Recently a client and good friend of mine sent me the below article from
SmartMoney.com. The premise of the article was that term life insurance was
always the way to go and that whole life insurance was terrible. Below is my
response to the article.
B. Chase Chandler
Patrick, thanks for sending me this article. See my analysis and
logic below in red. First let me say that this is an interesting subject. The entire
basis of my new firm is to teach people, mainly physicians, professionals and
business owners, what’s right and what’s working most efficiently. We are
extremely focused on evidenced based financial planning. If the math can’t back
it up as being the most efficient strategy we don’t use it. One reason for being
independent is so that if we are teaching something that is wrong we can change
it. I’m sure whoever told you the negative facts about whole life insurance had
reasons for telling you that. I addressed why I believe he or she is wrong
below… but I also believe that they probably have good reason for saying what
they said. Much of what has been sold over the past few decades has been
done so in a high-commission fashion. Many people get out there and spout off
all the great facts about it, then conveniently leave out the pitfalls. Any strategy
has pitfalls. It’s also good that you read an article like this before you ever put a
lot of money into the product. I encourage people to know the ends and outs.
So many people have so many opinions that it’s hard to sort through all of them.
Since I’ve engaged in all this research about “what’s best” and started our
independent firm I’ve only become more convicted that properly structured
whole/cash-value life insurance is the best place to put money (not universal life
Also, the commission we take is very low. This notion that agents make
ridiculously high commissions is only half true. Some do, some don’t. What
good independent advisors do is lower the commissions by about 70%. I explain
how this benefits you so much below.
Hope these answers help!
APRIL 5, 2012, 4:29 P.M. ET
Whole Life Insurance or
We'll give you a hint: The one you want begins with a "T." Here's why it makes
sense for most people.
The right type of life insurance can be summed up in a single word: term.
Completely untrue. I very much dislike blanket statements. There’s actually no
arbitrary right or wrong answer. The right answer relates to the context of what
you’re trying to accomplish within your plan. But before we explain why, it's
important to understand the differences between the most common types of
insurance available. Our glossary can help with that, and decipher some of the
more common insurance lingo.
The basic difference between term and whole life insurance is this: A term policy
is life coverage only. On the death of the insured it pays the face amount of the
policy to the named beneficiary. You can buy term for periods of one year to 30
years. Whole life insurance, on the other hand, combines a term policy with an
investment component. The investment could be in bonds and money-market
instruments or stocks. The investment is actually the insurance company’s
General Portfolio. The government requires these companies to keep 80-85% in
fixed income assets; i.e. corporate bonds, government bonds, treasuries, etc.
15-20% of the portfolio is generally invested in equities and equity like assets.
What does that mean? The 15-20% is the insurance company’s more
“aggressive” money. Let’s say the company’s general portfolio is $50 billion.
$7.5 billion (15%) would be their aggressive portion and with that $7.5 billion they
would look for opportunities to make as much money as they can. Example:
Recently a company we deal with bought a building in Seattle, WA from a
company that was going out of business. Since the company was going out of
business all they were worried about was selling the skyscraper building as fast
as possible; it was a fire sale. The construction cost of the building was $500
million and it was built in 2006. This insurance company bought the building, as
the highest cash bidder, for $160 million in 2009. They then turned around and
sold the building in 2011 for $450 million. That’s a great rate of return. But here
are the two main points – first, you and I and all of my clients combined cannot
pull of the same type of deal. We don’t have the resources. The second point –
when you have a policy with a mutual company, you literally own that company.
You are a shareholder. You get the profits of the company. So the insurance
company is pooling all of the policyholder’s money and creating a greater, safer
return for each of them. We get to tag along with what the insurance company
can do with $50 billion at work oriented to safety first and extreme diversification.
The policy builds cash value that you can borrow against. The three most
common types of whole life insurance are traditional whole life policies, universal
and variable. We do not use universal or variable life insurance, as it does not
provide the same safety as whole/cash-value life insurance. With both whole life
and term, you can lock in the same monthly payment over the life of the policy.
(Read more on how to buy a life insurance policy or determine how much life
insurance you will need.) Whole life stays in force for your WHOLE LIFE, hence
the name. Term insurance terminates after a certain TERM of time. Cash-value
aside, provided you pay the premiums the whole life policy will be around forever.
Term will terminate after 10, 20 or 30 years depending on what you decide to
buy. 10 year term is cheapest, then 20, then 30.
Whole life insurance is expensive: You're paying not only for insurance but also
for the investment portion. This statement is very much out of context. Whole life
insurance is an asset on your balance sheet. Most people have no clue,
especially these writers, how this actually works. The insurance and the cash-
value are technically and legally one. The cash-value is an advance of the death
benefit. Because you’re buying “whole life” coverage you’re also buying the right
to use much of your death benefit while you’re still alive. The cash value and the
death benefit must be the same buy age 121, that’s when the policy “matures.” If
you’re alive then you get a check for the death benefit/cash value – they are the
same! Sometimes people will say “well if you die they don’t even give you the
cash value. They just give you the death benefit.” That’s not a logical argument.
That extra cost might almost be worth it if these policies were a good investment
vehicle. But usually they aren't. Philosophical issue – it is not an investment
vehicle. It is a savings vehicle. I’m going to sound like a broken record on this –
when the policy is structured correctly you have immediate access to the majority
of your cash. At year three you begin seeing gains in what you’re putting in. It’s
liquid and very safe. What other assets are like that? Savings/money market
accounts – that’s it. That’s one of the greatest benefits of whole life, other than
the permanent death benefit; you always have access to the cash. When you
need money, it’s right there. You don’t have to go raid your IRA and pay 10% in
penalties plus taxes. Insurance agents like to call these policies retirement
plans, emphasizing the "forced savings" inherent in forking over the premiums
each month "for retirement."
Leaving aside the fact that there are many better ways to save for retirement,
these policies come with high fees and commissions, which sometimes lop off as
much as three percentage points from the annual return. I would say that there
is not a tenured whole life policy out there that has more than a 2% fee. The
policies we set up have less than 0.7% lifetime annual fees on the policy, quote
me on that. On top of that, there are up-front (but hidden) commissions that are
typically 100% of your first year's premium. Worse, it's often impossible to tell
what the return on the investment will be, and how much of what you pay in goes
toward the insurance and how much toward the investment. Both of the previous
sentences are blatantly untrue. We can easily calculate what the return on
investment will be – but what’s important is to calculate a comparison the asset
vs. mutual funds over 30-50 years. Life insurance wins and I’ll show you why.
Side note: Many of the issues raised so far have become conventional wisdom
be way of multiplication. Logically they don’t make sense.
Premiums for term insurance are downright cheap for people in good health up to
about age 50. After that age, premiums start to get progressively more
expensive. The same holds true for whole life policies, though people who need
coverage starting in their 60s and beyond may have no alternative but to buy
whole life. Most companies simply won't sell term policies to people over about
age 65. I really don’t know where this writer is getting this information. Virtually
every company sells term policies up to 70 or 75. The question is if the person
can qualify. Think about it this way – the insurance company says “We’re going
to put this 65 year old through a stringent health underwriting test. If they pass
we’ll give them the 10 year term insurance. Oh yeah, if they pass the test that
means they’re probably going to live to age 95! So this person is going to pay
out the preverbal wazoo for 10 years. Then, unless they get hit by a truck, we
get to keep the money forever.”
A few years ago I got a call from a 62 year old college professor. He was a big
Dave Ramsey fan and had always bought term insurance. Now he was 62 and
his 20 year term that his bought at 43 was expiring. But he still needed
insurance because he didn’t have near enough in his retirement account to stop
working and his wife had stayed at home since for over 30 years. So I gave him
a term quote - $15,000/yr for $1,000,000 of 10 year term. He qualified. That’s
$150,000 over 10 years and when he doesn’t die it’s $150,000 that he doesn’t
have. This professors response – “I wish I would have known how this worked
20 years ago.” Needless to say, he is no longer a Dave Ramsey fan. Term
insurance certainly has a place in financial planning. But the most efficient use
for term is only while you’re young and have a large insurable need without much
cash flow, like in residency.
To get a real sense of the value of term, let's compare a term policy and a
universal life policy. I do not like universal life. Ask me later. Say a 40-year-old
nonsmoking male has a choice between a $250,000 Met Life universal policy
with a $3,000 annual premium and a same amount of renewable term coverage
with a 20-year fixed premium of $350. Met Life is publicly traded. We do not use
public companies. At the end of one year, the universal policy, assuming it paid
5.7% per year, tax-deferred, would have a cash value of exactly zero (cash value
is the amount you would get back if you canceled the policy). But say he had
instead invested $2,650 (the difference between $3,000 and $350) in a no-load
mutual fund that averaged a total return of 10% annually. 10% annually? This is
very high. When you read my book, focus on chapter 3. The market has never
returned 10% annually, except for the short-lived period from 1980-1999. If you
take out that time period the annual return of the market is 3-4% after taxes!
(Again, quote me.) The 401(k) was instituted by congress in 1980. Previous to
1980 there were no arbitrary stock market vehicles where Americans could
blindly throw money. Before 1980 most Americans kept their money in cash,
CD’s, cash-value life insurance, gold and they may have had a few stocks here
and there. Then in 1980 things changed. So from 1980-1999 the stock market
became wildly overvalued because you had virtually every working man and
woman’s life saving being thrown into it via the 401(k) platform. Now, in 2012,
analysts say that we’re in a new normal. No more 10-12% annual returns. They
predict 5-6% annual returns, before taxes or fees. But it’s really not a new
normal; it’s an old normal. A pre-1980 normal. From a financial planning
perspective we have a major problem – Dave Ramsey, Suze Orman, physicians
and professionals over 40 and many of our parents were in their prime in the 80’s
and 90’s. So what do they remember – extreme periods of market growth like
we’ve never seen before. Many of these people, including some of my family
members, have not studied the history of how markets have actually performed.
And many times they’re the ones giving us advice. At the end of the first year,
he'd have $2,841, accounting for taxes on the earnings at a 28% rate. At the end
of 10 years, he would have accumulated more than $46,000 in after-tax savings
in the mutual fund. Over the same period, the cash value of the policy would
have climbed only to $31,819. The writer is using universal life, which is a
terrible example. But even so, any life insurance policy is a long-term tool. This
is like comparing the tortoise and the hare. When our research group ran 10
different analyses of actual market performances, excluding 1980-1999, against
whole life performances (not universal life) the cash value life insurance won
every time over a 40-50 year period.
That's not to say that whole life insurance is always a bad idea. Wealthy people
can use whole life in their estate planning by setting up an insurance trust that
will pay their estate taxes from the proceeds of the policy. This is a good point
and important for physicians who may likely have an estate tax problem. I
cannot find the author of this article on the site. Maybe I’m overlooking it but I’m
guessing he or she is getting their information from a conglomeration of other
articles. Many estate planning articles strongly advocate whole life. And for the
growing number of people in their late 40s or early 50s who are just starting
families, whole life is at least worth a look.
One of the great problems with whole life is only an expert can tell if a policy you
own or are considering will ever become a decent investment. James Hunt,
actuary for the Consumer Federation of America, who has analyzed thousands of
policies, notes that whole life policies hardly ever yield a reasonable return
unless held for 20 years or more. So if you buy one be prepared to pay into it for
the very long haul. James is actually a good guy and I’ve talked to him a few
times. He actually owns and puts quite a bit of money into a ‘properly structured’
whole life policy. You can send him an illustration of the type of policy you’re
looking at and he can tell you if the agent has your best interest in heart – i.e. if
they’re reducing their commissions and enhancing the efficiency of your policy. I
believe it cost about $50. Note that he said “a reasonable rate of return unless
held for 20 years or more.” That’s a big point. We’re planning for long-term
goals right? If we agree with that then we can compare it over 20, 30 or 50
years. The math points to properly structured whole life with a mutual company,
The key to a whole life policy is its internal rate of return -- the yield on the policy
after all fees and charges are subtracted. A competent analysis can determine at
a minimum whether the weight of the fees and charges built into one of these
policies will ever allow a worthwhile return. I would assume some of us who
advocate this are competent; i.e. Steve Forbes, Walt Disney, Donald Trump,
Robert Kiyosaki, Kim Butler, etc. “It’s important to put money in an asset like
permanent life insurance that goes up regardless of what the market is doing.” -
Steve Forbes. Such an analysis will also pinpoint the minimum amount of cash
value that you can derive from a policy at any given time interval.
You've been faithfully paying into that whole life policy a good pal of your brother-
in-law sold you 10 years ago. And now you're thinking, "Hey wait a minute, I
should be bailing out and getting a cheap term policy." Not so fast. First and
foremost, keep in mind the substantial sum you've probably paid in over the
years. How much will you get if you "surrender" or cash it in now? The answer to
that question can be found in the illustrations you got when you signed on the
dotted line. If you can't determine the surrender value you may have to -- heaven
forbid -- call your agent and ask. But it's worth taking the trouble before you make
a decision. Login to your online account and take a look.
Most policies don't start to build decent a cash value until their 12th or 15th year.
This is utterly untrue. Again, with a “properly structured” policy you will start to
see growth in the SECOND or THIRD year. That is, in the third year, you put in
$10,000 and it grows by $11,000 in that year. Proof: Look at actually clients in-
force illustrations, what’s actually happening. In-force illustrations are not
projections, not what might happen – what has already happened and cannot be
taken away. So if you cash in after 10 years, you could be out of a lot of money.
And you can be sure that if you surrender in the first five years or so, practically
every dime you put in will be down the toilet. Not true. The next thing you have
to consider is whether you are still insurable at a reasonable rate if you switch to
term. That's because you'll have to requalify medically. If you are over 50, smoke
or have health problems, you may find it's cheaper to hold onto your old policy.
Another option worth considering is a tax-free transfer of the value in your old
policy into a better one, perhaps from a low-commission company like Ameritas.
That’s interesting, my firm uses Ameritas very often. Many of you reading this
may have disability or life insurance with Ameritas. They’re good but we also use
other companies who are just as good. I’m still not sure were this writer got their
If you're looking for whole life coverage or a term policy that you'll want to keep
20 or 30 years, the financial soundness of the insurer is a critical concern. You
want some assurance the company will be around in case you aren't. For
insurance companies, the major credit agencies like Standard & Poor's rate
claims-paying ability. Agreed.
Fortunately, information on the credit worthiness of insurance companies is easy
to obtain. Reports are cheap or free over the Internet. You can always contact
the insurance company and ask about its ratings, but it's best to get this
information independently. In general, go with an insurer rated A or better; the
most financially sound insurers are rated AAA, though some rating agencies use
slightly different letter grades.
The premier Web site in terms of detail and ease of use, (best of all, it's free) is
insure.com where you can get ratings online from Standard & Poor's as well
comprehensive reports on individual insurers. AM Best has a huge database, but
you have to pay for it. While you can access ratings free of charge, a detailed
company report will set you back $75.
Make sure any report you get is current, say within the last six months. Be extra
careful to confirm ratings you'll find on many of the online quote services, which
may be stale.
Here are a number of other articles from major publications with a different view
of whole life insurance: