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How Much Life Insurance Should an Individual Carry?

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Very few people enjoy thinking about the inevitability of death. Fewer yet take pleasure in the possibility of an accidental or early death. If there are people who depend on you and your income, however, it is one of those unpleasant things you have to consider. In this narrative, I’ll approach the topic of life insurance in two ways: First I’ll point out some of the misconceptions, then I’ll look at how to evaluate how much and what type of life insurance one needs.

 

Does Everyone Need Life Insurance?

Buying life insurance doesn’t make sense for everyone. If you have no dependents and enough assets to cover your debts and the cost of dying (funeral, estate lawyer’s fees, etc.), then it is an unnecessary cost for you. If you do have dependents and you have enough assets to provide for them after your death (investments, trusts, etc.), you still do not need life insurance.

However, if you have dependents (especially if you are the primary provider) or significant debts that outweigh your assets, you likely will need insurance to ensure your dependents are looked after if something happens to you.

 

Insurance and Age

One of the biggest myths aggressive life insurance agents perpetuate is “insurance is harder to qualify for as you age, so you better get it while you are young.” To put it bluntly, insurance companies make money by betting on how long you will live. When you are young, your premiums will be relatively cheap. If you die suddenly and the company has to pay out, you were a bad bet. Fortunately, many young people survive to old age, paying higher and higher premiums as they age (the increased risk of them dying makes the odds less attractive).

Insurance is cheaper when you are young, but it is no easier to qualify for. The simple fact is insurance companies will want higher premiums to cover the odds on older people, but it is a very rare that an insurance company will refuse coverage to someone who is willing to pay the premiums for their risk category. That said, get insurance if you need it and when you need it. Do not get insurance because you are scared of not qualifying later in life.

 

Is Life Insurance an Investment?

Many people see life insurance as an investment, but when compared to other investment vehicles, referring to insurance as an investment simply doesn’t make sense. Certain types of life insurance are touted as vehicles for saving or investing money for retirement, commonly called cash-value policies. These are insurance policies in which you build up a pool of capital that gains interest. This interest accrues because the insurance company is investing that money for their benefit, much like banks, and are paying you a percentage for the use of your money.

However, if you were to take the money from the forced savings program and invest it in an index fund, you would likely see much better returns. For people who lack the discipline to invest regularly, a cash-value insurance policy may be beneficial. A disciplined investor, on the other hand, has no need for scraps from an insurance company’s table.

 

Cash Value vs. Term

Insurance companies love cash-value policies and promote them heavily by giving commissions to agents who sell these policies. If you try to surrender the policy (demand your savings portion back and cancel the insurance), an insurance company will often suggest that you take a loan from your own savings to continue paying the premiums. Although this may seem like a simple solution, keep in mind that if the loan is not paid off by the time of your death, it will be subtracted from the death benefit.

Term insurance is insurance pure and simple. You buy a policy that pays out a set amount if you die during the period to which the policy applies. If you don’t die, you get nothing (don’t be disappointed, you are alive after all). The purpose of this insurance is to hold you over until you can become self-insured by your assets. Unfortunately, not all term insurance is equally desirable. Regardless of the specifics of a person’s situation (lifestyle, income, debts), most people are best served by renewable and convertible term insurance policies. They offer just as much coverage, are cheaper than cash-value policies, and, with the advent of internet comparisons driving down premiums for comparable policies, you can purchase them at competitive rates.

The renewable clause in a term life insurance policy allows you to renew your policy at a set rate without undergoing a medical exam. This means if an insured person is diagnosed with a fatal disease just as the term runs out, he or she will be able to renew the policy at a competitive rate despite the fact the insurance company is certain to have to pay a death benefit at some point.

The convertible insurance policy provides the option to change the face value of the policy into a cash-value policy offered by the insurer in case you reach 65 years of age and are not financially secured enough to go without insurance. Even if you are planning on having enough retirement income, it is better to be safe, and the premium is usually quite inexpensive.

 

Evaluating Your Insurance Needs

A large part of choosing a life insurance policy is determining how much money your dependents will need. Choosing the face value (the amount your policy pays if you die) depends on:

  • How much debt you have. All of your debts must be paid off in full, including car loans, mortgages, credit cards, loans, etc. If you have a $200,000 mortgage and a $4,000 car loan, you need at least $204,000 in your policy to cover your debts (and possibly a little more to take care of the interest as well).
  • Income replacement. One of the biggest factors for life insurance is for income replacement. If you are the only provider for your dependents and you bring in $40,000 a year, you will need a policy payout that is large enough to replace your income plus a little extra to guard against inflation. To err on the safe side, assume that the lump sum payout of your policy is invested at 8% (if you do not trust your dependents to invest, you can appoint a trustee or select a financial planner and calculate his or her cost as part of the payout). Just to replace your income, you will need a $500,000 policy. This is not a set rule, but adding your yearly income back into the policy (500,000 + 40,000 = 540,000 in this case) is a fairly good guard against inflation. Once you determine the required face value of your insurance policy, you can start shopping around. There are many online insurance estimators that can help you determine how much insurance you will need.
  • Insuring others. Obviously there are other people in your life who are important to you and you may wonder if you should insure them. As a rule, you should only insure people whose death would mean a financial loss to you. The death of a child, while emotionally devastating, does not constitute a financial loss because children cost money to raise. The death of an income-earning spouse, however, does create a situation with both emotional and financial losses. In that case, follow the income replacement calculation we went through earlier with his or her income. This also goes for any business partners with which you have a financial relationship (for example, shared responsibility for mortgage payments on a co-owned property).

 

Other Ways to Calculate Your Needs

Most insurance companies say a reasonable amount for life insurance is six to 10 times the amount of annual salary. Another way of calculating the amount of life insurance needed is to multiply your annual salary by the number of years left until retirement. For example, if a 40-year-old man currently makes $20,000 a year, under this approach, the man will need $400,000 (20 years x $20,000) in life insurance.

The standard of living method is based on the amount of money the survivors would need to maintain their standard of living if the insured died. You take that amount and multiply it by 20. The thought process here is the survivors can take a 5% withdrawal from the death benefit each year (which is equivalent to the standard of living amount) while investing the death benefit principal and earning 5% or better.

 

Alternatives to Life Insurance

If you are getting life insurance purely to cover debts and have no dependents, there is another way to go about it. Lending institutions have seen the profits of insurance companies and are getting in on the act. Credit card companies and banks offer insurance deductibles on your outstanding balances. Often this amounts to a few dollars a month and in the case of your death, the policy will pay that particular debt in full. If you opt for this coverage from a lending institution, make sure to subtract that debt from any calculations you are making for life insurance—being doubly insured is a needless cost.

 

 

 

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Strengthening a Collaboration between Insurtechs and Commercial Incumbents in the Insurance Industry

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Companies across industries are seeking to embrace digital technologies—to support new business models, improve efficiency, and gain a competitive advantage. Commercial insurance executives recognize the benefits of digital but face several obstacles in making headway.

Large incumbents lag behind because the complicated nature of underwriting and claims often requires human judgment and interaction, transactions are sometimes low volume and bespoke in nature, and legacy IT systems and processes make the transition resource intensive and complex.

What’s more, commercial insurance has historically been slow to change, and a lack of companies with clearly demonstrated impact from digital has left many executives focused on their own plan of action.

Rather than seeking to completely transform commercial lines, most insurtechs are focused on enabling or extending the insurance value chain. In personal insurance, insurtechs have played the role of digital attackers and captured market share at specific points in the value chain.

Lacking the scale and expertise needed to excel in commercial, insurtechs can be viewed by executives not as competitors to be feared, but as potential partners that could accelerate their digitization efforts.

The rapid proliferation of commercial insurtechs has created a challenge for large incumbents: how to identify and prioritize worthy candidates for investment and collaboration. Due to this uncertainty, many commercial insurers have been sitting on the sidelines.

The urgency to embrace digital is accelerating, however, so those who wait may miss out on opportunities to benefit from this wave of innovation. As a first step, executives should become more familiar with the areas in the value chain where insurtechs are concentrating their efforts.

Armed with this context, insurers can prioritize their engagement toward insurtechs in ways that can add value to their own strategy. This strategic collaboration can help to usher in new, tech-enabled approaches that should inspire commercial incumbents and accelerate the digitization of their enterprise.

 

Impact of insurtechs on incumbents

Over the past few years, global investment in insurtechs has grown by leaps and bounds—from $250 million in 2011 to $2.3 billion in 2017. Although the United States was the pioneering market for these companies, only 38 percent of all insurtechs are currently headquartered there. According to the latest figures, there are more than 1,500 insurtechs globally, and 37 percent are based in Europe, the Middle East, and Africa (EMEA)—in particular, Germany and the United Kingdom. An analysis from McKinsey’s Panorama Insurtech database shows that around 39 percent of insurtechs are focused on the commercial segment, mostly in small and medium-sized enterprises (SMEs), as shown in Exhibit 1.

As the number of commercial insurtechs grows, their influence will take different forms. Some will partner with incumbents to provide innovative new products and services, and others will be acquired and integrated into incumbents. The majority of commercial insurtechs (63 percent) focus on enabling the insurance value chain and partnering with incumbents. Only a small number of insurtechs (9 percent) are attempting to fully disrupt the insurance market (Exhibit 2).

These companies do not currently pose a serious threat to incumbents, but in the coming years they might be able to make inroads in certain segments or niches and take market share.

Despite significant digital advances, commercial lines still rely heavily on human judgment and manual processing—particularly in underwriting. This high-touch model not only increases operating costs but also limits the ability of incumbents to provide superior customer service (such as risk prevention and loss control) for a select few clients, specifically those with large accounts or where change in risk behavior would have considerable impact.

Insurtechs, however, can help scale and expand risk-prevention services. In doing so, companies can extend their services beyond the largest accounts while significantly improving performance and efficiency.

Digital interaction models. Inspired by the success of digital brokers and advisers of insurtechs in personal lines, a number of commercial are providing new and seamless digital customer experiences. The new digital interaction models also lower the cost to serve customers and increase transparency in pricing and coverages.

Furthermore, some of the digital brokers interact directly with reinsurers and other capital providers while outsourcing insurance processes, such as claims handling. These emerging models may support consolidation in today’s heavily intermediated value chain. Notably, the digital interaction models used by commercial insurtechs will most likely have the greatest value in the SME segment.

As the customer decision journey for the lower end of commercial lines starts to resemble personal lines, North American traditional companies and insurtechs are actively pursuing commercial SMEs using digital solutions. Key trends include more automated or streamlined underwriting, a shift from brick-and-mortar to digital service and delivery, the replacement of intermediated with “direct” customer engagement, and the development of aggregator solutions.

 

Digital core insurance capabilities. By adopting new technologies, insurtechs in commercial lines are at the forefront of reducing manual touch and enhancing human judgment in key insurance processes, such as underwriting and claims. The increased dependence on technology lowers costs and allows insurers to adjust their approach from “art” to “science” in key disciplines, including underwriting, risk selection, and claims leakage prevention.

Moreover, insurtechs are using approaches with the potential to provide new services to their customers, better enabling them to monitor, prevent, and mitigate their own risk at an affordable cost.

It is still unclear where digital innovation will have the greatest impact on commercial lines. However, recent analysis found that administrative costs for Greenfield Insurers are, on average, half those of incumbents—sometimes even less. Their cost leadership is partially due to a monoline focus and the absence of legacy IT systems and processes, as well as digital-by-design products. While these results are primarily related to personal lines, the impact on commercial lines, starting within the SME segment, will become as significant over time.

 

Developing a plan of action

When the fintech movement started in financial services, the banks that adapted quickly to meet the challenge formulated a strategy in three phases—understand, engage, and act. Commercial insurers may follow a similar approach to determine the best way to partner with insurtechs (Exhibit 4).

Understand. While some of the larger insurers and reinsurers have made progress across all three stages of engagement, many insurers are currently in this phase. Commercial executives must become more familiar with the evolution of the insurtech ecosystem, gain an understanding of the research in insurtech databases or publications, and participate in insurtech accelerator programs, which are run by a third party. Other insurers have launched hackathons with insurtechs.

Engage. This phase involves interacting with players in the insurtech ecosystem to seek out partnerships or inspiration. Commercial insurers can conduct more formal scouting, partner with insurtechs to develop proof-of-concept solutions, or launch incubator programs. Incumbents have launched incubator programs to provide a springboard to promising insurtechs. Most global commercial insurers have established similar incubator programs.

Act. Commercial executives can use their firsthand knowledge of the opportunities to partner with insurtechs to determine whether to invest in, collaborate with, or adopt an insurtech approach, or to wait and see. A few large multinational primary insurers and reinsurers are also actively investing and seeding opportunities in the insurtech space using a multitude of interaction models, ranging from investments to partnerships to reinsurance support.

Many insurers have launched venture capital funds in the insurtech space. Since the insurtech space is changing rapidly, approaching the “understand” and “engage” phases as ongoing efforts rather than one-off activities can ensure that executives stay up to date on the latest developments.

Identifying insurtech partners

Finding the right insurtechs with which to engage requires a structured approach. Executives should consider several parameters when evaluating an insurtech for a more formal arrangement (Exhibit 5):

Placement along the insurance value chain. Insurtechs have emerged at each step of the value chain, from marketing and sales to administration and claims.

Degree of innovation. The analysis should include activities from improving the current value chain (such as through the introduction of advanced analytics or artificial triaging of quotes), extending the current value chain (such as by providing adjacent services for risk prevention and mitigation), and exploring completely new risk pools and business models (such as through ecosystems).

Strategic relevance and value for the company. This measure seeks to determine the importance of the innovation across the insurance value chain. Relevance and value can vary by function and client segment. For example, insurers seeking to extend the value chain may focus on claims, which allows broadening capabilities and enhancing service levels to insureds. Other insurers may seek to rebuild the end-to-end value chain with new, digital-based business models.

Insurtechs are entering the commercial lines space: many of these start-ups will fail, and only a few will succeed. The most important impact of commercial lines insurtechs is that they provide a source of inspiration for the incumbent commercial lines insurers and reinsurers and a way to leapfrog into digital.

Commercial insurers that are able to find the right insurtechs to engage with could improve margins, expand their client base, and extend their services. Forging such partnerships may allow them to relieve cost pressures and counter eroding margins once new technologies mature.

To reap these benefits, commercial insurers must manage their partnerships effectively and expand IT capabilities to implement the solutions provided by insurtechs. These moves will require investment to understand and engage with insurtechs, define the right business models, and build flexible architecture that will allow insurtech solutions to integrate into IT core systems.

The payoff could include not only increased digitization and new ways of generating value but also a stronger competitive position in the coming years, as disruptive models become mainstream.

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