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Who needs life insurance?

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Very few people enjoy thinking about the inevitability of death. Fewer yet take pleasure in the possibility of an accidental death. If there are people who depend on you and your income, however, it is one of those unpleasant things that you have to consider. To espouse the need for life insurance, there’s a need to consider life insurance in two ways: first, consider some of the misconceptions and then how to evaluate how much and what type of life insurance you need.

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 insurance 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.), then you do not need life insurance.

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

Insurance and Age

One of the biggest myths that aggressive life insurance agents perpetuate is that “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 that insurance companies will want higher premiums to cover the odds on older people – 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, this loan will cost you, as you will have to pay interest to the insurance company for borrowing your own money.

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 and are cheaper than cash-value, 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 means that the insuring company will allow you to renew your policy at a set rate without undergoing a medical. This means that 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 that the insurance company is certain to have to pay out.

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 secure enough to go without insurance. Even though you will be planning in the hope of not having to use this option, 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, which will be a major determinant of the size of your policy. If you are the only provider for your dependents and you bring in $40,000 a year, you will need a policy pay-out 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 trustees or chose a financial planner and calculate his or her cost as part of the pay-out). 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. Remember, you have to add this $540,000 to whatever your total debts add up to.

Future Obligations: If you want to pay for your child’s college tuition or have your spouse move to Hawaii when you are gone, you will have to estimate the costs of those obligations and add them to the amount of coverage you want.

So, if a person has a yearly income of $40,000, a mortgage of $200,000, and wants to send his or her child to university (let’s say this will cost $80,000), this person would probably want an $820,000 policy ($540,000 to replace yearly income + $200,000 for the mortgage expense + $80,000 university expense).

Once you determine the required face value of your insurance company, you can start shopping around for the right policy (and a good deal). 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 nurture. 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 trick we went through earlier (your spouse’s income/8% + inflation = how much you’ll need to insure your spouse for).

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).

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.

The Bottom Line

If you need life insurance, it is important to know how much and what kind you need. Although generally renewable term insurance is sufficient for most people, you have to look at your own situation.

If you choose to buy insurance through an agent, decide on what you’ll need beforehand to avoid getting stuck with inadequate coverage or expensive coverage that you don’t need. As with investing, educating yourself is essential to making the right choice.

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Insurance

Climbing the Power Curve: Winning in the Insurance Market

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Insurers can take concrete, evidence-backed actions to move them in the right direction and, cumulatively, improve their odds of long-term success. Purposeful, bold moves aimed at shifting resources, boosting underwriting margins and productivity, and delivering on a series of programmatic M&A deals can dramatically improve an insurer’s odds of reaching the top quintile of economic profit. While these moves may sound instinctive, many companies fail to pursue them rigorously. In fact, these moves are most powerful when undertaken in combination, at or beyond the thresholds of materiality described in this narration. The point isn’t that there’s a magic formula for achieving strategic differentiation. Rather, by taking a hard look at the potential of your key initiatives to achieve bold results in these areas, one can get a realistic forecast of the odds that one’s strategy will transform performance.

Understanding the power curve and how to apply it

Research identified a power curve—proof that economic profit is unevenly distributed among insurance companies (exhibit) across geographies from 2013 to 2017. The power curve illustrates the uneven distribution of insurance industry economic profit.

These findings may come as a wake-up call to insurers that find themselves outside the top quintile—but embarking on an effort to move up the power curve is difficult.

How to move up the power curve

Research shows that moving up the power curve requires a laser focus on the factors such as foundational factors and bold moves that have an outsized impact on success, measured as economic profit.

Pursuing the five bold moves by Insurers

While the five bold moves may seem intuitive, and many companies may already be doing them in some form, two factors set these actions apart. First, magnitude and intensity matter; these efforts force insurers to break free from their standard processes of investment and initiative prioritization. Even if a company is doing something in each of these dimensions, how much it is doing often makes a difference. In other words, strategy is not only about the directionality of moves but also their materiality.

Second, the impact of these moves is cumulative. Companies that employ three or more of these moves in concert are likely to be propelled up the curve. Findings show empirically that companies that focus on multiple moves over time can learn from and adapt to them, reaping even further benefits.

Dynamically shift resources between businesses

Some carriers offer customers too many legacy products that do not produce meaningful profit. These legacy products take attention away from distribution, product development, and policy administration. Instead, companies should reallocate capital to higher return-on-equity (ROE) activities and away from lower-ROE lines of business. Proactive measures are critical given the sector’s highly competitive pricing environment.

Resource allocation should also be employed across various strategic lines, not just products. Based on research, the threshold for outperformance is the reallocation of 60 percent of surplus generated over a decade. Insurers that optimize their business mix accordingly have a better chance of improving their odds of ascending the power curve. This threshold parallels our findings across industries that dynamic resource reallocators gain approximately three to four more percentage points of total return to shareholders each year compared with low reallocators.

Other companies have increased economic profit by divesting underperforming assets. In the wake of the financial crisis of 2007–08, a number of companies exited underperforming businesses through closed-block transactions through either legal entity sales or reinsurance transactions. These transactions were with organizations that were more natural owners of the distressed assets by virtue of their capital structures or business models. These back-book transactions, when thoughtfully structured, have freed up capital that helped move sellers up the curve.

Reinvest a substantial share of capital in organic growth opportunities

Reinvesting earnings in profitable and well-performing businesses is a reliable way to increase economic profit, but finding these opportunities has been challenging for many insurers over the past ten years. Companies meet the threshold in this area if they are in the top 20 percent of the industry by strategic reinvestment relative to new business premiums; typically, that means spending 1.7 times the industry median.

Often considered innovators in the industry, companies that achieve this high ratio of reinvestment to sales have a track record of introducing disruptive products and services, enabling them to grow faster than their peers. Indeed, these insurers are successful at finding accretive internal rates of return. And as they push the boundaries of new offerings, they are often able to achieve higher margins (and ROEs) thanks to the reduced competition at the vanguard.

Pursue thematic and programmatic M&A

The third move centers on the use of programmatic M&A, an important approach for insurers with financial flexibility and access to available targets. A programmatic approach to M&A focuses on executing a series of deals in which no individual deal is larger than 30 percent of market cap but in which the total over ten years is greater than 30 percent of market cap. This is often done in thematic areas of technology and capability building or in extensions to new product lines and geographic markets. Typically, programmatic M&A outperforms both pursuing very large transactions and avoiding M&A altogether. By using a series of small, thoughtfully curated transactions to advance innovation and growth, programmatic acquirers have several advantages: they can simplify integration, avoid competitive bidding, and facilitate the exploration of new opportunities without committing large amounts of capital up front. This approach to M&A also enables more effective acquisition of new capabilities, such as digital and analytics.

Enhance underwriting margins

The fourth bold move involves making ROE improvements through better underwriting and lower loss ratios—a particularly important objective given how, as a core competency of all insurers and particularly in the P&C segment, underwriting efficiency can serve as a differentiating factor that leads to higher economic profit. Insurers accomplish these results either through privileged access to particular customer segments or better use of customer or risk data through analytics. Benefits from productivity improvement are often reinvested to improve product margins. To maximize the odds of moving up the curve, companies need to be in the top 30 percent of the industry by gross underwriting margin.

Make game-changing function improvements in productivity

Insurers feel continued pressure to reduce costs because of increasing price transparency, the effects of digitization, and low interest rates. Indeed, new entrants are closing the gap on incumbents. It’s generally recognized that even though the loss ratio has the greatest leverage, insurers benefit significantly from improving efficiency, lowering expense ratios, and increasing revenues per employee. Many executives in the industry believe that a dramatic wave of efficiency and retooling will crest in the next three to five years, and many are embarking on these high-ambition, enterprise-wide efficiency journeys now. Research reveals that to maximize the odds of entering the top quintile, companies should aim for a cost improvement that is in the top 30 percent of the insurance industry.

The odds of moving up the curve become exponentially larger as insurers pull more levers, while a strategy that does not incorporate any of the moves will likely fail. Indeed, the CEO, CFO, other senior executives, and board members can often use these bold moves as a test of strategies brought to them by their teams. Strategies that neglect to engage these actions typically have a one in ten chance of succeeding, compared with one in two (or better) for those that do.

Rather than thinking about strategy as primarily a matter of frameworks and broad themes, leaders should ask themselves what they are doing to make bold moves along the five dimensions that matter and whether efforts already underway are truly significant. The extent of the moves matters a great deal—materiality matters, not just directionality. And CEOs are in a unique position to calibrate materiality; this, in fact, is one of the greatest aspects of their role and a productive means of challenging their teams. If proposed plans don’t meet the required threshold of activity to bend the odds of moving up the power curve, they are likely not aggressive enough. What often gets in the way is a resource allocation process hindered by social dynamics. Other common obstacles include a lack of objectivity on opportunities and an insufficient understanding of critical thresholds needed to move the needle. As a result, too many companies simply check the box on certain priorities while investing too little in the ones that truly matter.

Improved economic profit is within reach for insurers that can adjust their business models in the face of an efficient market and inject a newfound objectivity into their strategic processes. Indeed, insurers that have a favorable endowment, navigate industry and geographic trends, and make bold moves will be in a good position to climb the power curve.

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