Insights Into Life Insurance From An Actuary

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One of my closest friends in the world completed a Ph.D. in mathematics recently and became an actuary for a very large life insurance company. I had lunch with him recently just to catch up on things and we spent about ten minutes talking about life insurance itself. He basically told me that if I am a financially sound person, I am throwing my money away on life insurance unless I meet a few strict criteria (young, a relatively low net worth, and young children). This kind of blew me away considering he’s in the life insurance business, but when he broke it down for me, it made a lot of sense. Note that the advice that follows is based on a conversation between friends and shouldn’t be viewed as professional advice and you shouldn’t just follow it blindly without doing your own research (like on this site here), but it is quite interesting and worth sharing.

First of all, unless you are a financial train wreck, you should never buy anything but term life insurance. Insurance as an investment is a great investment for the insurance company but a terrible one for you. If you want insurance, get insurance; if you want to invest, buy an investment. Don’t mix the two – it’s akin to buying a box of bad cereal to get the cheap plastic toy inside. Why not just save a buck and get a better box of cereal, then spend the buck to get a better toy? If you are convinced to use your insurance as an investment tool, you must understand how to do it. Use TSD’s advice on: cash-value, life insurance settling, and building and borrowing cash from your life insurance policy.

Second, if you have no dependents and no spouse, don’t buy life insurance. Ever. Don’t let a salesman talk you into it.

Next, the more net worth you have, the less insurance you need. This means that before you start thinking about life insurance, know what your net worth is. This is an important number for figuring out how much net worth you’re going to need.

After that, think about your family’s needs carefully. Look at how many people are in your household (spouse plus dependent children) and multiply that by five, or maybe a bit more if your children are very young – this number is the number of years worth of your salary that would be needed to support each person in your house should you pass away. He suggested multiplying it by six in my situation, but I wanted plenty of security for my kids, so I used eight. I then multiply it by the number of people in the household, four. That gives me thirty two. This number is the number of “salary years” that I should leave behind.

Then, multiply your calculated “salary years” by your current salary (or reasonably expected salary in a few years) to see how much net worth you should leave behind. Let’s say I make $50,000 a year; times thirty two, that means I need to leave behind $1.6 million. Ouch. That’s a lot.

However, one should subtract from that their net worth. I would make a little dent in that number, but not a big one, leaving me with still quite a sizeable policy. If I went with a lower multiplier (say, my friend’s recommended 6), I could reduce the policy quite a bit.

Once you have your magic number, get a relatively short term policy for that amount, usually long enough for your children to have left the nest. For my example here, that means I would get a twenty year term life insurance policy for $1 to $1.5 million. The premiums on that would be $600 to $800 a year, or $50 to $65 a month. He suggests doing this so that one can potentially get a better rate with a twenty year policy instead of a ten year one, but that policies that extend past the children leaving the nest are a fool’s game.

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When your policy expires, don’t renew it immediately – recalculate. Let’s say that in twenty years, my children have left the nest, leaving my wife and I home alone together. We’ve built up some serious savings, our home is paid for, and thus our net worth is in pretty good shape. I sit down and recalculate and discover that in fact my net worth now exceeds ten times my salary (five times the people in household, which would be two), so I just don’t bother with life insurance again, leaving me with $50 a month more to enjoy or invest.