Diversify Your Life Insurance

Here's a piece from MSN Money that asks if your life insurer will outlive you. Their key thoughts:

When you're buying coverage that might not be paid out for decades, you need to check whether the insurer is likely to be around for a long time. Here are three ways to evaluate life insurance companies:

1. A company's rating is a barometer of its ability to pay a claim down the road.

2. Many states compile complaint reports each year, tallying the number of complaints made against insurance companies and ranking them in relation to their market share. If your state has such a report, you can better keep tabs on your insurer.

3. The life insurance industry offers a "seal of approval," the Insurance Marketplace Standards Association designation. Membership is granted for three-year periods, so if the association drops its endorsement of your insurance company, that should raise a red flag.

One issue they don't bring up is the idea of diversifying your life insurance needs over several companies. That way, at least you have some protection if one of the companies goes belly up. This is a decent option, one noted in my post titled 13 Smart Insurance Moves for 2009, but it's also a more expensive option than staying with one company. Here's a thoughtful comment from a reader of that post on this issue:

Diversifying life insurance carriers may help spread your risk like putting money in multiple banks to stay under the FDIC limit but unlike banks diversifying carriers is likely to result in higher premiums because the larger the policy amount typically, the lower the cost per 1000 on the insurance. For instance, the first 100-200K of insurance is usually more expensive because of the administrative fees. Once you add on after that the rates are pretty similar.

You might find for instance that a 250K policy for a certain individual costs 250 dollars per year but a 500K policy only costs 450 dollars per year and a 1 million dollar policy only costs 825 dollars per year. In that instance that would mean that the first 250K was 1 dollar per thousand per year, the second 250K was 80 centers per thousand per year and the next 500K was 75 centers per thousand per year.

If you go to 4 different carriers to get the insurance you are likely going to pay 1000 per year for 1 million instead of 825 and perhaps even more because odds are that you won't find 4 who all give you as good a rate as the best 1 you found at the credit rating that gave you the 250K for 250 per year. So likely you would pay more than 1000 for 1 million in coverage by using 4 carriers versus the 825 by using 1.

The extra cost may be worth it for the risk protection, but you need to understand the extra cost associated with spreading your policies.

Personally, whenever I have redone my policies because of rate reductions I consolidated to bring rates even lower and I only buy from top rated companies although obviously we have seen that nothing is ever guaranteed in this kind of an environment.

However I would add that once we get through the next couple years, the appetite for risk and the willingness of the government to allow it will be greatly curtailed for a long time. After a couple decades we could end up back where we are now but once this clears the system will not allow it to return in the near term. Boom and bust cycles take longer than that so I think the risk is mostly being squeezed out of the system now and over the next couple years, painful as it may be.

I have my life insurance with one, solid company (of course, we all thought AIG was solid several months ago), but this idea of diversifying life insurance "risk" (basically) is an interesting one. Anyone out there doing this or ever think of doing it?

Comments

[NCN]

I actually have two policies w/ two different companies. Frankly, this is just due to the fact that I purchased the second policy after we got out of debt, and it was less expensive than the policies that the first company was offering. After reading this post, it does feel good to have a little diversity. Interesting.

[Josh]

When you have coverage from multiple insurance companies, won't claims become a messy battle over which company is liable? My policies all have something along the lines of "if you have other applicable coverage, our company is the last to be liable".

To avoid this, I suspect you'd need to buy insurance products that are slightly different and account for primary/secondary payers. For example, a standard umbrella policy only pays after a large deductible and usually doesn't overlap with other insurance. On the other hand, if you do this, you aren't really diversifying your risk, just stratifying it....

Maybe I'm missing something though. I'd love to hear your ideas on how to implement this.

[JimL]

I think have diversification has become even more important in today's climate. Who would have thought AIG would be in the position they are today. Even though someone's rating is high today, what will it be 7 years from now? For me, I have policies with 4 different companies and my overall costs are not that much higher than a single policy.

[Mark]

For short-term insurance (e.g annually renewable life, auto, house, etc.) it's not such a big deal, but for long-term issues (long-term care, life) it's valid. I think the concept of paying a bit more for life insurance from multiple companies is very valid - it's like buying insurance for your insurance. Not sure ho you would do it for long-term care insurance though.

[Shadox]

Recently, as the financial crisis has continued to unfold, I have become more concerned about the viability of my life insurance company (Protective Life) that has had its bond rating donwgraded. Still, it seems to have stabilized for now.

[Param Iyer]

I recommend buying additional policies based on need & using that opportunity to diversify across companies (preferably all from the high-rated, reasonably-priced group). I bought my first insurance (3 policies) after marriage from firm A. After we had a child, I bought additional insurance, this time from firm B. If we decide to take a loan for buying our house, I'll take additional insurance, this time from a new firm. I think this approach introduces diversification without the need for forfeiting low premiums.

[Michael @ The Life Insurance Insider]

Josh,

When dealing with multiple policies, life insurance is different than health insurance. If you have 5 life insurance policies, with 5 different companies they are all obligated to pay if you die. With health insurance there are issues as to who is responsible for claims as the medical provider is only going to be able to collect the fee one time, it just becomes a matter of who is going to pay it.

Everybody else,

I'm not sure I would recommend going out a purchasing policies from multiple companies just because you will end up paying extra policy fees and losing out on the big cost breaks that usually occur at $250K, $500K, and $1 million. Keep in mind that you will need to refresh your coverage from time to time, usually upward as your salary goes up and you have more to insure. Rather than cancel my old policy, I plan to layer another on top of it from another company. This usually makes since because your rates go up as you get older so you usually don't want to give up the locked in lower rates from the old policy.

[Life Critical Illness]

I always stick with the biggest companies that are AAA rated. Sure they might be bought and sold but the policy still rmains intact as it is part of the value of the business

[Mike B.]

The lack of diversification of life insurance is completely idiotic. In the coming years as waves of Boomers die we are going to discover more and more about the shady risks companies have taken on to get "short term gains" (premiums) at the expense of "long term liabilities" (death claims earlier than accounted for). Companies will teeter. Big mutuals will go public. And if a big failure occurs that results in cash values being diminished or death claims being reduced to government protected limits, you can be sure that thousands of hungry lawyers will line up to take their shots at insurance professionals and even fee-only financial planners who failed to even identify the risks of failing to diversify coverage.

The notion that a diversified life insurance portfolio is more expensive is based on extremely simplistic assumptions and/or a very limited understanding of proper insurance acquisition strategies. I would be happy to explain this at length.