The principle behind life insurance is simple, in theory. It’s also morbid, at least compared to other financial services. You pay small amounts at monthly intervals, so that when you die, a beneficiary of your choice gets a sum of money approximating what you would have earned had you stayed alive.

That’s the stark truth right there, which a lot of life insurance customers fail to comprehend: the service is supposed to be nothing more than a replacement plan. The idea is that should your family suffer a crisis that transcends finances, at least their finances won’t be impacted too negatively. If you die, your spouse and kids won’t have to take on multiple jobs, beg for alms, nor lose the house and car.

Hedging Your Bets

It’s important to remember that life insurance isn’t really “insurance” in the dictionary sense. When you buy life insurance, you’re not “insuring” anything. No matter how much money you give them, Ameriprise can’t keep you from dying. No, life insurance is more about hedging your bets than anything else. While you’d prefer to live, if fate has an alternate plan, then you can spend money now to help your family avoid multiple catastrophes later.

But as a result of it being called insurance, there’s an overly conservative type of person who believes that if “coverage” of some kind is good, then more coverage must be better. Buying life insurance thus becomes a test of one’s capacity as a responsible adult and breadwinner. What kind of person doesn’t want to protect their loved ones? To that end, some people insure anything that moves–even their children.

Sounds great in principle, until you remember that kids don’t earn any money. Or at least not any money that’d be difficult to replace. Which reinforces the morbidity of life insurance: losing a child is such a colossal tragedy that if there’s any eventuality that needs to be prepared for, it’s that. Some parents argue that they couldn’t function after the death of a child, and thus a policy on said child helps them sleep at night. But if you claim you’re not going to be able to function anyway, why not keep the money you’d have otherwise spent on life insurance for someone who barely earns any income?

The same goes for older relatives. Both the healthy and infirm have a decreasing amount of time remaining, and the less healthy an older relative is, the smaller the death benefit you’ll receive for a policy of similar premium size. Add retirees’ limited income (regardless of how substantial their net worth may be), and much of the time, senior insurance seems like an unwise move.

How Much You’ll Get

Stay alive, and a standard term life insurance plan has zero return. Start a 20-year term policy today, and if you don’t die by 2040, you’ll have received nothing. That’s not a bug of life insurance design, but a feature. After all, throughout the policy’s term you’re getting whatever peace of mind comes with knowing that your death won’t impoverish your family. Most policyholders understand this and appreciate that life insurance isn’t intended to be an “investment” in the conventional sense.

Other insurance customers are uncomfortable with the idea of sending a long series of fixed payments to a financial services firm with the possibility that they’ll never see any potential payouts for it. Rather than accept life insurance for what it is—again, a replacement plan—these customers want some sort of return. Thus the industry devised whole life insurance and universal life insurance, two variants on term life insurance that each offer a cash value beyond the standard life insurance death benefit. You pay a little more each month than you would with a term policy and the difference builds and can be redeemed at your convenience.

Purchasing policies more complex than a term life insurance policy could make economic sense if the cash value increases quickly enough. But investing and insuring are two different and usually incongruent goals. There are surer and more direct ways to invest, beyond enhancing one’s insurance policy with a form of annuity. A combination protection plan/investment plan is like a combination toothbrush/nail file, assuming such a thing exists. The hybrid probably isn’t going to perform either task as well as the disparate products it aims to replace.

The Bottom Line

This isn’t a jeremiad against life insurance in principle. If you’ve got sufficient income, a risky enough likelihood of staying alive (which a prudent insurer will take note of and charge a correspondingly higher premium for), and enough dependents with little earning power among them, a term policy isn’t necessarily a poor way to spend your money. Just remember that investing is deferring spending in hopes of a financial gain. Insuring is spending now in hopes of avoiding financial loss. In that respect, the two activities are almost opposites. An insurance policy that masquerades as an investment is rarely going to be your best option for accomplishing the conflicting goals of maximizing return while minimizing risk.