Has the Return On the Cash Value of Whole Life Insurance Been Really Bad?

If you watch financial television shows you have been told that the rate of return on money invested into a whole life insurance policy is awful. Many fee-based financial advisers, whose income depends on managing investors’ portfolios, agree the returns on investment in a whole life insurance contract is poor.What is this poor return compared to and is there any benefit to owning this contract?

Some of the criticisms about whole life returns:

1) It takes years, sometimes decades for the cash value to break even,
2) The commission on whole life is so high that the product can never have a good return. It is only sold by salespeople out to make money.
3) Whole life insurance has a lousy return compared to stocks; and investors cannot afford to earn these substandard returns – especially in their early years,
4) It is “too expensive.” An investor who needs coverage would be better off buying term life insurance and investing the difference.
5) A policy owner never has access to 100% of the cash value unless they lapse the policy.

The purpose of this article is to discuss some of the objections surrounding whole life insurance and its returns.

Investment advisers continually plead with their clients to “take a long-term approach” to investing. Even with that advice, many of the temptations in the investment marketplace convince the average investor to abandon their plans and chase the promise of better returns. Promises of quick returns usually end up being money-losing endeavors.

Cash value policies require a commitment by the investor to “stay on course.” The break even point of a whole life policy depends on many factors like: the insurance company, the design of the policy’s premium vs. face value, and the interest rate that is credited to the policy among other things.

In general, whole life policies that are designed to have the maximum face amount, or death benefit, for the premium will take longer to break even. These types of policies can take decades to break even but their purpose wouldn’t be to accumulate cash anyway, the purpose would be to acquire a larger permanent death benefit.

On the other hand, a policy designed to build cash with a minimum amount of death benefit will accumulate cash faster, breaking even in less than 6 years.

If investors need all of their money in less time than this while still needing the life insurance protection, they may be better of “buying term and investing the rest.”

The commission earned by an agent selling the whole life policy can be as much as 100% of the first year’s premium, and this is the main reason that the policy has a low cash value in the early years. After a few years, however, policy returns accelerate making up for the loss of earnings on the front end. The policy owners who continue to hold the policy will benefit from the ones who abandon.

The rate of return of whole life insurance should never be compared to that of the stock market.

First, whole life has a contractual minimum rate of return on the cash value; stocks do not. In addition, insurance companies invest policy owner’s money into fixed income securities, like bonds, that historically are less volatile but have lower returns than stocks.

A fair long-term return comparison for life insurance would be an index like the “Barclay’s Corporate Bond Index.” When this comparison is made, life insurance has had a superior risk adjusted rate of return over this bond index as measured by Beta and Alpha statistics.

Whole life does require significantly more premium than term insurance or the same life insurance amount however term will only cover the individual for a limited period of time or “term” of the contract. If the insured person lives through the term, which of course is hoped, then the premium payments are lost. On the other hand, all of the premiums paid into whole life will be used to pay a claim some point in the future since the policy is designed to cover someone for their “whole life.”

This makes term life insurance an expense and whole life insurance an asset that increases in value each year it is owned.

It is true that a policy owner never has access to 100% of their money unless they surrender the policy. The product is not panacea for all financial needs. If the policy owner doesn’t want to cash in the policy, the permanent death benefit can be used to replace other money that was spent for a specific need or to provide an income.

For example, the life insurance can provide a lump sum of money to replace Social Security money that a retiree doesn’t receive if they wait until age 70 to start receiving the increased income benefits.

Whole life insurance is a tool that can make life much simpler and much more abundant when examined for what it can do and how to compensate for perceived shortcomings. Every financial product has “pros and cons.” Whole life insurance is no different.

It is not an investment that increases (or decreases) rapidly like stocks can. Additionally, whole life is contractually guaranteed not to decrease in value due to investment losses.

The rate of return for whole life insurance and the commissions earned by agents who sell it are debated topics in the financial industry. Life insurance is a long-term asset that should not be compared to the performance of stocks but instead compared to an allocation of fixed income securities. Policies can be designed to accumulate cash value faster by lowering the face amount of the insurance.