The Facts of Life

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Once you become a parent, any adult in your house earning income should have life insurance coverage that will last until your youngest kid gets through college. And in a family without a lot of money saved, a stay-at-home parent may need a small policy, to cover child care costs that would be created by that parent's absence.

Even if you belong to the dual-income, no-kids crowd, you may need life insurance to cover large shared financial obligations such as a mortgage. For older empty-nesters, though, life insurance is often an expense you don't need — as long as your retirement nest egg is big enough to support your surviving spouse. But if that nest egg is really big — at least $1 million, enough so that your assets will generate estate taxes — it's worth staying insured, because your heirs can use the proceeds, which are tax-free, to pay off those liabilities.

The money grows tax-deferred, in fixed-income investments with whole life coverage, or in mutual funds with variable life.

But here's what your agent may not tell you: It'll be a while before you see any of that cash. For the first two to 10 years, part of your premiums are paying the agent's commission. Even after that, the average variable life policy has annual maintenance charges of more than 2% of your cash value, and many states charge taxes of 2 to 3% of your premiums. Given that, most people are better off buying term and using the money they save on premiums to invest in other tax-deferred vehicles such as IRAs, 401(k)s or Section 529 college-savings plans.

Let's say you're a 35-year-old Georgia man who qualifies for preferred rates, and you buy a $250,000 variable life policy from TIAA-CREF. Every year you pay $2,500 in premiums; whatever's left after fees, commissions and the cost of your death benefit goes into an investment account. If that money earns an 8.5% net annual return, you'll build up $97,362 in that account after 20 years.

But say you bought a $250,000 20-year term policy instead. That would cost you $225 annually from Federal Kemper Life, giving you an additional $2,275 a year to invest as you saw fit. If you earned the same 8.5% return, you'd rack up $121,687 — beating that permanent-life account by 25%.

So why do agents push permanent life so hard? Simple: Higher premiums mean higher commissions.

That said, permanent life can make sense for select groups of people. Peter Katt, a life-insurance adviser in Mattawan, Mich., recommends it as a savings vehicle for people who consistently have income left over after maxing out their other tax-deferred accounts. But Katt urges even those clients to cover their baseline insurance needs — the money to protect their families — with cheaper term life. Permanent life is also often a better option for older people because term's price advantage fades as you reach your late 60s.

Katt's advice to those customers who do buy a permanent policy: "Overfund" it, making big payments up front so you start amassing earnings faster. Another way to do that is with a low-load policy — one with low fees (less than 1% a year) and low commissions (10 to 20% of a year's premium). Reputable low-load insurers include TIAA-CREF (800-223-1200), Ameritas (800-745-6665) and USAA (800-531-8000).

For the vast majority of families, level-premium term life is the best option. With that as your foundation, annual-renewable term can be a good supplement if your family takes on any big short-term obligations. (Maybe you're amassing debt while earning a midcareer MBA.) The premiums on ART policies grow slightly as you age, but for periods of up to five years, they're usually cheaper than level premium.

The Web is your best starting point. But since dozens of sites offer price quotes, which should you turn to? The answer depends on how healthy you are.

The cheapest, "preferred" rates go to the 21% of applicants in the best health. You can generally count on qualifying if you don't smoke, you have a low cholesterol count (under 250) and low blood pressure (140 over 90, or lower), and you fall within a healthy weight range (under 210 pounds for a 5-foot-10-inch man; 175 pounds for a 5-4 woman). If you make the cut, start your online sleuthing at AccuQuote.com, Term4Sale.com and Quotesmith.com. Each has a large database of about 150 to 300 insurers and quotes prices to customers in any state. Also, unlike some competitors, each shows you quotes, rather than forcing you to call an agent to get your results. (By the way, young, healthy folks shouldn't bother buying additional group coverage through their employers. You'll get lumped in with those chain-smokers in accounting and pay more than you would on your own.)

If you suspect you don't qualify for the medical elite, approach the Web a little differently. Start with InsWeb.com. This site quotes from fewer insurers — only a dozen — but it asks for more extensive data, which means the prices will more accurately reflect what you'll pay. You'll spend about 15 minutes filling out a questionnaire that asks for information such as your blood pressure, family medical history and driving record. The quotes you get will be a good benchmark for a wider search on AccuQuote and Term4Sale. (Be sure to designate that you're looking for "standard" rates rather than "preferred.") Any quotes on those sites that fall more than 30% below the lowest on InsWeb are likely to be too optimistic. People who aren't in better-than-average health needn't bother with Quotesmith, because it won't let you sort rates based on fitness level.

Can you get better deals elsewhere? It's enough of a possibility to merit more digging. TIAA-CREF, Allstate and New York Life (800-710-7945) don't make their prices available on the big quote Web sites, so it's worth checking with them directly. Shoppers in Ohio and Washington can find prices from most insurers on the consumer information pages of their state insurance department Web site (www.ohioinsurance.gov or www.insurance.wa.gov ).

To find the right amount of coverage, you must weigh your dependents' spending needs against their future income and assets. Our worksheet will help you do that. It'll remind you of costs (additional child care for a suddenly single parent, funeral charges, etc.) and sources of help (investments, Social Security benefits for survivors). But remember, this will give you only a rough estimate. Ideally, you should run the numbers every two years or so to see if your needs have changed.

Click here to see our worksheet.

Term policies offer a thicket of optional "riders" to choose from, but most of them aren't worth your time. Waivers of premium allow you to keep your policies without paying for them if you become disabled, but they often increase the price of your policy by as much as a third. Consider them only if you don't have any other disability insurance. Spousal riders that extend coverage to your wife or husband can sound like a good deal, but they're usually more expensive than buying a separate policy, and your spouse may lose coverage if you die. And accidental death riders, which double the payout to your family if you die in an accident, are not only expensive (adding 10 to 15% to the policy's cost) but unnecessary: Does your family really need twice as much money to live on just because a runaway truck got you before a heart attack did?

Once you've whittled down the field to a handful of potential insurers, check out their financial ratings. The price-quote Web sites post ratings, but they're often a few months out of date, so double-check your carriers' grades from Standard & Poor's (click on "Ratings Lists" at www.standardandpoors.com) and A.M. Best (search by company name at www.ambest.com). Firms with Best ratings of A- or better, or S&P grades of at least AA, are the safest bets. You'll also want to find out whether your would-be insurer is leaving a trail of irate customers. The statistic you're looking for is the "complaint ratio," which compares the number of grievances filed with the number of policies or amount of premiums the insurer earns in the state. In California, for example, 16 life insurers have a complaint ratio of 0, meaning no gripes have been filed that the state has found to be justified. But on the other end of the spectrum, Conseco Life, troubled by shaky finances, has a whopping 16.9 complaints per 100,000 policies. Many state governments track such information, and you can find links to their data at www.insure.com/complaints. Some states, including New York and Pennsylvania, either don't keep tabs on gripes or make it difficult to compare insurers. If your state is one, you can find national complaint stats for bigger insurers on the Web site of the National Association of Insurance Commissioners.

"It's easier to trust someone [we] know with confidential information about our finances. And if something happens to me, my wife knows to call Rick first thing."

To find a good agent, you've got to do more than ask for referrals from friends. Basic licensing requirements for insurance agents can be notoriously lax: In some states, all a would-be agent needs to do is pay a small annual fee (usually around $50) and pass a licensing exam that a fifth-grader could ace. So look for agents who have the designation CLU (Chartered Life Underwriter). To earn these letters, an agent needs three years of job experience. CLUs also take about two years of course work, including classes in financial planning. That can make them helpful in fine-tuning your decisions about how much insurance to buy and in figuring out, say, whether it's better to name your wife, child or widowed mother as your beneficiary.

CLUs can be especially useful in finding policies for clients who face higher premiums because of health problems or risky lifestyles (think hang-glider pilots and scuba instructors). One good litmus test for would-be agents in these cases: Ask them if they have experience with "impaired risk" coverage. If you get a blank stare, find another candidate.

So while sucking in your gut won't help you save on your insurance, avoiding a steak dinner and other high-salt-and-cholesterol foods for 24 hours before the exam just might. And to keep sugar and caffeine out of your system, don't consume anything other than water for at least eight hours beforehand. Also, for your blood pressure's sake, forgo strenuous exercise for 24 hours.

"I hear horror stories from people who ate a jelly doughnut right before an exam, and their premiums turned out hundreds of dollars higher," says Richard Eisenberg, an agent in Newton, Mass. "People should fast, and if they forget and eat something, they should send the paramedic home and reschedule."

The discrepancy doesn't have to be glaring to justify a challenge, as one SmartMoney editor found when he applied for a 20-year term policy with American Mayflower Life Insurance. His cholesterol scores barely knocked him out of the "preferred plus" category, so he asked his own doctor to retest him. His results improved slightly, and his M.D. ran an additional test for cardiac risk that he scored well on. He sent the results to American Mayflower — along with a note suggesting he might take his business elsewhere if his rating wasn't revised. The move paid off: He qualified for the elite rates, and while the additional tests cost him $210, the better premiums will save him $2,400 over the life of the policy.

If you're grappling with health issues, find out whether your employer offers supplemental life insurance coverage through a group plan, which will be cheaper for you. Once you've maxed out that option, look into one of the national carriers that specialize in writing coverage for people with serious health problems.

They include CNA (800-262-0348), Empire General (800-688-3518), Banner Life (800-638-8428) and Guarantee Trust Life (888-898-3279). If you submit medical records that show you can control your health problems with medication and therapy, some of these insurers will offer you rates only 5 to 25% higher than premiums for those in average health. "Insurers have learned a lot over the past 10 to 20 years about how medical care balances out the negatives of an illness," says Mary Jo Fox, a chief underwriter at CNA.

Even after you're stuck in a high-risk category, most insurers are willing to rewrite your policy later with a lower premium, if your status improves. You'll usually need to wait until the policy passes its first anniversary before you can make any changes. And be prepared to produce test results taken six months to a year apart to show your health turnaround is no fluke.

Paying high premiums because of your nicotine habit? Abstain from cigarettes for three years and most insurers will upgrade you from "smoker" rates. To prove your virtue, you'll need to have your urine tested for nicotine and have your doctor certify that you've left the smokes behind. Your bank account will thank you. At MONY Life Insurance, for instance, the annual premium for a 20-year, $750,000 standard term policy on a 40-year-old Denver woman who smokes runs $2,428. For a nonsmoker? Only $928.

If you're in the first year or two of a contract and want out, no sweat. You haven't built up any cash value, so all you'll lose are the premiums you've already paid. After that, you're better off staying put for a while. Surrender charges usually decline as the policy matures, and once they hit zero, it's fine again to consider cashing out. If the math is swamping you, submit your plan to the Consumer Federation of America, and for $50 to $75 its analysts will walk you through the surrender decision.

There's another way out of a bad policy: A maneuver called a Section 1035 lets you swap the savings in your current policy into a cheaper one, or into an annuity. Under some circumstances, that move is tax-free. Unfortunately, some insurance agents use this technique to roll customers from one high-commission policy to another, a crooked practice called churning. "That's one of the rackets that costs people the most money," warns James H. Hunt, a life-insurance actuary with the CFA.

If you're considering the switch, make sure you have help from a financial adviser — someone who won't earn a commission off the swap.