THE PERILS OF WHOLE LIFE INSURANCE

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

• Riscario wiki: dividends, whole life, types of life insurance
• Keeping promises: corporate governance 2011
• Great-West, London Life ordered to pay $455.7M (Winnipeg Free Press, Oct 2010)
• Universal life sales propel growth in the national accounts channel (Insurance Journal, Sep 2011)
• Ontario Court of Appeal upholds award to London Life policyholders but cuts amount (Financial Post, Nov 2011)
• Great-West judgment partially reduces (London Free Press, Nov 2011)
• Does Warren Buffett "buy term and invest the difference"?
• RBC and TD end free accounts for older clients (Moneyville, Mar 20, 2012)
• Whole life insurance, long derided, gets new lease (Wall Street Journal, Feb 2010) (new; read the comments too)
• image courtesy of Brett Mulcahy (Australia)

Podcast 161

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PS What are your thoughts on whole life?