Life Insurance: A Bet You Don't Want to Win

When I was a young actuary about 15 years ago, I came to fairly strong opinions about life insurance and said to myself that I would write a book about it someday. Now that I am in my early 40s, I realize I only have enough material for a few articles. So RealMoney readers can gain my insights without having to visit Amazon.com.

The main purpose here is simply to expose a few unique ideas about life insurance to you. This is not meant to be comprehensive but to point out some ways you can best use life insurance to your advantage.

People think they will live forever, despite the impressive track record that death has. Because of that, most people are reluctant to shop for life insurance and will not buy it until an agent convinces them to do so. Life insurance tends to be sold, not bought.

My opinion on life insurance is very different from my opinion on annuities. It is my firm belief that most people are underinsured with life insurance. The critical question is this: Are you leaving enough behind for your dependents to do well without you? This is particularly important to families in which the wife stays home to raise children, and to one-parent families.

In the typical situation, you need five to 10 times your annual salary in life insurance. This is just a rule of thumb; there are a zillion Web resources to help you calculate the amount more exactly. The main question is how much others will miss your continuing economic contribution.

Laying Your Secrets Bare

When a person applies for life insurance, he or she gives up a lot of personal information. This information goes not only to the company but also to the Medical Information Bureau, which stores information on insurance applicants. In some respects, this information works like credit bureau data: If it's wrong, it's hard to change, and it could get misinterpreted by others later. In the same way that taking out multiple credit cards harms your credit score, multiple underwriting can hurt your record at the MIB.

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At time of publication, Merkel and/or his fund was long Prudential, Phoenix, Stancorp Financial and Torchmark and short Mony, though positions may change at any time.

David J. Merkel, CFA, FSA, is a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. Previously, he managed corporate bonds for Dwight Asset Management. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Merkel cannot provide investment advice or recommendations, he welcomes your feedback.