Think Your Whole Life Premium is Guaranteed? Think Again!

[Faithful Steward]

If you own a whole life policy you might want to read Bill Borsma's latest blog post, entitled "The Truth Behind Whole Life Premiums." Here is the link: http://www.billboersmaonlifeinsurance.info/the-truth-behind-whole-life-premiums/

Bill does a great job explaining how a whole life policy is not as guaranteed as the agents selling them would lead you to believe.

At least a few times a year, I see policies come across my desk where the policy is headed toward disaster. Often it's because both the owner and the agent treated the policy like a "set it and forget it" financial instrument. Even whole life policies, as this article illustrates, need to be managed and require a review every couple of years - if not annually. Problem is, most life insurance buyers rarely hear from their agent again - after the sale - unless the agent is pitching another policy.

[Steven Podnos MD CFP]

Both of you have some good points.  I see dozens of client physicians who have been "sold" whole life policies early in their career with the "sell" of it being a great investment. It never never is.

 

What we see over and over is that in this time of diminished interest on bond portfolios (where insurance companies invest their cash) and rising age, that the cash value of the life insurance policies quickly erode.  To see how much the insurance costs, you have to add up the lost opportunity on the cash value investment plus the premium paid.  For example, take a policy with 1M cash value and premiums of 30K per year.  You might see that the cash value increases 50K in the next year.  Sounds good, but the potential was the investment return on your 1M dollar cash value plus the premium .  Even if we assume a low 4% on the cash value, that is 70K in "cost to you."  So the insurance and company profit was 20K.

 

This just keeps getting worse as time goes on.  I work with many physicians who no longer need the death benefit (they have accumulated significant savings) and we move the cash value over to a no load/no surrender annuity at Vanguard, Fidelity or a similar custodian.

[FIREshrink]

Steven Podnos MD CFP wrote:

Both of you have some good points.  I see dozens of client physicians who have been “sold” whole life policies early in their career with the “sell” of it being a great investment. It never never is.

 

What we see over and over is that in this time of diminished interest on bond portfolios (where insurance companies invest their cash) and rising age, that the cash value of the life insurance policies quickly erode.  To see how much the insurance costs, you have to add up the lost opportunity on the cash value investment plus the premium paid.  For example, take a policy with 1M cash value and premiums of 30K per year.  You might see that the cash value increases 50K in the next year.  Sounds good, but the potential was the investment return on your 1M dollar cash value plus the premium .  Even if we assume a low 4% on the cash value, that is 70K in “cost to you.”  So the insurance and company profit was 20K.

 

This just keeps getting worse as time goes on.  I work with many physicians who no longer need the death benefit (they have accumulated significant savings) and we move the cash value over to a no load/no surrender annuity at Vanguard, Fidelity or a similar custodian.

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The opportunity cost argument doesn't hold water with me. You can make that argument about any investment. The internal return of a WL policy is low, but it's also very safe. Compared to treasuries, total bonds, passbook savings, EE or I bonds, the returns are reasonable. My wife was sold a policy 24 years ago but when we did the analysis ten years ago we were earning an internal rate of return of 4-5% per year. So we kept the policy. We keep paying the PUAs and earning a rate of return about 0.5-1% less than the total return of the total bond market, and maintaining the insurance along the way. For example, in a recent 12 month period her cash value increased from $17,559 to $18,953. There was a premium payment of $539, so the net return was 4.72%. During the same period of time the total bond market returned under 1%. This is an unusually strong period of outperformance, and on average the internal returns have been just about 1% less than the bond market's - which makes sense. Essentially that 1% is the cost of insurance. As an extremely minor part of our portfolio it's ok. We can live with it. I'm not convinced a 1035 exchange is really in our best interests. At current bond yields I would expect a $19k investment to be worth $19,380 next year, which is less than I'd expect the cash value to increase ex-our PUAs.

Note I'm not recommending anyone buy WL. However the analysis to keep or not an older policy can be different than the analysis to buy one in the first place.

[FIREshrink]

generally agree but I have many bond investments and have since beginning to invest in my 20s. the policy has yielded less than some and more than others. in a very low rate world i'm happy with the returns we've received, given when we did the initial analysis.

[FIREshrink]

Rex wrote:

Oh you won’t be happy with it long term if we stay low rate. The companies won’t be able to meet guarantees. That’s what happened in Japan. Fortunately I doubt it goes that long. Already you see insurance companies struggling with it though. Easier to see in the ULs bc they have to disclose more. It isn’t going to beat bonds in the long term. The reason you are happy now is the lag. There is at least a 6 year lag with WL. So as interest rates go up, WL will also lag then. This is also why so many people got suckered into exchanging their WL to ULs in the past as interest rates rose. It’s going to happen again IMO.

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it doesn't matter, for two reasons.

 

First, preserving WL preserves optionality. I can 1035 to a VA any time I want. If returns start to lag and look like they'll continue to lag, I can exchange. If returns continue to be favorable, I won't. It's like holding onto a mortgage instead of paying it off.

 

Second, state guaranty associations ensure I will be made whole in the event of a bankruptcy. My policy death benefit is below my state's guaranty limit. It's not quite as safe as US debt, but it's pretty close.

 

Compared to a TBM investment, we've historically earned 0.5-1% less. Like I said - a fair rate for insurance. Not a steal, not a ripoff. Not something I'd go out of my way to buy; not something I feel compelled to sell.

(Actually, the returns have been better than calculated. When her provider demutualized about a decade ago, we took the shares, sold them, and invested them in TSM. So I really need to add those proceeds back into the calculations to see how she's done. I think once we've done that we'll see returns greater than TBM - of course, with greater risk as well for that small portion of the investment.))

[FIREshrink]

I may not be making myself clear. I'm not happy with the purchase. I'm not arguing in favor of WL. I have no view on 'how WL performs.' We didn't make this purchase - it was an affinity sale to my wife's parents when she turned 18. In fact, they bought one for each of their kids. Nice, huh?

However in our case, the policy has been worth keeping. My view is only that in some cases, WL can offer a reasonable return after it has been held for X number of years, and in some cases it is not advantageous to get rid of it. The analysis came when they handed the policy to her almost 15 years later. At that point, the damage was done. The internal returns since have been fine for a conservative investment. And we have many conservative investments - all the ones I mentioned, in fact - EE and I bonds, stable value funds, municipal bonds and total bond market. I have a conservative allocation because I have little need to take risk. With the PUAs we're averaging a perfectly nice rate of return. We need the insurance benefit and if we had to buy term in the open market to replace it there would be a real cost. In our case we're far below the state guaranty limits so we don't have to worry about having uninsured exposure. For my wife to buy 10-20 year term insurance at this point, at her age, would cost roughly what the insurance is costing her within this policy.

The real damage on these policies is done at the outset. For many years after the initial purchase I'm sure her cash value was zero or negligible. But we didn't have the opportunity to get in a time machine and change events. When her parents handed over the policy we did the analysis and decided the policy was, at that point, worth keeping. Every individual should make his or her own analysis. If incapable there is a service which charges a nominal fee for the analysis:

 

http://evaluatelifeinsurance.org/

[FIREshrink]

Savings accounts pay 1.3%. EE bonds pay 3.5% if held 20 years and are illiquid. I bonds pay 1-2%. 10 and 30 year treasuries are currently yielding 2.25% and 3.1%. Intermediate muni bonds are yielding 1.7%. In my case, which is all I spoke about, the 4.7% returns in the last 12 month period for the whole policy is obviously reasonable. You're being unreasonable if you don't think that's reasonable.  

[FIREshrink]

Fortunately most readers will read the whole paragraph, including the part where I wrote that after holding a policy for 10-15 years:

"On average the returns have been just about 1% less than the bond market's."