Question

In: Finance

Malcolm and Ainsley Weaver are a dual-career couple who just had their first child. Malcolm, age...

Malcolm and Ainsley Weaver are a dual-career couple who just had their first child. Malcolm, age 30, already has a group life insurance policy, but Ainsley’s employer does not offer a life insurance benefit. A financial planner is recommending that the 27-year-old Ainsley buy a $250,000 whole life policy with an annual premium of $1,670 (assumed rate of earnings of 5% a year). Help Ainsley evaluate this advice and decide on appropriate course of action.  

Solutions

Expert Solution

In a whole life insurance, there is a contract whichinvolves payment of premiums at regular intervals that alsoincludes the insurance and the investment component in it.

The component involving the insurance part is used for paying adetermined amount upon the death of the insurer. While thecomponent earmarked for investment continues to build andaccumulate a cash value which the insured person can use to borrowor even withdraw.

A whole life insurance product is basically a combination ofinsurance (risk management) and investment product. However thistype of combination often results in suboptimal returns.

In fact on the contrary if a person opts for a pure terminsurance policy which would only pay a determined amount upon thedeath of an individual, the premium charged would be much lower.The difference between the two premiums can be used by the personto invest in financial products such as bonds, stocks, real estateetc. The returns earned are higher as the intermediary cost of theinsurance company, as the case for whole life insurance, are notincurred.

So in this particular case, we don’t agree with the consultantwho suggested a whole life police for $250,000 for Ainsley. Insteadour recommendation is to opt for a pure term insurance policy andinvest the balance between the premiums of the two policy in mutualfunds, stocks and bonds to get a superior return.



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