Whole Life Insurance For A Child?

Whole Life Insurance For A Child?

Sep 19, 2012

Question: At what age can a child start having whole life insurance, assuming that the child already has a steady source of income? – Carlo via email

Answer: Hi Carlo. I wonder how old the child is? And what are you trying to insure? Since you said that the child has a steady source of income, is he the bread winner of the family?

The main reason why we buy insurance is for protection. We buy a car or home insurance to protect our properties from theft or damage. The benefit we get from our insurance is what we use to replace the loss or to repair the damage of the property. We buy life insurance to protect our dependents financially in the case of untimely death or disability, especially for a bread winner. The main idea here is we want our dependents to more or less have the same standard of living with the help of the cash benefits paid out by the insurance company.

So life insurance is a product that should be purchased by someone with dependents. Does the child in your question have dependents? There are two general kinds of life insurance. Term Insurance and Whole Life Insurance.

Here’s the difference between the two: A term policy provides life coverage only. On the death of the insured it pays the face amount of the policy to the beneficiary. On the other hand, a whole life insurance combines a term policy with an investment component. So on top of the death benefit, you also get proceeds from the investment component. But the latter comes with a price.

Term life insurance is the cheapest kind of protection because of the low probability of claims. In other words, it’s cheaper to “produce” this product; hence, it can be passed on to its customers at a lower price.

Whole life insurance is expensive because you are also paying for the investment component. Your friendly insurance agent calls this the retirement or the forced savings portion. However, the more cost efficient way to do this is to separate the two. Buy your term insurance and then buy your own financial instrument for your retirement. Studies show that you are better off buying term life insurance and then investing the difference in the cost of whole life vs. term insurance yourself. Of course, the operative words here are you will invest the difference.

Here’s why it’s more cost efficient. We know that the big cost of insurance policies is the agent’s commission. It’s 50% of the premium paid in its initial year and goes down in subsequent years. If you split the two, you will avoid the hefty commission on the investment component. You may also want to check the terms and conditions of the whole life insurance. What happens when you go on default on your premium payments? Will you also forfeit the investment portion of your policy? Usually, this depends on the amount of cash you have accumulated in your policy. An insurance should be current (all payments are made on time) for it to be in full force.

If you look at the history of life insurance, all insurance products used to be term. But there was a clamor from policyholders who became upset with the thought that after paying their premiums for 20 to 30 years they have nothing tangible in terms of cash accumulation. Take note that insurable age is usually up to 85. So if you’re lucky to live beyond that, you may feel that you don’t have anything to show for all those decades of payments. So insurance companies came up with products with cash values, against which the insured can even borrow.

A good analogy is buying something from a store and here comes your friendly salesman offering you a lot of add-ons and rattling off to you how you can save by buying all these other things together with your main purchase. The question is, “Do you really need the other stuff?” And even if you do, is this the right store for you to buy those other stuff? Are you really getting a good deal?

Most of the time it boils down to relationships. And most of the time insurance agents beat bank employees in their charm in convincing consumers to buy their products. We like personal touches. The insurance agent can come up with a product or set of products specifically for you. They will come and pick up your payments and so on.

Going back to the child in your question, what does he really need? Does he already have dependents this early that he needs to buy a life insurance? If the concern is to put away his earnings for his future, then maybe he should consider other financial instruments such as fixed income and equity investments. Determine his risk appetite. Generally, the younger you are, the higher your risk appetite which means you can afford to hold on to higher yielding instruments.

There are a lot of options to choose from but my favorite recommendation, especially for those who have yet to start their wealth building, is the Easy Investment Plan wherein all you have to do is a one-time enrollment of your account. You fill up a form to indicate what instrument you want to invest in (fixed income fund, equity fund, balanced fund which is a combination of the two, peso or dollar, etc.), how much, and on what day(s) of the month. That’s it, one time only and your contributions regularly become part of a big pool of funds managed by professionals. And this service you can avail of for as low as P1,000 per month (this minimum is true for BDO). This ensures two important factors in wealth accumulation – regular and automatic. No more excuses of forgetting, not having the time to go to the bank, having to spend for something this month, etc.

Again, ask the question, “What financial product(s) does this child really need?”

I hope the above gave you valuable insights in your decision-making on what financial products to buy.

Wishing you financial happiness,