May 31, 2016
The Case Against Whole Life Policies
by Tony Steuer
Forty years ago, whole life insurance made a lot of sense as an investment vehicle. Today, it's as outdated as disco, hula hoops and pet rocks.
One of the longest-running and most heated-discussions is about who is the greatest quarterback of all time. Many will say Joe Montana, but others will go with Tom Brady or Peyton Manning (among others). This discussion depends on your viewpoint and what you feel is valuable. At one time, the common answer may have been Johnny Unitas or Sammy Baugh, but their names don’t even enter the conversation for most of us any more.
Another long-running argument concerns whether whole life or term life is the greater life insurance product. (For the purposes of this article, we are omitting other common types of life insurance, such as universal life, variable life and indexed life.)
My colleague and friend Chris Huntley, founder of Huntley Wealth & Insurance Services, is organizing a movement to promote awareness of term life insurance and some of the downfalls of investing in whole life. The Whole Life Rebellion fits into the Insurance Consumer Bill of Rights, which provides that consumers should purchase policies that match their needs.
Whole life insurance remains a top-seller. In fact, the American Council of Life Insurers estimates that 64% of all policies purchased in the U.S. are whole life.
For the majority of consumers, term life insurance is a better fit. Yet, as with everything, it’s not quite so simple.
See also: Bringing Clarity to Life Insurance
The bottom line is that you need to be able to make that decision on your own, and the key is to become educated. The Insurance Consumer Bill of Rights is designed to provide guidance in knowing what questions to ask and what are reasonable expectations for your insurance agent and insurance company.
Rather than starting with the question of whether whole life or term life is better, consider the following points:
- Do you need life insurance? If you have no need for life insurance, then you have no need for either term life or whole life. We’ll go through the various reasons why whole life is suggested when there is no need for life insurance; just remember that, if you don’t need life insurance, then you don’t need ANY type of life insurance. Some day, I might buy a Porsche, but I’m not going to buy auto insurance on the Porsche until I own it.
- How long do you need the life insurance? This is the classic question that really gets at the heart of the debate. Life insurance is needed when someone is financially dependent on you. Most needs for life insurance are for a finite period, such as providing insurance for the benefit of your children, most of whom will be financially independent by the age of 18 to 25. You may also need insurance to make sure your family can pay the mortgage. Well, most mortgages are for a fixed period and can be matched with term life policies, almost all of which are guaranteed for a certain time.
- Will you outlive your term life insurance? What if the need for life insurance is permanent, let’s say for a spouse? Well, in a situation where there are no other investments available to you or you choose not to participate in them, some type of permanent life insurance may make sense. However, according to the Economic Life Cycle Planning Method developed by Dr. Laurence Kotlikoff, your need for life insurance will diminish as your other assets grow. See my article with Dr. Kotlikoff published in AM Best, “A Different Approach,” or visit Dr. Kotlikoff’s site and learn more about the Economic Security Planner.
- Isn’t it true that only 1% of term life policies pay a claim? Out of all the term life insurance policies issued, only 1% will result in a claim. But how many homeowners’ policies pay out? Most people are happy if their home doesn’t burn down, and they don’t have to file a claim. Keep in mind that, while great statistics for whole life aren’t available because insurers consider the information proprietary, estimates are that 15% to 20% of whole life insurance policies result in a claim. One of the big reasons that so few whole life policies result in a claim is that many owners let them lapse every year. A joint study by the Society of Actuaries (SOA) and the Life Insurance Marketing Research Association (LIMRA) on 2007 to 2009 found that, in year one, 7% to 9% of whole life policies lapsed; in year two, 6% to 7% lapsed; and in year three, 5% to 6% lapsed. You can find the study by clicking here.
- What if you have someone who will always financially depend on you or have some other permanent need? Is this finally a reason to have whole life? Well, almost. However, something called guaranteed universal life insurance acts as a term life insurance policy up to age 120 and does not build cash value. The premium is lower than a whole life policy. And of what benefit is a cash value if you intend to keep the policy in-force for the rest of your life? A primary rule in investing is lowering expenses when looking at two similar financial vehicles.
- Can you buy term insurance and invest the difference? That doesn’t work. With whole life insurance, there are very high surrender charges in the first few years of a policy, so when a policy lapses before the fourth or fifth year, the policy owner may only recoup 10% to 20% of the premiums paid. The question should really be, Will you still want to and be able to pay the premiums for a whole life policy?
- Doesn’t whole life allow for tax-deferred cash accumulation? Yes, completely true. And so do 401(k)s, IRAs, etc. In these retirement accounts, you can have a wide variety of investments such as exchange traded funds with expense ratios of less than 1% per year. By contrast, whole life is a black box when it comes to quantifying expense. Costs and expenses are not fully disclosed and are at the discretion of the insurance company. And then, of course, there’s the fact that there’s no guarantee that the tax treatment for whole life insurance will continue. Almost every year, the U.S. Senate and House of Representatives discuss the cash value component of permanent life insurance and note that taxation of this “inside buildup” could yield $300 billion over 10 years. Hmmm, with a growing national debt….
- Whole life allows me to borrow from my policy: The key here is you are borrowing your own money, which you could do from many other vehicles such as a 401(k). And borrowing from your whole life policy may incur an interest rate that’s higher than interest rates on other types of loans and will also reduce the internal cash value build-up on your life insurance policy. Isn’t this the same as not investing the difference? And if you borrow too much money from your whole life policy, it can lapse without any value AND cause a phantom income tax gain. (See my A.M. Best article on the Pitfalls of Policy Loans.)
Consider that the CEO of Northwestern Mutual, John Schlifske, recently stated that face-to-face meetings are the best way to sell life insurance. Why face-to-face? The key word here is “sell.”
What if the goal was to help consumers make the choice that works for them? Yes, it’s a subtle difference, but the tone of the conversation needs to be changed.
If the only tool you have is a hammer, then every problem is a nail. If the only type of product your insurance agent has is a whole life policy, then every planning issue will be solved by whole life.
See also: What’s Next for Life Insurance Industry?
Having an efficient plan for your insurance and for your finances overall removes the need for whole life. Forty or more years ago, whole life insurance made a lot of sense, especially as it was pretty much the only type of life insurance sold. But this was before the average consumer had easy access to the stock market through discount brokers, mutual funds and other modern ways to invest.
So, yes, using whole life insurance as a savings vehicle did make sense a long time ago — just like disco, hula hoops, pet rocks and Rubik’s cubes were hot items at one time.
In today’s financial world, where there are many different types of life insurance and consumers have access to a wide variety of investment options, it does seem like the time for whole life has passed us by.
But the decision is yours. Knowledge is power. Become educated and use the Insurance Consumer Bill of Rights to guide you and your insurance portfolio.