1. You actually have too much life insurance
Americans bought more than $1.7 trillion worth of individual life insurance coverage in 2012, according to the American Council of Life Insurers, a trade group. Overall, there was $11.2 trillion in individual life insurance policies in effect in 2012, up from $9.3 trillion in 2002.
But many pe ople may be buying too much insurance, or buying the wrong kind. For one thing, 64% of policies are "whole life" or "endowment" policies, which combine a "death benefit" (which pays money to your survivors if you die) with some kind of savings or investment mechanism. Whole-life coverage is usually more expensive than term life, which provides only a death benefit, and some financial advisers view whole life as an inefficient way to build savings.
Consumers have also been buying larger policies. The average face value of a policy in 2012 was $163,000, up 37% from a decade earlier—a faster increase than the rise in average salaries over the same period, according to the Social Security Administration.
The insurance industry argues that, if anything, most Americans have too little insurance. About 30% of U.S. households have no life insurance at all, according to Limra, an industry-funded research group. "If everyone got the recommended coverage, the minimu m face value held by Americans should be almost $60 trillion in 2013 and perhaps as high as $88 trillion, based on only labor compensation," says Whit Cornman, a spokesman for the ACLI.
What's the right amount of life insurance to have? There's no cookie-cutter answer. Financial advisers say it's generally a good idea for family breadwinners to have a policy big enough to pay off their mortgage. After that, it's a question of whether your survivors will need to replace your lost income for help in paying for daily living expenses, and for longer-term goals like college and retirement.
2. We'd rather sell you investments than insurance
The dull life insurance industry of your grandfather's era is a distant memory. The Financial Services Modernization Act of 1999 gave insurance providers more leeway to sell products that combined insurance benefits with investment vehicles—which, in turn, gave agents an opportunity to earn bigger comm issions.
But the changes generated a wave of complaints from consumers who say that their investment returns didn't live up to agents' promises. So-called indexed policies, for example, offered customers a chance to earn investment returns on their savings, but many policyholders didn't realize that their gains would be capped. "Indexed universal life policyholders missed out on several points of yield that way," says Glenn Daily, a financial adviser and author of several books on buying life insurance products.
More recently, the industry and regulators have adopted new "suitability" standards for these products, which theoretically require agents to make sure they match buyers' needs. But buyers should always ask their agent about the assumptions behind an investment's advertised return.
Also, when selecting an insurance agent, its best to find out how long the agent has worked in a state: The longer the track record in one state, the better, as it means there's a longer paper trail you can follow.
3. Your child doesn't really need life insurance
Insurers often persuade parents to take out whole-life insurance on their children, selling the policies as savings vehicles to help pay for college or get them launched into adulthood.
But James Hunt, a retired life insurance actuary and former insurance commissioner of Vermont who now works with the Consumer Federation of America, says he tries to talk parents out of that move. Hunt says using the money to add to the premium of an adult who is the family's chief breadwinner is a better investment of those pennies, especially as the adult gets older and into their peak earning years. Setting up a tax-deferred savings account or an investment fund will probably yield a better return as a savings vehicle for the child.
Also worth noting: The basic purpose of life insurance is to make up for the loss of a breadwinner's income, so the likelihood that a family will have a financial need for the death benefit they would get in the event of the death of a child is relatively low.
4. This variable annuity is like a really expensive mutual fund
One of the industry's most profitable and popular products is the variable annuity, which combines a death benefit, mutual-fund investing and the option for a guaranteed income in retirement. About $143 billion in variable annuities were purchased in 2013, more than double the annual sales of fixed-annuities, according to the Insured Retirement Institute, a trade group.
Insurers have long pitched variable annuities as a retirement-savings vehicle for people who max out their 401(k)s or IRAs. Like a lot of other insurance-investment hybrids, they can reap substantial commissions for the agents who sell them. But many consumers and financial advisers have complained about their complexity—and their costs.
Because of all the different components that go into an annuity—the income component, the investments, the death benefit, and of course, those commissions—their annual expense ratios can reach as high as 3% of the invested assets, far more than most people would pay in a traditional retirement plan or mutual fund. "The variable annuity producers still haven't squeezed out enough of the costs," says Hunt, the former insurance commissioner.
Investors who withdraw money earlier than they had planned often face high surrender charges--withdrawals from an annuity during the first 10 years of the contract can be assessed fe es of as high as 8%, according to the National Association of Insurance Commissioners. And some savers who have begun living off the investments from variable annuities have complained their tax bills on the withdrawals were higher than they expected.
Some insurers sell "no-load" annuities, which have lower annual expenses, but often offer fewer features. But the bottom line, says Daily, is that most variable annuities are simply too complex for consumers (and even some advisers) to understand. "If you can't understand how the product works, don't buy it," Daily says.
5. This whole-life policy won't pay for itself…
One of the chief selling points of a whole-life policy is that the interest generated by its cash account can be used to pay the premium. But some consumers have found out that the "vanishing premium" promise didn't come true—leaving them on the hook for unexpected payments to keep the policy from expiring.
The issue stemmed from the steady decline in interest rates in recent decades, says Hunt; the decline in yields hurt the ability of insurance companies to use cash balances to pay premiums. "All of a sudden, policyholders were getting phone calls from agents saying they needed to make more payments," he says.
Consumer complaints about vanishing premiums led to several lawsuits accusing insurers of deceptive and misleading sales practices. Insurers including Principal Life Insurance (now part of the Principal Financial Group), Lincoln National Life, Mutual of New York, and New England Life settled class-action suits in the late 1990s and early 2000s. Hunt says that the issue of how or whether insurance companies will provide steady low-risk yield for their policyholders going forward is an open question. "If interest rates stay this low or even go lower, where will insurance companies get their margins?" he said.
6.…and you'll have to wait years to bui ld cash value
With a whole-life policy, you're paying more than you would for a death benefit alone so you can build up savings. You can borrow from the "cash value," and eventually cash it in.
But in practice, a customer can own a whole-life policy for years without building any "cash value." That's because most of the premiums in the first couple of years go to cover the agent's commission, underwriting and marketing expenses, says Daily. It's like paying interest only on a home loan and not paying down the principal.
Daily and Hunt say it's often better for buyers to pay extra during the first couple of years so the policy builds value immediately.
7. Our regulators can be toothless
Unlike banks and big investment firms, which are largely regulated at the federal level, insurance companies are largely regulated by states. The NAIC, a federation of state commissioners, helps them coordinate regulations, but has no enforcement authority of its own.
For consumers, this situation is a mixed bag: State insurance commissioners can slap agents with a loss of a license, for example, but they don't have as much power to affect the practices of nationwide companies. And agents who do get slapped sometimes just set up shop across state lines under a new name or new business title.
The ACLI, which represents large nationwide life insurance firms, says it's committed to working within the state regulatory system. But it has also advocated for some insurers to be given the option of federal regulation, which they say could be preferable to the patchwork of state regulators. Consumer advocates say that wouldn't necessarily be better for consumers in states where regulators are already tough.
8. Someone could fake your death and collect on your benefits
Identity theft is a problem in the life insurance industry, according to the Identity Management Insti tute, a Chatsworth, California-based organization that specializes in helping companies safeguard consumer and employee data. With many elderly policyholders and a blizzard of forms and contracts, it's relatively easy for thieves to make themselves the beneficiary of a policy, submit a phony death certificate and collect the money. All told, life insurance fraud costs the industry about $70 billion a year, according to Henry Bagdasarian, president and founder of IMI.
Some tips to protect yourself: Never give an insurance agent the power of attorney; review your insurance contracts and policies regularly to ensure that the beneficiary is who you intended it to be; and beware of phone calls, emails, or official-looking correspondence claiming your life insurance policy has been canceled due to nonpayment and a credit card payment is needed to reactivate it.
9. If you die, we'll pay your boss
It sounds like the premise of a detective novel: Your b oss takes out an insurance policy that pays your company if you die. But many companies do it, in part to cash in on related tax breaks, and in part to collect the death benefits if an employee dies.
The practice, derided by consumer advocates as "janitor" or "dead peasant" insurance, has become less common in recent years. Still, the crime-novel scenario sometimes plays out: In 2012, an Ohio man was sentenced to four years in prison for attempting to hire a hit man to knock off a former employee—all in an attempt to collect $250,000 on an insurance policy.
The NAIC says that employees need to be notified when an employer takes a policy out on them, and that the employee shouldn't be penalized if they refuse to participate.
10. Our long-term care coverage isn't so great (for you or us)
More than two-thirds of Americans who reach age 65 will need long-term care, according to the Department of Health and Human Services. And bills for such care—which Medicare generally doesn't cover—can easily top $5,000 a month. It's no wonder the industry expected long-term-care insurance to be a success.
But so far, the coverage hasn't lived up to expectations. Just 5.1 million long-term-care policies were in force in 2013, up from 4.1 million in 2007. Premiums for existing policyholders have shot up in recent years, and older adults with chronic illnesses often can't qualify for coverage.
Insurers, meanwhile, have been losing money on the policies, and some have stopped selling them. Glenn Daily says a long-term-care policy hasn't been a good product for insurers because they've struggled to figure out the probability that the insurer will have to pay out claims, which hurts the insurer's ability to price a policy affordably. Cornman of the ACLI says that long-term-care insurance is "still a relatively new product that serves a need that more and more people are recognizing."
For so me older people, it may make more sense to plan to pay long-term care bills with a reverse mortgage, or with savings. Still, "It is extremely difficult for people to do the kinds of calculations needed to determine if [long-term-care insurance] is a good deal for them," said Jeffrey Brown, a professor of finance at the University of Illinois who has studied such policies. "When people face a highly complex decision, don't have the information and cognitive skills needed to do the analysis, and nobody is providing them with education about it, then it may be that the path of least resistance is to do nothing."
Daniel Goldstein is a personal-finance and real-estate reporter for MarketWatch.
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