The origin of modern life insurance harks back to the days of the Roman Legion, when legionnaires pledged to one another that they would care for the families of fallen comrades, insurance experts say.
Notably, all of today’s policies attempt to do what those legionnaires did: provide security to the families of people who die, as well as address some of the problems of that basic assurance.
What problems? The legionnaire’s pledge worked essentially like term insurance. It acknowledged that someone might suffer an untimely death, leaving surviving members of that family with costly financial obligations. But if a large group of people agreed to pay just a little money each, they could help that hapless family pay their bills.
Today’s term insurance works much the same way, spreading risk around a large pool of similarly situated individuals.But problems arise when age, infirmities or war fell a large number of people in the pool.
Recognizing that term insurance could become prohibitively expensive long before most people would need it to protect their families, the insurance companies that sprung up hundreds of years ago to provide legionnaire-like promises for non-legionnaires set to work on alternatives.
What they came up with was called “whole life.”
It started with a simple premise: All life starts at 0 and ends at age 100. If you buy a policy somewhere between those ages, some clever guy with a calculator can determine just how much it will cost you to fund your own death benefit.
How? You buy a hybrid product that’s part insurance, part savings account. Each year, a portion of the premium you pay will go to fund the insurance, while the other portion accumulates in a tax-favored savings account.
A lot of people didn’t like whole life insurance for two reasons: The product was tough to understand, and the policies were inflexible.
Because of the way the policies were structured, the consumer needed to pay a set premium every year. If you couldn’t afford the cost some year, your policy lapsed. If you had accumulated money in the savings portion of the policy at that point, you got the savings money back.
Insurance companies set their best minds to work and came up with an answer to these complaints: universal life.
Universal life would work much the same way as whole life, but the policy would be a bit more transparent. The companies would spell out how much of each year’s premiums would be eaten up in mortality fees and expenses, and how much would actually be invested. Better yet, if you couldn’t afford the whole premium in some year, this policy offered choice. As long as you paid enough to cover the insurance portion of the policy, you could keep the policy in force. In good years, you might decide to overfund the investment side of your policy, paying a higher premium so that more of your money would be invested. In a lean year, you might pay less–or nothing at all, letting the premium come from the savings accumulation within the policy rather than from you.
The problem? The invested portion of the policy was still being invested by an insurance company, which was buying fixed-income instruments such as bonds and mortgages. That produced steady but modest returns.
And, in the early 1980s, the stock market began to take off and a host of financial gurus advised: “Forget permanent insurance. Buy term, and invest the rest!”
In a nutshell, this camp was telling Americans to do on their own what insurance companies were doing for them: Buy term insurance for the unlikely chance of your untimely death, and then reduce your need for insurance over time by accumulating savings that could be used to cover your family’s financial obligations when you died of old age.
Insurers responded with a product that allowed consumers to choose how to invest the dollars accumulating in their accounts. And, in fact, investing in those high-returning stocks is one of the more popular choices. Hence, “variable universal life” was born.
Still, even variable universal life couldn’t answer all consumer needs, such as the need for tax-favored retirement vehicles; products that would aid in estate planning; and those that would cover specific obligations, such as home mortgages, or specific risks, such as the loss of a job or your mental capacity.
In the past several decades, insurance gurus have been working at a fever pitch, creating a wide array of products to address nearly every need and lots and lots of whims. There’s variable annuities for those who are so well-heeled that they’ve maxed out on all other tax-favored retirement plans; there are a host of products aimed at estate-planning, including “second-to-die” policies that pay benefits to your heirs rather than your spouse. There’s mortgage insurance, disability insurance and vacation insurance.
If you need to protect yourself or your family from some looming financial obligation, there is doubtless an insurance product designed to suit your needs. But sorting through the dozens of options is tough and requires plenty of introspection.
