Planning for your own death can be unpleasant. Figuring out life insurance shouldn’t be.
Unfortunately, it’s easy to get lost in a sea of policy types and financial jargon that obscures the math. Even small assumption errors can lead to expensive mistakes, especially when crediting rates or loan arbitrage myths make a policy sound better than it is.
The good news? With the right guidance and a little clarity, life insurance mistakes are easy to avoid.
The Big Four Errors
Many start their life insurance planning with lofty optimistic returns, but the most common mistakes are usually more practical. Below are four big assumption errors that can undermine even well-intentioned policies.
The Wrong Amount of Coverage
You might hear the rule of thumb “10 times your salary,” but choosing an income multiple may be too simplistic. Instead, take a big picture view of your finances.
How do you want to provide for your family? Do they rely on your income or your time? This matters for the primary breadwinner, but just as much for stay-at-home parents, whose contributions (childcare, household management, daily care) are expensive to replace.
Timing Risk
In life insurance, death is certain, but its timing isn’t.
Timing risk is the uncertainty surrounding when an insured event, like death or disability, will happen. This is different from underwriting risk, which is the uncertainty about the event itself.
Insurance companies spend large resources modeling risk variables to set premiums, hold reserves, and stay financially healthy. When the timing assumptions are off, the ripple effects are real for insurers and policyholders alike. These include:
- Mortality Assumptions: If life expectancy assumptions are off, a policy may not be priced or funded as accurately as it should be.
- Lapse/Surrender Timing: When policyholders lapse earlier or in larger numbers than expected, the cost of insurance can rise.
- Medical Underwriting: If your insurer misjudges your health risk, you may pay too much for coverage or face problems if a claim is contested.
Static Expenses
Treating the cost of living as a static, fixed expense is problematic because those costs rise over time. As lifestyle inflation grows, so do debts, healthcare needs, and spending habits. This can increase the amount of coverage your family needs.
What’s more, inflation can erode the purchasing power of a fixed death benefit. That means a death benefit amount that seems sufficient today may not cover housing, healthcare, and education ten years from now.
Long-term policies, like 30-year term or permanent insurance, are especially susceptible because the final payout is far in the future. The further out the payout, the more time inflation has to erode its real value.
Static assumption mistakes can also be wrong in the opposite direction. While some costs rise over time, others eventually end. Once a mortgage is paid off or children graduate college, the need for higher coverage might drop.
Particularly in universal life or similar policies, if a policyholder keeps cash value high, the net amount at risk (NAR) decreases over time. Static assumptions might anticipate rising mortality costs but if the NAR drops, the actual expense is much lower than projected.
Updating Your Beneficiaries
The perfect policy is useless if your family can’t find it. So, make sure they have the key information: your insurer’s name, policy number, and where to find your documents.
Follow up with an email so there’s a searchable record, or better yet, walk them through the details yourself. A quick ten-minute conversation can save hours of confusion and frustration later.
Correcting the Model
A better life insurance plan starts with more conservative assumptions. Instead of building around best-case scenarios, leave room for lower returns, rising expenses, and changes in your family’s needs.
If you’re unsure where to start, or need a review of a current policy, get an unbiased life insurance policy assessment from an independent advisor. They can stress-test your options and apply margin testing to evaluate the “margins” (extra cushion) to cover risk.
Remember, the goal isn’t a policy that looks good on paper. It’s one that holds up when it needs to.
The post Small Assumptions That Cause Big Failures appeared first on Stratus Financial Partners.