Is purchasing a life insurance policy a good idea for you? The short answer is it depends on your situation. Let’s begin by understanding what life insurance is.
In its simplest form, you pay premiums to the life insurance company and it pays money to your household or your beneficiary upon your death. But let’s be clear: On average, your household would be worth more, if, rather than buying life insurance you wisely invested the money you would have spent on premiums. If this were not true, the insurance companies would be bankrupt and they most assuredly are not. Indeed, life insurance policies are very profitable for the companies.
Think about it. The insurance company takes your premiums and invests them. Assuming you live to a normal life expectancy, the insurance company will have X number of pesos at the time of your death. Had you taken the premiums and invested them, your household or would have the same X number of pesos upon your death (assuming you invest as well as the insurance company).
If you invest the premiums, your household getsto keep all of the X pesos. However, the insurance company cannot pay your household all of the X pesos.
It first has to pay all of its operating expenses—the salaries of its executives, back office and administrative personnel; the rent on its big office buildings; the cost of its salesforce; etc. After that, the company has to make a profit for its shareholders.
The company can only afford to pay your household a number that is less than X—considerably less. For the company to remain solvent, the amount it pays your household will be equal to X minus a pro rata share of the company’s costs and profit.
Assuming you achieve your full life expectancy and invest as well as the insurance company, your household will be worth more if you invest the premiums rather than turning them over to the insurance company. Therefore, on average, life insurance is a bad deal—it has to be.
Obviously, if you die sooner, the purchase of a life insurance policy is a better deal for your household. Conversely, if you live longer, the purchase of life insurance is a worse deal for your household. But on average, your household will have more assets if you invested the premiums rather than giving them to the insurance company. On average, life insurance is a losing propositon.
So why should you ever sign up for a losing proposition? The answer is that you shouldn’t unless there is some financial obligation that will remain after your early death that you would have been able to fulfill had you lived to your normal life expectancy. If you are willing to pay a premium to protect your children from this unfortunate possibility, life insurance may be a good investment.
Let’s consider a couple of examples. You have just graduated from college. You are marrying the most wonderful person in the world. He or she is a classmate who already has a job offer. You have been accepted to a graduate school in the same town where your future spouse’s job will be. As a full-time student, you will not be working.
Many would say, “You’re getting married, you need life insurance.”—you actually don’t. You have no income, but you do represent an expense to the family—you eat. You are a net financial drag on the family. It may sound harsh, but the truth is if, God forbid, you died, your spouse would actually be better off financially. Therefore, a life insurance policy on you is unnecessary at this time.
Fast forward a few years. You have completed your education. You are expecting your first child. Your spouse is planning to stay at home to take care of your offspring. You have a good job and will be the sole source of income for your young family. Athis point, life insurance for you would be very appropriate. If you were to die, you would want your family to be protected from what might otherwise be significant financial hardship.
Is life insurance appropriate for you? It all depends. If your early demise would create a significant financial hardship for your children, life insurance may make sense. However, even in these situations, understand that you are paying for this protection. If you live to your full life expectancy, your children would have been better off if you had invested the money you might have paid in premiums.
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This article originally appeared on Entrepreneur.com. Minor edits have been done by the Entrepreneur.com.ph editor.
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