While emotion often plays a role in the life insurance buying process, it is a logical choice, as I’ve written before. However, the vast majority of people I talk to don’t view it that way.
It seems that most people believe that if they can just hang on long enough, they won’t need life insurance at all. While that is a possibility, it’s not the way to bet. And it’s not the way most people conduct their other affairs.
As an example, I have a friend who owns a Mercedes S550. While not in the mega-rich category, he his quite well-to-do, and the loss of the car would not impact his lifestyle one iota. So why does he carry comp and collision, to the tune of approximately $1,500 a year? Because doing so is logical.
Sure, he has the wherewithal to replace the car and not miss a beat, but why take that chance? If replacing the automobile wouldn’t impact his lifestyle, then certainly $1,500/year wouldn’t. But in effect, isn’t he buying insurance that he doesn’t need?
But how many people view life insurance the same way? Most of the people I talk to feel that if their beneficiary wouldn’t suffer a decline in lifestyle upon their demise, then they don’t need life insurance. But, like my friend with the Mercedes, it would probably make sense, because if they have accumulated a large enough estate so that their beneficiary would suffer no adverse financial effects from their death, then in all likelihood paying the premium wouldn’t impact their lifestyle either.
When I point this out, what do you think the typical response is? What would your response be? What I hear most often is “I can invest the premium and get a better return.” Oh, really?
That would depend on several factors, but the primary factor is longevity. No matter how good of an investor you are, you have to live to have any shot at beating the return (on death) on a life insurance policy. How long? One would have to live 15-20 years to have a chance at beating the return on a life insurance policy.
So does that mean that if you have a life expectancy of over 20 years, you should forego the life insurance and invest the premium? Not necessarily. A basic tenet of investing is diversification, not only of assets, but also of asset classes.
Bonds as an asset class can diversify a portfolio, and cash value life insurance can further diversify the bond component. Using cash value life insurance as a portion of your bond allocation has two significant advantages.
First, unlike bonds, the cash value does not vary with interest rates; it only goes up, never down. And secondly, the life insurance provides an income tax-free death benefit.
In conclusion, almost always, life insurance is purchased because it’s needed. However, in certain circumstances, it can still make a lot of economic sense even when there is no need.