Life insurance is an important asset and financial risk management tool. The purchase of life insurance typically involves a long-term commitment and coverage amounts can be substantial. Therefore, similar to diversifying your 401(k) or brokerage account, it is important to consider diversifying your life insurance portfolio (especially for portfolios with higher coverage amounts). A diversified life insurance portfolio provides significant flexibility for changing coverage needs and circumstances and it reduces risk.
The diversification of a life insurance portfolio can have various meanings. Highlighted below are four areas where diversification may be worth exploring when purchasing and managing life insurance coverage.
Diversify by insurance carrier — An insurance carrier’s financial strength and claims paying ability are very important when purchasing life insurance. Death benefit proceeds are subject to the claims paying ability of the insurance company. In addition, for permanent life insurance, the cash surrender values allocated to the carrier’s general account is subject to credit risk.
If a carrier develops solvency concerns, the intended benefits may be compromised. Therefore, purchasing life insurance from multiple insurance carriers reduces the potential credit risk for your insurance coverage if one carrier develops solvency concerns.
Diversify by product type (permanent and term) — Buying permanent life insurance is a long-term commitment and the purchaser should plan on holding the policy until maturity. This means that even during tough economic times, the owner should continue to pay the scheduled premiums. Therefore, it is important to only purchase permanent insurance that one can stay committed to and afford over the long term.
If additional insurance protection is needed, then the purchaser should consider buying term insurance to make up the difference and lock in insurability. Many term insurance policies offer conversion privileges that allow the policy to be converted to permanent insurance at a later date with no further underwriting requirements. This allows the purchaser to wait and purchase the additional permanent coverage when their financial picture is clearer.
Purchasers may also choose to diversify within permanent insurance products options such as whole life, universal life, variable life and equity indexed life. Each of these product types offer different cash accumulation alternatives and risk/reward profiles.
Diversify by policy duration — Although term insurance is the least expensive form of life insurance protection, purchasing one policy for the amount and duration needed may not be feasible due to financial constraints (e.g., purchase of 30-year term for total insurance coverage amount). The longer the policy duration, the higher the cost of the life insurance protection becomes. If cost is a concern, it may be wise to ladder policies with various durations such as 10-, 20-, and 30-year terms. – by Ken Godfrey
