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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.

10 Unusual Things Can Impact Your Quoted Life Insurance Rates

There is a defined moment when many of us start to consider getting life insurance to protect family members and loved ones. It could be after a child birth or a catchy insurance commercial that tweaks your interest. When this moment strikes, the first thing most people do is get a quick online quote to understand their ballpark rates. A more detailed assessment follows afterwards. Some elements of this assessment are intuitive (age, health condition, smoking status, occupation, etc.). There are, however, some other surprising assessment criteria that underwriters also consider. Such as…

  1. Driving History: Yes, your driving history matters, not only for your auto insurance premiums but also your life insurance rates. If you had a DUI accident in the recent past, you will likely experience significant higher quoted rates than somebody who has a clean driving history. Remember that smaller offenses fall off your driving record after three years (for insurance purposes).
  2. Be Happy: Having a history of depression can hijack your life insurance premiums, almost doubling them. Happy people experience less health issues and stress, and thus represent lower risk for insurance companies.
  3. Policy Date: The policy’s starting date can be sometimes adjusted (also called backdating), meaning that in some cases you can benefit from lower premiums (based on your younger age; if you turned 50 this week but backdate your policy to last month, for example). Obviously you will need to pay all the premiums starting from the backdated time point, but you can benefit from a lower rate going forward.
  4. Dangerous jobs (e.g. stuntmen, bomb squad member) can mean higher risk for your life and thus lead to higher insurance premiums. Do you think that your job is dangerous?
  5. Payment frequency: Paying for a life insurance policy on an annual basis saves insurers administrative costs, and they reward you with lower premiums than if you’d paid for your insurance monthly. In this case, though, you’d need to plan carefully because a big annual charge can create a significant hole in your household budget if you forget about the annual premium.
  6. Travelling (to dangerous destinations): Some destinations are more dangerous than others and some are very dangerous (war zones, areas with known history of kidnapping, etc.) Consult an insurance broker or your agent to understand how your future plans can impact your insurance coverage. Your policy can be declined or you might be able to get a life insurance policy, but it would explicitly exclude the time you are abroad. In some cases, a simplified issue no medical life insurance policy is a solution since it does not ask travel questions. It is important to know, though, that a simplified issue policy is more expensive than a standard one and its coverage is typically limited to $50,000 – $300,000. You can test this out by getting an anonymous simplified issue no medical life insurance quote via one of numerous insurance online platforms.
  7. Sports (extreme): Being involved in extreme and/or dangerous sports, especially professionally, can impact your life insurance premiums (for example: sky diving, cliff diving, scuba diving). Similarly to getting insurance while travelling to dangerous locations, you need to understand which cases are not covered by your life insurance policy.
  8. Private pilot licenses: This one usually falls into a category of dangerous hobbies – licenced pilots (only private) might experience higher insurance rates. When calculating insurance premiums, an insurer will consider both the pilot’s age and experience. This information will probably not asked during the initial quoting process, but will be required during the detailed assessment later.
  9. Your citizenship: If you are not a Canadian citizen or resident, you will not be able to apply for a Canadian life insurance policy.
  10. Your income: Insurance companies can decline your life insurance policy if your household income falls below a particular threshold, typically $30,000. The reasoning behind this is so insurance does not stretch your budget beyond its capabilities. Note that you should still speak with a broker to create a detailed future plan for insurance protection, and brokers that are also financial planners can help you triage your upcoming financial expenses to best manage your needs. It’s a good idea to check with your insurance broker, if your income might be an issue, before submitting your application. Remember, that once you have been declined for a life insurance application, it may impact your next applications since some insurers include in their surveys, “have you ever been declined for a life insurance application?” Similarly to a pilot license, this question might be not be included in initial quote questions, but will be asked later by your insurer.

As you can see, many aspects outside of your health impact your life insurance quote and policy. You should remember that underwriting rules (application assessment) are different across insurers and thus, it is advisable to work with an insurance broker who deals with numerous life insurance companies and can share his/her expertise with you as you navigate through this complex process.