“At bottom, any insurance policy is simply a promise, and as everyone knows, promises vary enormously in their quality.” — Warren Buffett, Berkshire Hathaway 2004 Annual Report
Some insurance is free
- Travel insurance with your credit card
- Extended warranties with your credit card
Ontario Placerain-free guarantee
- 30 minutes or your pizza’s free guarantee
Term or Permanent?
With life insurance, term coverage costs less than permanent coverage for the same reasons as above. Term life is a gamble because death is unlikely during the period of coverage and because the steep premium increases at renewal encourage you to cancel coverage.
With permanent insurance, the tax-free death benefit will be paid as long as the coverage remains in force for life. Naturally, this stronger promise costs more. As long as you keep paying the premiums, the insurance company must provide coverage even if your health deteriorates.
Your chances of dying increase as you get older. Suppose you bought term coverage with rates that increased each year as you age. Do you see the problem? The insurance becomes increasingly expensive as life expectancy approaches. So you can’t afford insurance when it’s most likely to pay out. What good is that?
What’s the solution? Prefunding. To encourage Canadians to save for retirement, the government allows savings to grow tax deferred until withdrawals are made. Permanent life insurance gets the same advantage of tax deferred growth.
You maximize the benefits of compound growth by making large contributions as quickly as possible. This means that when insurance charges are deducted, part of the money comes from investment growth that was never taxed. In effect, the government is subsidizing the cost of your insurance.
The government isn’t crazy. As with RRSPs, there are limits on how much money you can invest. There’s much more flexibility, though. The maximum premium varies by age, gender and the face amount.
If you decide you no longer need your permanent insurance, you can cancel your coverage and get a taxable cash surrender value. According to Warren Buffett, you’re probably giving up an excellent investment:
Berkshirepurchases life insurance policies from individuals and corporations who would otherwise surrender them for cash. As the new holder of the policies, we pay any premiums that become due and ultimately – when the original holder dies – collect the face value of the policies. The original policyholder is usually in good health when we purchase the policy. Still, the price we pay for it is always well above its cash surrender value.”
— Warren Buffett, Berkshire Hathaway 2004 Annual Report
If permanent insurance is so good, why would anyone “buy term and invest the difference”?
Universal life insurance, the predominant form of permanent insurance, combines term insurance with the tax deferred growth.
That’s why you won’t find many articles from external credible sources. Insiders know but they
- are perceived as biased
- guard their knowledge or lack ways to communicate them
The answer depends on your age, health, gender, risk tolerance, time horizon and goals. A competent insurance specialist will fairly compare universal life against a conventional investment reflecting taxation and all other costs. You’ll want to compare investment growth and also estate values. The results may surprise you.