There is no self-insurance: The True Cost of Term Insurance

August 24, 2020

My Dear Reader,
Earlier today, my good friend and colleague Brock Fortner shared a post about the theory of self-insurance and with my recent event with Clayton Lasure, I thought it would be a poignant theory to discuss with you today. In his post, Brock made several important points
“Upon retirement most people are told they don’t “need” their life insurance anymore so they should cancel it because now they can “self insure”. This isn’t the origin of the problem; the actual origin came from when the person was led down a path to buy term insurance their whole working life just to be sure it’s canceled when they should want it the most.”

Brock is absolutely correct in describing the problem with term insurance. The product was designed in the 1970s and lent itself to a new financial philosophy called “buy term and invest the difference”. This is not a whole philosophy in of itself, but it has infiltrated many financial plans. The basic idea is that because life insurance is purchased for a death benefit and mortgage protection, the policy should only provide enough coverage for the insured working years. As a result, this theory suggests that the insurance should run out in a predetermined amount of time. But on a logical note, shouldn’t we ask ourselves why the financial industry no longer deems our lives valuable enough to pay a death benefit after a certain amount of time? When does your life’s earning potential become worthless? I would argue that the answer is never if you’re 25 or 95, you still have earning potential for you and your family.
But on a deeper level, purchasing insurance for 20 or 35 years without ever having a payoff is incredibly detrimental to your personal finances.

For those who may not be familiar with my work, I often talk about a hidden financial cost known as opportunity cost. Opportunity cost is seldom explained by the financial community. If your financial advisor has already explained this to you, or you know what it means, thank him or yourself; not understanding it can cost you hundreds of thousands of dollars over your lifetime. The basic premise is that every dollar you spend today could have been invested to yield increasingly more money over time. This is a sobering fact: every dollar spent today will never again be able to work in your favor. For instance, $100 invested today at the market average rate of return of 7.91 percent will be worth about $1,000 in thirty years. So, every payment made today with your own dollars hurts you in the future. This is why excessive taxation, especially personal income tax, is so harmful to all levels of society. USA Today estimates that the average American pays roughly $10,000 in personal taxes per year.1 If we use this number and apply the current market average rate of return of 7.91 percent, that one year’s payment of $10,000 costs $96,463 thirty years later.

So not only are we spending thousands of dollars per year on term insurance, the fact of the matter is that most of those policies never pay out, which turns into pure profit for the insurance company. Not only are we transferring away all of the potential interest on those dollars, but we are also handing that right over to the financial institutions and will most likely get ZERO benefit. Term insurance certainly has its place, but if used incorrectly, it can derail an entire plan over time.
To Your Creation and Potential,
Kevin Prendiville