Knowing what a thing is for often clarifies its design, its limits and how it interacts with other parts, or people.
Roman architect, Marcus Vitruvius Pollio asserted that a building must be solid, useful and beautiful. American architect Louis Sullivan expressed the idea as “Form follows function.” The identical idea applies to financial plans and especially to financial products. Therefore, the question. “What is Life Insurance for?” is important.
Before anyone selects a particular life insurance format, they must address questions.
- How important is the problem?
- In money, how big is it?
- Could I solve it in any other way?
- How long will it last if I live?
- How will it change?
- How much could I afford to spend now to make it go away?
- Can I integrate the solution with something else I am doing and gain advantage by doing so?
The answers to these questions are contextual. Context defines how. Life insurance comes in many packages and one of them or a combination of them can match the shape of the problem. You must understand the, “What am I trying to do question” first.
The problem of paying taxes due at death is a quite different problem than a young family’s need for capital to replace income and pay off debts. Similarly a business with a key-person need sees the problem differently than their banker who wants to make sure a loan is repaid should catastrophe strike.
Always though, form follows function.
The function of life insurance, and I suppose all other kinds of insurance, is to replace with money, the value of some asset that has been lost to some covered risk. Your house burns down, or you car is destroyed in an accident, or you lose cash because of a product liability problem, money makes you whole again. The connection between loss and claim is fairly clear.
With disability, critical illness, and life insurance the loss is less clear. Many people fail to fully understand the monetary value of their career. It is quite large. Even a minimum wage job supplies more annual income than $800,000 invested in bonds. If someone dies, value is lost and just as a check replaces the value of a lost house and its contents, a check from a life insurer replaces an asset.
For families, life insurance usually replaces the value of a lost asset – income.
In businesses and more complex estates, the insurance creates an asset in a different form. Cash. Liquidity is often important. If an executor owes $5,000,000 for the taxes on the estate value, they will write a check. The check must clear. The harder part is knowing where the deposit will come from. Life insurance is a useful asset to create liquidity and prevent losses from disposing of some complex or hard to sell asset.
Liquidity is a crucial factor in times of trouble. Buying out a problem is often the easiest way to solve it, but only possible if the cash is available.
The function of life insurance is two-fold.
- Replace, with money, the value of a lost asset.
- Create liquid wealth where none exists and thus prevent the sale and loss of value of other estate assets.
Sometimes life insurance can act in concert with an investment portfolio. Life insurance has valuable tax advantages that can make the combination of investment and liquidity solutions more efficient.
Define the problem and its dynamics. Examine solutions in that context. Then the form of the required insurance will be clear.
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario. In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
Please be in touch if I can help you. firstname.lastname@example.org 866-285-7772