meet any financial obligations left by the deceased, thereby leaving a larger estate for the beneficiaries.
- Oran A. Hall, author of ‘Understanding Investments’ and principal author of ‘The Handbook of Personal Financial Planning’, offers personal financial planning advice and email@example.com