Four ways to build a diversified life insurance portfolio
By Ken Godfrey
Life Insurance Financial Evaluations, LLC
Insurance agents and case designers today have many options in building diversified life insurance portfolios for their clients. One size no longer fits all. Creativity is the key.
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. The primary risk of purchasing term insurance is coverage will still be needed after the term period expires and the insured becomes unhealthy or uninsurable. If the insured becomes unhealthy, securing new coverage may become unaffordable due to underwriting concerns. Laddering the policies between 10-, 20-, and 30-year durations helps reduce this risk.
Diversify variable life account values — Most variable life insurance policies offer an array of equity and bond type sub-accounts to allocate the cash values within the policy. It is important to diversify the account values across a balanced portfolio of the available sub-accounts based on the owner’s risk profile and make periodic adjustments. Variable life insurance can be ideal products for the right consumer and can offer significant cash value growth potential. It can also be the wrong type of insurance if the owner doesn’t actively manage the policy or is too aggressive or too conservative in their asset allocations. Too many variable life insurance policies are neglected and risk lapse. Having a diversified asset allocation should help the owner manage the policy to meet their expectations.
Insurance agents and case designers today have many options in building diversified life insurance portfolios for their clients. Carriers continue to be innovative and provide an array of products to use in constructing life insurance portfolios that are flexible and meet their client’s short and long-term cost, coverage and duration objectives. One size no longer fits all. Creativity is the key.