Ask Liz Weston

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Insurance

Term or whole life? What you need to know

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Dear Liz: My mother and her insurance agent swear by whole-life insurance policies. I am 45 and have heard from everyone else to only have term life, which is what my husband and I both have. We have a 15-year-old daughter. Can you please put in layman’s terms what a whole-life policy is and what the benefits are?

Answer: Term insurance provides a death benefit if you die during the “term” of the policy. Term insurance provides coverage for a limited time, such as 10, 20 or 30 years. It has no cash value otherwise and you can’t borrow money against it.

Whole-life policies combine a death benefit with an investment component. The investment component is designed to accumulate value over time that the insured person can withdraw or borrow against. Whole-life policies are often called a type of “permanent” life insurance, since they’re designed to cover you for life rather than just a designated period.

If you need life insurance — and with a daughter who is still a minor, you certainly do — the most important thing is to make sure you buy a big enough policy to cover the financial needs of your dependents. This is where whole-life policies can be problematic, since the same amount of coverage can cost up to 10 times what a term policy would cost. Many people find they can’t afford sufficient coverage if they buy permanent insurance. Also, many people don’t have a need for lifetime insurance coverage. Once your kids are grown and the mortgage is paid off, your survivors may not need the coverage a permanent policy would provide.

If you are interested in a whole-life policy, make sure to run it by a fee-only financial planner who can objectively evaluate the coverage to make sure it’s a good fit for your circumstances.

Insurance scores aren’t the same as credit scores

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Dear Liz: I have very high credit scores, but recently got a notice from my homeowners insurance company saying that my rates were rising because there had been a number of inquiries on my credit report. The inquiries were as a result of my looking for the best deal on a mortgage refinance, and we applied for a retail card to save the 5% on our purchases. Do many insurers use FICO scores as a rate determiner?

Answer: Insurance companies don’t use FICO scores to set rates, but they do use somewhat similar formulas that incorporate credit report information in a process called “insurance scoring” to set premiums. Insurers, and some independent researchers, have found a strong correlation between negative credit and a person’s likelihood of filing claims. (California and Massachusetts are among the few states that prohibit the practice.)

The formulas insurers use sometimes punish behavior that has only a minor effect on your FICO scores. Since insurers use different insurance scoring formulas, however, you may well find a better deal by shopping around.

Don’t buy life insurance if you don’t need life insurance

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Dear Liz: I recently inherited around $200,000. I’m on track for retirement, so my broker is encouraging me to consider buying a policy for long-term care. He recommends a flexible-premium universal life insurance policy that requires a one-time upfront payment and provides a death benefit as well as a long-term care benefit. It does appear to me to be a better option than buying a long-term care policy in which I pay a certain amount every month, which can of course increase greatly as time goes on, with no guarantee of ever needing or using the benefits and no hope of money paid in becoming part of my estate.

Answer: Long-term care policies can indeed be problematic, since the premiums can soar just when you’re most likely to need the coverage. So if you need life insurance for another purpose — to take care of financial dependents should you die or to pay taxes on your estate — then a life insurance policy with a long-term care rider may not be a bad idea, said Laura Tarbox, a fee-only Certified Financial Planner in Newport Beach who specializes in insurance.

But buying life insurance when you don’t need it just to get another benefit, such as long-term care coverage or tax-free income, is often a costly mistake.

“The golden rule is that you do not buy life insurance if you don’t need life insurance,” Tarbox said. “It would probably be better to invest the money and have it earmarked for long-term care.”

If you decide you want to buy this insurance, don’t grab the first policy you’re offered. Shop around, because premiums and benefits vary enormously. The financial strength of the insurer matters as well. You want the company to still be there, perhaps decades in the future, if you should need the coverage.

What you don’t want to do is take guidance solely from someone who is going to make a fat commission should you buy what he or she recommends.

“Get two or three proposals from different agents,” Tarbox said. “A fee-only financial planner can help you sort through them.”