All of today's policies attempt to do what those legionnaires did--provide security to the families of people who die--as well as address some of the problems of that basic assurance. What problems? The legionnaires' pledge worked essentially like term insurance. It acknowledged that someone might suffer an untimely death, leaving family members with sizable financial obligations. But if a large group of people agreed to pay just a little money each, they could help the hapless family pay its bills.
But problems arise when age, infirmities or war fell a large number of people in the pool. The greater the number of people in the pool who can be expected to die, the greater the cost to those buying a policy.
Consider, for example, the cost of a $250,000 term insurance policy. A healthy 35-year-old woman would pay $170 annually for a 15-year level-premium policy, according to InsuranceQuote Services, an online insurance shopping service. But a healthy 70-year-old woman would pay more than 10 times as much--$1,950 a year--for the same type of policy.
Recognizing that term insurance could become prohibitively expensive long before most people would need it to protect their families, insurance companies set to work on an alternative.
What they came up with is something called whole life.
It started with a simple mathematical premise: Life starts at 0 and ends at age 100. If you buy a policy somewhere between ages 0 and 100, you can fund your death benefit yourself, based on specific calculations.
How? You buy a hybrid product that's part insurance, part savings account. Each year, a portion of your premium goes to fund the insurance--which, like a basic term policy, covers the death benefit for those who die prematurely. The other portion of your premiumaccumulates in a tax-favored savings account. If you die before the policy matures, your beneficiary will receive a death benefit that comes partly from the insurance and partly from the savings accumulated in your account. If you die young, then, the bulk of your death benefit will come from the insurance portion of the policy; if you die old, the bulk of the death benefit will come from your savings.
How much of your annual premium goes for the insurance part and for the savings part? That depends on how many people are expected to die in a given year. Presumably, mortality rates are low for those who are younger and rise as time goes on. On the bright side, though, as the savings portion of your account grows, you need less term insurance coverage. So at a time when more people in your age group are dying, the cost of the insurance portion of your policy shouldn't be rising very fast, if at all.
But with these policies, too, there has been a problem.
A lot of people don't like whole life insurance. First, it's hard to understand. Although consumers know it's both insurance and investment, they don't know which portion of the premium is going to which part of the policy. Insurance companies tell them, but only after the year is over, the mortality figures are in and it's largely too late to do a thing about it.
Second, the policies are inflexible. Because of the way they are structured, the consumer needs to pay a set premium each year. If you can't afford the cost one year, your policy lapses. If you have accumulated money in the savings portion of the policy at that point, you get the savings money back. But if the policy lapses in the first few years, the amount you get back is likely to amount to a minuscule fraction of what you paid.
Insurance companies came up with an answer to these complaints: universal life.
Universal life works much the same way as whole life, but the policy is more transparent: Companies spell out how much of each year's premiums will be eaten up in mortality fees and expenses and how much will be invested. If you can't afford the whole premium in some year, this policy offers choice. As long as you pay enough to cover the insurance portion of the policy, you can keep the policy in force. In good years, you might decide to over-finance the investment side of your policy, paying a higher premium so more of your money will be invested. In a lean year, you might pay less or nothing at all, letting the premium come from the savings accumulation within the policy rather than from you.
* * *The problem? The invested portion of the policy is being handled by an insurance company, which buys fixed-income instruments such as bonds and mortgages for these policies. That produces steady but modest returns.
But in the early 1980s, the stock market began to take off. Consumers noticed that they could make a lot more in the stock market than in an insurance contract. Thus came a clamor from a host of financial gurus, who shouted: "Forget permanent insurance! Buy term, and invest the rest!"
In a nutshell, this camp was telling Americans to do on their own what insurance companies were doing for them: Have term insurance for the unlikely chance of your untimely death, and then reduce your need for insurance over time by accumulating savings that can be used to cover your family's financial obligations when you die of old age.
It was a no-brainer to realize that if you invest $1,000 in stocks and earn an average of 10% on your money, you'll be doing better than if you invested $1,000 through an insurer who would put the money in bonds earning an average of 6%. Logically, the term insurance should cost the same whether you bought it alone or through a hybrid type of policy. (That's not, in fact, the case, but more on that in later lessons.) So the only difference between this and buying a universal life policy would be how much you earned on the invested dollars.
Insurers responded with a product that allows consumers to choose how to invest the dollars accumulating in their accounts: variable universal life. And, in fact, investing in those high-returning stocks is one of the more popular choices.
* * *Still, even variable universal life can't answer all consumer needs--such as for tax-favored retirement vehicles, products that aid in estate planning, coverage for specific obligations such as home mortgages, or for specific risks such as the loss of a job or one's mental capacity.
So insurance gurus are continuing, as they have for several decades, to work at a feverish pitch to create an array of products to address nearly every need--as well as a lot of whims. There are variable annuities for those who are so well-heeled that they're maxed out on all other tax-favored retirement plans; there are products aimed at estate planning, including "second-to-die" policies that pay benefits to your other heirs rather than to your spouse. There's mortgage insurance, vacation insurance, pet insurance, disability and workers' compensation insurance, and there's insurance to cover nursing home expenses.
* * *What this jumble of products spells for consumers is both challenge and opportunity. Sorting through the dozens of options is tough and requires plenty of introspection.
You must determine what you need a policy to accomplish. Are you buying insurance for short-term peace of mind or long-term financial planning? If you are looking for long-term planning, you should consider a form of cash-value insurance. But if you buy a cash-value policy, you have to be certain you'll stick with it long enough to have it pay off.
How the major products--whole life, universal and variable universal life, and variable annuities--work will be discussed in detail in Lessons 4, 5 and 6.
* * *Adapted from "Kathy Kristof's Complete Book of Dollars and Sense." Printed with permission of Macmillan Publishing, New York. Write to the author in care of Personal Finance, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or email@example.com. KATHY M. KRISTOF welcomes comments and suggestions for columns but regrets that she cannot respond individually to letters and phone calls.