Life Insurance: Who Really Needs It...and Who Really Doesn't

A type of marketing mailout I've been getting a lot lately involves pitches for life insurance policies for little children.

The offer is simple. Insure a small child now and you'll "lock in" an incredibly low premium for the child's entire life. This is a seductive idea, especially for grandparents who are struggling to pay ever-increasing life insurance premiums themselves. Little Susie or Billy will still be paying $15 a month for life insurance when they're eighty! What fond grandma or grandpa wouldn't be thrilled with the idea of such a deal for their darling grandkids.

Often such pitches also point out that if your child dies, you'll have money for funeral expenses. Who can object to that?

Well, I can. Let's take a little closer look at these great deals.

The purpose of life insurance is to make sure a death in the family doesn't create a financial disaster for the survivors. When a breadwinner dies, that income disappears. Immediately, the family can be in serious financial trouble, especially if they have little or nothing in savings. Without money to pay the rent or the mortgage, money for utilties and food, such a family can literally be homeless in a matter of a few months. Even a family where both parents work can face a financial crises if one of the parents dies and the household income drastically drops. If it's a stay-at-home parent who dies, the family will still need money for house cleaning, child care and the hundreds of other services that parent provided.

In such cases, a generous life insurance payout can keep a family's financial situation stable for years. Even a relatively modest amount can give the family enough time to adapt: time to move to a smaller home, for example, or time for the surviving parent to learn a skill and obtain a job.

But children do not provide income or services, and when they die, the family isn't faced with a financial crises. I can't imagine anything more emotionally devastating than the death of a child, but in pure financial terms, it's rarely a disaster. And though it might be an effort, most families can find the money to pay for a child's funeral, either by dipping into savings or taking out a short term loan.

So there's little or no actual financial need to buy a life insurance policy for a child.

What about locking in that low, low premium rate? Or the fact (claim the mailouts) that the benefit can never be canceled or reduced due to changes in the child's age or health. Isn't that a good deal?

First of all, let's actually check those low, low rates. I looked at a major company providing such insurance and, using the example of a 3-year old little girl living in Texas, was quoted a rate of $15.25 a month for $25,000 worth of insurance.

What's wrong with that?

First, this hypothetical child won't have a family to protect for at least 15 years. (No underage child brides in this article, thank you very much!) So a parent or grandparent would pay $2,745 in insurance premiums before insurance was even necessary.

Second, $25,000 worth of insurance may sound like a lot, but it's actually a small amount to act as a safety net for a family, especially if you factor in cost-of-living increases for the next 15 years. If Amy (let's give her a name) gets killed in a car accident twenty years from now, $25,000 may only be enough to last her family a few months. So eventually she'll need to buy more life insurance....and I guarantee you she won't get the additional coverage at that highly-touted low, low monthly rate.

Third, how does one even know that an insurance company will be around in fifteen years?Insurance companies, like any other company, can get into financial trouble or even go bankrupt. (Check the recent history of insurance giant AIG.) Although there are usually safeguards in place to make sure policy holders' claims are paid, there are no guarantees that Amy's super special lifetime rate of $15.25 wouldn't change if another company took over the policy.

Fourth, such policies are almost always whole life policies, and premiums for whole life policies are traditionally much, much higher than term life insurance premiums. (For an brief explaination of the difference between whole life and term, check here.)

Example? I decided to get some idea of how much term life insurance $15.25 a month would buy, so I checked Met Life's online sample quotes.Everything will vary, of course, for any specific situtation, but I still got quite a shock.

Assuming both 3 year old Amy and 30 year old Amy are in good health, here's what they can buy for less than $16 per month.

For 3 year old Amy, $15.25 a month will buy $25,000 worth of insurance.
For 30 year old Amy, $12 a month will buy $250,000 worth of insurance.

Ten times as much. Is that pitch for insuring your kids or grandkids sounding quite as good now?

But, Cathy, you say, what if Amy gets sick between the ages of 3 and 18? With the whole life policy, she still gets those low rates. (It says so right in the mailout.) With the term life policy....who knows?

Here's where we get to the crux of the matter.

Most of us have a limited amount of money to spend on insurance of all kinds: life, health, auto, home. The financial well-being of our families depends on how well we allocate what we can afford to spend.

So, if Amy gets seriously ill between the ages of 3 and 18, it's going to do her a lot more good if her family has spend a little more money on health insurance for her, rather than buying a life insurance policy that she doesn't actually need. Even if her parents get basic health insurance through work, the relatively small cost for supplmental health insurance might be a much better buy.

And if Mom and Dad are struggling to buy enough life insurance for themselves, it might make much more sense to spend that $15.25 a month to help them afford more. Remember, buying a life insurance policy for Amy benefits her dependents, not her. Doesn't it make more sense to spend your money to protect Amy herself while she's growing up?

Don't just accept the word of an insurance company marketing mailout that whole life insurance for a child is a great idea. And don't believe every promise you read in such pitches, including the claim that there are no conditions whatever that could cause that premium to increase. (Always, always, always check the fine print of the actual policy before you agree to buy.)

Also, keep in mind that when Amy is 80, she won't need much life insurance. Her kids won't be dependent on her any more, her house will likely be paid off, and she and her spouse may have savings or investments to supplement any retirement income. (Besides, in 2086 when she's eighty, how much will $25,000 actually be worth?)

Check and compare premiums, and know the pros and cons of different types of insurance before you buy. And remember.... spend your money to protect your kids and grandkids when they're children. Let them make their own insurance decisions when they're grown.