Building a Life Insurance Portfolio
Most advisors are familiar with the concept of investment diversification, but how well does the average advisor understand the need for diversifying life insurance coverage?
Investment diversification is the strategy of reducing exposure to various market risks and promotes more consistent performance in an investment portfolio.
Diversifying a client’s life insurance coverage is similar in concept, but with different criteria. The strategy looks less to managing potential market conditions, and more to the client’s family relationships and future financial trajectory. The advisor must identify and help manage the risks presented along the way.
Advisors often focus on life’s common liabilities to create a client’s risk profile: income replacement, mortgage repayment, and children’s college funding. Each of these is easily quantified in dollars, and the financial risk tends to fall mostly on a single life. As a consequence, the advisor and client may settle on the simplest solution, a single high-denomination contract. In this approach, the only serious analysis involves whether to use permanent or term insurance.
This article covers only some of the major considerations in a portfolio approach to managing life insurance coverage. Among other considerations, advisors should at least consider the following reasons why a client may need more than one contract and type of coverage:
- To insure the family caregiver
- To spread risk
- To avoid over-paying for coverage
- To protect a legacy
I. Insuring the family caregiver
During the risk analysis, the economic value of a “stay-at-home” mom or dad may be overlooked. It's important to recognize that a person maintaining a home and caring for a family has financial value. If an individual takes care of children or another person in the home, such as an elderly parent, their death could create unexpected – and significant – caregiver expenses.
Will the client’s family suddenly be faced with childcare or adult daycare costs – or even assisted living expenses? Will they need a housekeeper to get chores done and run errands? These costs can be very significant.
Stay-at-home parents represent an important financial consideration, and should have life insurance coverage to minimize any potential hardships.
II. Spreading Risk
Though life insurance is a risk management tool, it is important to look at risks to the insurance itself. Structuring a fallback or hedge may be prudent against poor policy performance.
Consider a scenario where the client elects permanent coverage, but future benefits depend heavily on favorable but uncertain outcomes. If the policy provides a death benefit guarantee, how likely is it to materialize under all circumstances? Where a baseline level of coverage is non-negotiable to the client – as it most always is – a 30-year level premium term contract or universal life contract with guaranteed death benefit would complement the variable contract.
Consider also the client’s understanding of how their permanent contract works. It is often founded on the assumption that the carrier will enjoy favorable results, and therefore be able to charge modest amounts for generous benefits. Carriers are required during the sales process to illustrate the effect on performance of the contract’s guaranteed costs and minimum benefits, and the costs and benefits themselves are shown in the contract.
Still, if the carrier falls back on the contract’s charge structure to ensure payment of future claims, many clients may be unprepared to pay those costs in return for minimum benefits. They may surrender the contract, or exercise a settlement option. Either way, they will have a coverage gap. Since carriers do not often resort to charging maximums, simply splitting coverage between one or more carriers effectively mitigates the risk to the client of losing most or all of their coverage in this way.
Next page: Layering coverage
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