March 24, 2012

THE PERILS OF WHOLE LIFE INSURANCE

trap?Opinions on whole life insurance get fiery. Advisors who sell it tend to be older. Whole life was probably the first product they sold. They've learned how to position it and deal with objections. They've convinced themselves of the merits. Criticize whole life and you're in for an argument.

Over the years, advisors have said that whole life pays higher compensation than any other life insurance product. Let’s ignore that. Let’s get to the core question: why do you buy insurance? To transfer risk to the insurer.

Whole life transfers risk back to you. Is that what you want?

Rejoice?

Tax refunds feel nice but why do you get them? Because you overpaid. Insurance dividends feel nice but why do you get them? Because you overpaid.

With participating whole life insurance, you pay more than the insurer needs. The insurer conservatively projects mortality claims, expenses and investment earnings. If actual mortality claims are lower, you get a dividend. If expenses are lower than projected, you get a dividend. If investment earnings are higher than expected, you get a dividend. That's nice but there's the other side.

Your dividends could be lower than you expect. Here are three examples.
  1. AIDS: in the 1980s, AIDS became a concern for insurers who sold guaranteed products. There was no problem with par whole life since higher mortality claims simply meant lower dividends. If Hollywood is to be believed, there are epidemics and scourges waiting for us. With whole life, you get to share in the cost.
  2. Y2K: upgrading computer systems was pricey. With whole life, higher expenses simply mean lower dividends. Who knows what might lead to higher expenses in the future?
  3. Investments: with whole life, you're stuck with the returns on the investments the insurer selected. Maybe you wouldn't have done better but you would have had choices. If you’re not good at deciding, your advisor is there to help you.
Rather than return your premium overpayments to you, your advisor may encourage you to spend on more insurance. If you'd like to cancel your coverage, you'll be offered "nonforfeiture options", which are other ways spend your money the insurer instead of getting it back.

The Evolution

Whole life is an expensive black box. Clients and their accountants were looking for products which were transparent and cheaper. The solution was universal life, a combination of life insurance and investments. In essence, you're "buying term and investing the difference". You're also getting guarantees. Typically, you know the mortality rates and expense charges. As with whole life, the investment returns are unknown but now you and your advisor get to choose from the choices available. Premium tax rates may not be guaranteed.

With universal life, you win if actual mortality rates or expenses are higher than projected. The insurer wins if mortality rates or expenses are lower. Doesn't this give insurers an incentive to guarantee inflated rates?

They can try, but there's competition with other insurers, whole life and "buy term and invest the difference". Also, mortality has been improving and technology reduces costs. The projected savings can be factored into the guarantees.

In Canada, most insurers have stopped selling whole life insurance. Instead, the market has shifted to term life and universal life.

Trust

With tax, you or your accountant can calculate the costs. You're cannot verify or calculate a dividend. You're trusting the insurer, possibly for decades. Do you? The financial sector is the least trusted in the world … again.

Some insurers selling whole life rank low in corporate governance, a measure of keeping promises. I have a fondness for London Life because their coveted London Life Actuarial Scholarship helped pay my way through university. However, 1.8 million policyowners have not fared as well. In a class action, Great-West Life and London Life were ordered to pay $455.7 million for violating the Insurance Company Act and general accounting principles. An appeal court confirmed the decision but reduced the settlement to $220 million.

Companies change their behaviour. This week, RBC and TD announced they are ending free bank accounts for their older clients --- even if they’re been clients for decades. It's easy to change banks accounts. Right now, BMO, CIBC and Scotiabank still have free ones.

With insurance, you can’t easily switch. You undergo new underwriting and may face tax on the cancelation of your old plan. All that assumes you’re still insurable.

Stay Away?

Whole life insurance may may sense in some situations. If guarantees are important to you, ask an advisor you trust for other options before you decide

Links

Podcast 161


direct download | Internet Archive page | iTunes

PS What are your thoughts on whole life?

5 comments:

Daddy Bear said...

Well, nice theory but not true to life. Universal Life (UL) is tied to interest rate and is highly sensitive to changes in those rates. With the "flexibility" of premium that is marketed as one of the advantages of UL people have tendency to underfund their policies. Same thing happens with Variable Universal Life. It is a human nature to try and get by with a minimum possible premium and in your writing you are pretty much confirming that. Years later - if left unattended - these policies start draining the cash values they accumulate and require larger premiums as cost of insurance increases. This is a high maintenance situation.
In defense of whole life, it is designed to be properly funded from the get go and yes it does return the excess to the owner in a form of dividends. Once again thank you for confirming that. In essence it assures a smooth sailing. You know what you are getting into: the death benefit is guaranteed, the premium is guaranteed not to increase, and the policy is structured in a way where you always get your money back and more on top of that. Most of UL policies do not have those kinds of guarantees.
So would you rather have an unstable psycho girl friend (UL) or a mild tempered and loyal wife (WL)?
Please note, I AM NOT an insurance sales man. I am working as a kind of a "back room techician" crunching numbers. I have seen a lot of new policy illustrations along with the in-force ledgers of the policies that perform and those that don't. My training, my knowledge and my experience all tell me "Buy Whole Life". It is THE ONLY FAIR DEAL!

Daddy Bear said...

Well, nice theory but not true to life. Universal Life (UL) is tied to interest rate and is highly sensitive to changes in those rates. With the "flexibility" of premium that is marketed as one of the advantages of UL people have tendency to underfund their policies. Same thing happens with Variable Universal Life. It is a human nature to try and get by with a minimum possible premium and in your writing you are pretty much confirming that. Years later - if left unattended - these policies start draining the cash values they accumulate and require larger premiums as cost of insurance increases. This is a high maintenance situation.
In defense of whole life, it is designed to be properly funded from the get go and yes it does return the excess to the owner in a form of dividends. Once again thank you for confirming that. In essence it assures a smooth sailing. You know what you are getting into: the death benefit is guaranteed, the premium is guaranteed not to increase, and the policy is structured in a way where you always get your money back and more on top of that. Most of UL policies do not have those kinds of guarantees.
So would you rather have an unstable psycho girl friend (UL) or a mild tempered and loyal wife (WL)?
Please note, I AM NOT an insurance sales man. I am working as a kind of a "back room techician" crunching numbers. I have seen a lot of new policy illustrations along with the in-force ledgers of the policies that perform and those that don't. My training, my knowledge and my experience all tell me "Buy Whole Life". It is THE ONLY FAIR DEAL!

Daddy Bear said...

Well, nice theory but not true to life. Universal Life (UL) is tied to interest rate and is highly sensitive to changes in those rates. With the "flexibility" of premium that is marketed as one of the advantages of UL people have tendency to underfund their policies. Same thing happens with Variable Universal Life. It is a human nature to try and get by with a minimum possible premium and in your writing you are pretty much confirming that. Years later - if left unattended - these policies start draining the cash values they accumulate and require larger premiums as cost of insurance increases. This is a high maintenance situation.
In defense of whole life, it is designed to be properly funded from the get go and yes it does return the excess to the owner in a form of dividends. Once again thank you for confirming that. In essence it assures a smooth sailing. You know what you are getting into: the death benefit is guaranteed, the premium is guaranteed not to increase, and the policy is structured in a way where you always get your money back and more on top of that. Most of UL policies do not have those kinds of guarantees.
So would you rather have an unstable psycho girl friend (UL) or a mild tempered and loyal wife (WL)?
Please note, I AM NOT an insurance sales man. I am working as a kind of a "back room techician" crunching numbers. I have seen a lot of new policy illustrations along with the in-force ledgers of the policies that perform and those that don't. My training, my knowledge and my experience all tell me "Buy Whole Life". It is THE ONLY FAIR DEAL!

Steven Young said...

Before taking up whole life insurance, look into the various types
offered under this category by your insurance company and consider the
features of each and your benefit under each. This way you can choose
one that suits your whole insurance requirements.

cishemant said...

Thanks for some new kind of food for buying life insurance policies.