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Update News for April 2015
Here is a quick run-down on what you will find in this bulletin:
$1,000,000 or $65,000 per year?
The Need To Simplify
Life Insurance Needs Analysis
These topics will be dealt with in more detail throughout this bulletin.
When I was growing up my parents rarely talked about money and they certainly didn't discuss how much life insurance they were buying. The only thing I can ever remember my mother saying about life insurance was that my father was worth more dead than alive. From that I am able to conclude two things:
There is a line which sticks out in my mind from the "Coal Miner's Daughter", the movie about the life of Loretta Lynn. After her husband called her a stupid hillbilly, Loretta shouted back, "I may be ignorant, but I'm not stupid". It takes a well informed and intelligent person to understand the distinction.
The thing that most buyers of life insurance are ignorant about is the "time value" of money. If I asked you, which would you rather have, $1,000,000 or $65,000 per year, what would be your response? Most people would hear $1,000,000 and think "rich". By contrast, very few people would think $65,000 per year makes anybody rich. Needless to say, most people would grab the million bucks, I would need some further information.
When you say $65,000 per year, how many years are we talking about? Is the $65,000 a flat amount or is it indexed to inflation? How is the $1,000,000 taxed? How is the $65,000 per year taxed? What is the guarantee that the $65,000 will be paid each year? As I said, I would need answers to further questions because it's not a simple question.
But most people see $1 million as a lot more money than $65,000 per year and that underlines the fact that most people are ignorant about the time value of money. That ignorance is the greatest challenge that most life insurance agents face when trying to sell life insurance.
For most life insurance agents I would consider this a "hidden" challenge because the vast majority of life insurance buyers are under insured, just like my mother and father were under insured. They are under insured because their life insurance agent never explained it to them, and that is usually because that agent was also ignorant. It is interesting to consider some statistics which you can find here:
Go to page 67, figure 7.2. The average size of a life insurance policy purchased in 2010 was $165,000.
If you got to page 68, table 7.2, the average face amount for term was better. In total there were 3,615,000 level term policies sold, with a total face amount of 1,051,519,000,000 (that's trillion with a "t") for an average level term face amount of $291,000.
By contrast, there were 5,971,000 whole life policies sold, with a total face amount of 517,246,000,000 for an average whole life face amount of $87,000.
You can find similiar statistics for Canadian life insurance here:
Average policy size appears to be better than in the U.S., but there is no breakdown on term versus whole life face amounts and we are comparing 2010 numbers (U.S.) with 2013 numbers (Canada).
But most consumers will be lucky and never realize that they were ignorant. That's because most will live past the most critical period when they needed life insurance and they didn't die. Those who sell against term life insurance will often point out that most term policies never pay a death benefit, and they are correct. But that's not a bad thing.
Most life insurance agents who are ignorant about how much life insurance people really should buy, come into the business for a relatively short period time and never witness the huge mistake that is made when a consumer is sold too little life insurance and then dies. The family is OK for a while, but eventually they run out of money. Worse, some think they have more money than they actually do, and blow through it before realizing it.
Pity the dependents who are left behind when the family breadwinner dies unexpectedly. Thankfully it didn't happen to my mother and that's why I would say that she was lucky. But it does happen, and those of us in the life insurance industry should be ashamed when a family loses their paycheck because the breadwinner died and there wasn't enough life insurance to take care of the family.
Years ago, when I was still living in Canada, I was approached by a producer from the CBC television network. She was putting together a story for a consumer program called CBC Marketplace. They wanted to do a segment about "buy term invest the difference" and knew me from a previous in-studio segment where I had demonstrated how I could use a computer to shop and find the lowest priced term life insurance policies.
When the producer called I worked very hard to talk her out of doing a program on "buy term invest the difference", which was the original plan. She already had a strong sense that whole life insurance was not the best alternative for most consumers, but I told her she was missing the real story/problem. I explained to her that there was a much more fundamental problem with the life insurance industry's preference to sell whole life insurance. I explained that most people who bought whole life insurance were badly under insured because they couldn't afford to buy enough whole life insurance to adequately protect their families if they died.
I told her that if she really wanted to make the point she should try to find a couple of young widows whose husbands had died, find out how much life insurance those husbands had, and how those death benefits were working out for them.
That's exactly what the producer did, and it made for a very effective program segment. In fact that segment continues to live on. You can watch it on youtube by going here:
And yes that's me starting at 7:45. I was a little younger then and I have since upgraded the station wagon to a mini-van.
So let me say again that my mother was lucky because she wasn't like either of the two young widows who were featured in that story. My mother's husband didn't die as a young family man, and so he didn't leave his family with too little life insurance.
But some families aren't that lucky.
All of this to say that there is an under used option in Compulife that addresses this problem. The option is called "Income From Capital Analysis" which you can find when you click on the "Income Calculator" which is a button about half way down on the Red Master Menu (the menu you first see when you start Compulife).
When you click on that button a box will appear which has 4 tabs across the top. Those tabs are:
The Income Calculator is a simplifed and scripted version of the Income From Capital Analysis. The Income Calculator is designed to step-by-step lead someone through the process of finding out how much lump sum money it takes to generate an indexed income for a period of time. You can play with that on your own. I want to focus on the second tab which is the "Income From Calculator Analysis". That's the option a practiced user will go to.
NOTE: We first released the Income From Capital Analysis program about 30 years ago. At that time it was a stand alone program that we sold for $179. Now it comes FREE with your Compulife subscription. If you learn to use it, it will pay for your subscription each time you do use it.
I asked earlier, which was better, $1,000,000 or $65,000 per year?
Using the Income from Capital Analysis we can get a very fast answer to that question. Click on the "Income From Capital Analysis" tab. The first question is "age", let's use 35. The second question is "Inflation Rate", which sets the amount the income will be indexed. Let's use 2%. The next question is the interest rate. Let's use 5%. Make the Tax Rate 0%.
The next question on the screen has to do with what you are calculating. Generally, if you know two things, it will calculate the third. In this case we know how much capital we have ($1,000,000) and we know much income we want ($65,000), we just want to know how long that will last. So we will be calculating:
After selecting that option the system will tell you it will last 19 years. Click the button which says "Display Year By Year Results". That will produce this schedule:
Please print that out and look through it as I explain the numbers.
While the schedule has a lot of numbers on it, they are simple to follow providing that you take the time to explain the first few lines very carefully.
Here's how I would do it. In year one we begin with $1,000,000. I always explain it by saying that we take $65,000 from the $1m and we put the $65,000 into a checking account. That's this year's paycheck. That leaves $935,000 which we will put into the savings account. At 5% the $935,000 earns $46,750 in interest giving us a 2nd year starting total of $981,750.00.
In year 2 we take $66,300.00 in the checking account for that year's paycheck. I would always stop and ask the client, "Why did we increase the $65,000 to $66,300?" The answer is "inflation". IMPORTANT: make them say it. If they don't understand then you are going too fast for them and you need to slow down. It is vital that they understand the mechanics of the numbers and can follow along. If they do, they are going to get the idea very quickly that $1,000,000 is not a lot of money, and that's the idea we need them to understand.
Having taken away the $66,300 in year 2, we are then left with $915,450.00 which earns interest of $45,772.50 giving a year 3 total of 961,222.50. Keep doing this year by year until you know your client is following along. Once you see the "lights go on", then point down the income column showing how the income keeps going up (even at only 2% inflation), and point out how the investment capital keeps dwindling to the point where there is insufficient money left to pay the full income needed in the 20th year.
To conclude, $1,000,000 is about the same as $65,000 per year for 20 years. In other words, $1,000,000 is NOT a lot of money.
In truth I rarely use the calculation I just showed you. I ALWAYS use the schedule, I just rarely have the program calculate the time from capital and income. The calculation you really want to focus on is:
That's what the Income Calculator does, using a script. Again, that's for folks who are first learning this approach to insurance needs analysis.
Going back to the $1,000,000 versus $65,000 example, had I calculated it by entering $65,000 for 20 years, the software would have solved the capital need as $1,000,913.67. In that schedule, the income nicely zeroes out after 20 years. Here is that version of the schedule:
Think about it, if you die, and I can come up with a way to provide your family with the paycheck you used to provide, haven't I fixed the economic problem caused by your death? And for most people that is the ONLY economic problem caused by death. Oh sure, there's the cost of a funeral, but then we don't have to feed and clothe you anymore. And really, what's the cost of a funeral compared to the cost of replacing an annual income?
But here's how badly people get distracted from the real need for life insurance. They think they need to buy life insurance to cover their mortgage. That's a common thing I hear/see from people who contact agents from www.term4sale.ca. I just bought a house and I need life insurance for the mortgage. Why? Because the bank told them it was an option and now they are trying to find out if the bank is offering a good deal for the coverage.
Life insuring a mortgage is a complete distraction from the real problem? The thing that is lost if you die is not the mortgage or the house, it's the income that you earned, which is how you made the mortgage payments. That's the problem, the income is gone not the payment. Insure the income and you can forget about the mortgage. In fact you can forget about everything else. You are replacing the income used to provide everything else.
What about money for the children's education? Assuming you live, where is that money coming from anyway? From your income. How about money for retirement? Where is it coming from if you don't die? It's ALL about the income, and people instinctively know that, you just have to remind them about it. Instead of sitting there an trying to construct a budget to show where all the income is being spent, just point out that that they are spending all the income. Why should that change for your family just because you died?
The problem is how much lump sum money does it take to replace the income. Earlier we used $65,000 as the example. What is the old industry rule of thumb to replace $65,000. Some will say it's 10 times income, some 7. But in the example I gave you it was 15 times income.
The problem is that whatever number you use, it is a struggle to get the consumer to understand why you used that number. Why? Because they didn't see the year by year illustration showing how the lump sum of money is paying out an income. Once they understand that, and understand that the money RUNS OUT in the end, selling the big number is no longer a big challenge, especially when life insurance is as cheap as it is today.
Agents often tell me they can't make any money selling term. That's only true if you are selling small policies. But if you will learn to use Income From Capital Analysis, you will sell bigger policies and you will sell them ALL THE TIME. And more important, your client's will stop being ignorant about how much capital it takes to produce an income, which might also prove to be useful when explaining their need to save for retirement (yes, that's what Retirement Investment Analysis can do).
It is always hard to get an agent to try a new way to sell or explain something to a consumer. But will you try this for me? The next time you have a young family and you are trying to explain how much life insurance they need, talk about insuring the breadwinner's paycheck, and then use the Income From Capital Analysis to show them how much that takes.
How long do they need the paycheck?
Maximum: until they retire. Remember, you retire when you have sufficient money saved to obtain an income without working. Your spouse can now rely upon those retirement savings instead of your earned income.
To read further on this subject, here are some past article that I have written, and where are found at www.term4sale.ca: