Does He Look Like He Needs Life Insurance?
Pitches for juvenile life insurance tug at the heart, but the policies don't deliver
(MONEY Magazine) – Perhaps you've seen the TV commercials, designed to melt any new parent's heart. One features a montage of three-hankie moments--bringing baby home, the tyke's first steps, Little League, college graduation, wedding day. In another, a young mother holding her tot says, "Is your child protected for the future? Gerber, the baby people you've known since you were a baby, offers you a way to help with that protection."
The product? Life insurance for kids. The mom in the Gerber ad explains, "It's a $5,000 cash-value insurance program that costs less than 11¢ a day.... Any healthy child 12 or under is eligible. No medical exam necessary...." Sounds like a small price to pay to protect your little one's future. And Gerber isn't the only big company pushing juvenile life; others include State Farm, Northwestern Mutual and AXA. Nearly 2 million policies were sold last year, up from 1.75 million five years ago.
Too bad. Fact is, almost all of those policies were a waste of the purchaser's money. "If you examine the various features of policies sold to cover kids," says Jim Hunt, life insurance actuary for the Consumer Federation of America, "none of them really make much sense. We think people ought to stay away from juvenile life insurance." The features Hunt is referring to are generally threefold: In the typical policy there's a death benefit, a guarantee of future insurability and a cash value.
What Is a Child's Life Worth?
Let's start with the death benefit. Parents buy juvenile life insurance, at least in part, to be prepared for the unthinkable. Policies are available for children ranging in age from two weeks to 18 years. (Because of increased mortality risk, insurers won't write policies on newborns.) Should a child die, the policies provide a cash payment that can be used to cover a funeral or unpaid medical bills. According to LIMRA, an insurance and financial services research association, premiums average $213 a year and policies offer an average death benefit of $35,310. (Gerber's Grow-Up Plan, featured in the ad, pays $5,000 to age 21 and $10,000 thereafter, as long as the policy is continued. The initial premium of 11¢ a day works out to $40 annually.)
Granted, even $213 a year is small potatoes. But the chance that a child age 18 or under will die is smaller still: An average of one in 3,000, according to actuarial tables used by the life insurance industry itself. For this reason, many experts urge parents to increase their own coverage instead, particularly because heads of household tend to be underinsured. For a healthy 40-year-old male, that same $213 buys roughly $150,000 in (20-year) term life, a policy that covers a set period for a fixed cost.
"First things first," comments Scott Simmonds, an independent insurance consultant in Portland, Maine. "There's a far greater chance a breadwinner will die, and that's way more financially crippling for a family."
A little-known fact is that most adult life policies also offer something called a child rider. These cost roughly $60 a year and provide a death benefit of roughly $10,000, enough to cover funeral and burial costs, now averaging around $9,000. Moreover, that one $60 premium usually covers every child in the family. By comparison, to cover three kids with juvenile life, a family would have to buy three separate policies, costing upwards of $600 in annual premiums. (We're not saying you need a child rider. You could apply the $60 to some other expense, or save the money. But it does make more sense than the juvenile life death benefit.)
A Guarantee Seldom Needed
The second touted selling point--guaranteed future insurability--also crumbles under scrutiny. Take out a policy when your kids are young, goes the sales line, and if in the future they develop a chronic illness, they won't face the possibility of being denied life insurance. The reason is that a juvenile policy can be carried over into adulthood.
But buying a policy to guarantee future insurability involves placing a series of unwise wagers, according to critics. "You're buying insurance on an infant to guard against unlikelihoods that are years in the future," says Mark LaSpisa, a South Barrington, Ill. financial planner. "Who knows what advances medicine will make over that time? Who knows what the insurance climate will be?"
Even today, says the American Council of Life Insurers, 98% of people who want a policy can find one. A combination of health-care advances and sharper actuarial models has led companies to extend coverage to people with certain cancers or other conditions who would have been uninsurable a few years ago.
Another reason not to worry about insurability is that many employers offer group term life insurance as a standard benefit. Usually these policies are worth either one or two times an employee's annual salary. Because no medical tests are required to qualify for group term life, this kind of insurance is available even to people with serious health problems.
Why Savings Don't Add Up
Finally, there's the savings component--enticing because it requires no extra effort on the part of young parents short on investment know-how and spare time.
Here's how it works: The company sets aside as savings an unspecified portion of the premiums you put in. If the company has a bad year, incurring a high number of payouts, the money set aside will likely be smaller. There's no way to predict that going in. Nor do you have any say over how your money is invested. When you buy, the company guarantees you a minimum cash value after a set number of years. It may provide a more optimistic projection as well. You can borrow against the accumulated value at any time and pay back the loan with interest. Or you can simply withdraw the money; any gains are taxed as regular income.
The problem is that the agent's commissions and administrative costs, many of which are assessed during the early years of a policy, drain value before a penny is invested. And the returns on the remaining investment portion are pathetically low. Assuming an annual premium of $213, you will have paid $3,834 by the time the child turns 18. Yet juvenile policies rarely accumulate a cash value of more than a couple thousand dollars over that time.
"This is a horrible way to save for college," says Byron Udell, CEO of online insurance broker AccuQuote.
A better plan would be to insure the breadwinners to the max. Save for college with mutual funds or tax-deferred investments that can really grow. And make your own video of happy three-hankie moments.
What They Tout, What to Doubt
Sellers of juvenile life insurance promote their policies' three key features. But on closer inspection each of the claimed advantages looks a bit wobbly.