UNDERSTANDING THE INGREDIENTS OF LIFE INSURANCE (TERM AND PERM)

Michael James wrote a thoughtful post comparing temporary (term) life insurance and permanent life insurance. Like our canine friends above, both are similar, yet different. The best choice depends on different factors. A winner on one scale loses on another. As Michael’s analysis shows, comparisons can be misleading or omit important elements (like inflation).

Typical Plans

A temporary plan like Term 10 is often

• renewable to extend coverage for another 10 years for a higher-but-guaranteed premium
• convertible to permanent insurance without underwriting up to a maximum age

Since a permanent plan lasts for life, there’s no need for renewal or conversion options. Here are typical plans.

Temporary Life Plan	Permanent Life Plans
Term 10 (renewable, convertible)	Term 100
Term 20 (renewable, convertible)	Whole Life
Level term to age 65	Universal Life

We won’t be looking at which form of insurance is better. We’ll be looking at how they’re different.

First Principles

Mortality rates underlie all life insurance. The mortality rate is based on the true probability of someone like you (same gender, age, smoking status and health) dying during the year. Your mortality rate  increases annually because you’ll die eventually (based on current medical science and how we define life).

Your retail premium rate is based on your wholesale mortality rate with margins added for expenses and profits. Your premium is the premium rate multiplied by how much insurance you’re buying. There may be additional loads for premium tax and Investment Income Tax (IIT).

One Year At A Time

When you buy insurance, you are getting one year of protection at a time.

Comparing With Property Insurance

With your car and home insurance, the insurer will usually offer you coverage for another year under similar conditions. Your new premium depends on factors such as their claims (actual vs. projected), expenses (actual vs. projected), investment earnings (actual vs. projected), capital requirements and profit targets.

The insurer could refuse to insure you next year or change the contract provisions (e.g., weaken protection for water damage). You could decide to switch companies.

The Additional Guarantees With Life Insurance

Life insurance also protects you a year at a time but usually

• you have the right to renew your coverage until a maximum age (even if the insurer stops new sales)
• your premium rate scale is fully guaranteed (e.g., you keep your nonsmoker rates if you start smoking or stop exercising in the future)
• your insurer can’t modify the contract unless the change is an improvement

You get this extra protection because you may not be able to switch insurers if your health has deteriorated. You might even become uninsurable.

Yearly Renewable Term

The building block of all life insurance is Yearly Renewable Term (YRT), which is sometimes called Annually Renewable Term (ART).

Do you see the problem?

Your probability of dying during the year increases from 0.01% to 1% to 10% to 80% to 100%. This means your YRT rates will increase every year and become increasingly unaffordable as claims becomes more likely. That’s not good for you or your beneficiaries.

There is a solution: prefunding. Suppose you need insurance for 22 years. You could average the premiums and put that amount into a savings account every year and make withdrawals to pay the YRT premiums.

You could have the insurer invest for you instead. With Term 10 life insurance, you pay a level premium for 10 years at a time. The insurer does the averaging and bears the investment risk. At the extreme, Term 100 life insurance has a level premium for life (and is really permanent insurance and often continues beyond age 100 without further premiums).

Whole life insurance uses YRT rates (which might not be guaranteed). Universal life usually offers two guaranteed scales: YRT and LCOI (Level Cost of Insurance).

Start With The Need

Is your need for insurance temporary or permanent? If you’re addressing the risk of dying while you have financial obligations (e.g., children, a mortgage, a spouse or ex-spouse, other family members), life insurance is the ideal way to create or enhance your estate — if you’re insurable. How else can you get a specified tax-free lump sum at death?

For a temporary need, term life insurance is ideal. You get the most protection for the lowest price.

What If You’re Wrong?

A need which initially looks temporary may last longer than you expect. For instance, a child may have a lifelong disability due to an accident. If you guess wrong, term life insurance gets expensive. You can often renew coverage up to a maximum age without underwriting but the premiums shoot up each time.

Compared with renewing, you may be able to save money by buying a new term plan with new underwriting.

Conversion

Term life insurance often allows you to convert to permanent protection without underwriting up to a maximum age (e.g., 65). You pay the premiums for your age at the time of conversion (your “attained age”).

Example: Suppose you buy Term 10 at age 32. If you convert eight years later, you pay the permanent premium for a 40 year old. This will be more than the permanent insurance premium at 32 and may be more than what a newly underwritten 40 year old would pay for permanent insurance.

Why Permanent Insurance?

You might want permanent life insurance for estate planning. You may not see the need now because you’re not thinking of your legacy. Maybe you will in your 50s or 60s.

The tax-free insurance proceeds can be an inexpensive way to pay taxes at death, leave money for heirs or help a charity. Coverage is available in a cheaper form called Joint Last To Die (JLTD), which insures you and your spouse. The money gets paid when the longest living spouse dies. That’s when the bulk of taxes are due.

Some younger people buy a small amount of permanent insurance for their legacy and a large amount of term insurance for their temporary needs.

An Appreciating Asset

Why does permanent life insurance have a savings component? Further, why do the savings grow on a tax deferred basis? The government doesn’t give valuable advantages without reasons. There are ways you can benefit with planning.

Permanent life insurance grows in value every year because the payout becomes more likely — especially if your health has deteriorated. Your insurance contract could easily have a market value which is much higher than the cash surrender value. An investor may want to buy your contract, pay the future premiums and get the death benefit. That’s called a life settlement. They are legal in the US and several Canadian provinces (but not Ontario).

More

Permanent life insurance gives you the opportunity for tax-deferred savings. Universal life provides the most guarantees, flexibility and transparency. You could

• invest more (limited by the Maximum Tax Actuarial Reserve (MTAR))
• select the investments
• stop paying premiums (e.g., in 20 years or at age 65), though not always guaranteed

Having more options helps with tax planning, especially for incorporated businesses.

Affordability

You can offset the cost of your insurance by reducing your coverage as

• your financial responsibilities drop (e.g., children older, mortgage smaller, spouse’s income)
• your assets grow (e.g., savings, pension)

Before you do, consider inflation which decreases the value of money. Also, your financial obligations could grow (e.g., new children, divorce, health issues).

Conclusion

Temporary life insurance gets compared with permanent life insurance but both cover different needs and timeframes. Since advisors get paid much more for selling permanent insurance, they may have biases they don’t even realize. Explore different scenarios before deciding and re-evaluate your needs over time.

For general questions, ask below. I'll answer what I can here or on Question an Actuary (QanA). For personalized answers, reserve time to Learn About Life.

Links

• Life Insurance: Permanent vs Term (Michael James on Money)
• How Pink Floyd’s insights on mortality help you
• Does Warren Buffett “buy term and invest the difference”?
• The two drawbacks of investing in life insurance
• image courtesy of nafets

PS Remember insurance for disability, critical illnesses and long-term care too.

YOU BUY LIFE INSURANCE WITH YOUR HEALTH

Disaster-proofing your life is the foundation of financial success, according to Preet Banerjee (and me). That means protecting your biggest asset: your future income. You need insurance for disability and death. Getting coverage takes more than money.

You buy insurance for the four financial risks with your good health. If you're in poor condition or have harmful habits like smoking, you pay higher premiums. No law forces an insurer to cover you. In extreme cases, you can't get coverage at all. That’s when you most need protection.
How do you get the health insurance or life insurance which you and your family need? Here are three strategies that work alone and together.

1. Buy young
2. Buy more now
3. Stay healthy

Buy Young

You tend to be healthier when you're younger. That means it's easier to qualify for insurance. You also pay lower premiums since you’re less likely to make a claim. The price always go up because you're getting older, even if you get healthier.

Younger people tend to ignore the savings available to them. Perhaps they have less money, a smaller perceived need for insurance and other priorities.

Buy More Now

You can always reduce your coverage but can't always add more later. You face new underwriting each time. The testing is becoming more sophisticated too. Future prices are always higher because you're older.

If you buy more coverage now, you have better protection and reduce the need to add more insurance later. Even if you have lots of money, you're limited in how much protection you can buy. To be prudent, insurers limit the amount of coverage for which you qualify.

Exception: you might be able to add a “guaranteed issue” option to buy more insurance later with no questions asked about your health. This flexibility is especially helpful with disability insurance since you’ll likely want more coverage as your income increases. (You can also add options to offset the effects of inflation.)

Stay Healthy

Since we can't predict the future accurately, we can't anticipate all our changing future insurance needs. If you're healthy, you can apply for more coverage later. You also enjoy a better life.

Maybe you're in the midst of improving your health (e.g., by stopping smoking). Don't wait to buy insurance. You can apply for lower premiums later. In the meantime, you're protected.

Health is wealth. Health is the price you pay to qualify for insurance.

Links

• Disaster-proof your life: the first rule for financial success
• What happens during a paramedical exam for insurance?
• How to afford the insurance you need
• What do you learn from getting sick?
• The four financial risks
• image courtesy of Elnur

PS Get help with your insurance at Taxevity.

THE PITFALLS OF MORTGAGE LIFE INSURANCE

When you're gambling, the “house” expects to win. They’re on the lookout to make sure you don’t have insider information that puts the odds in your favour.

Term life insurance is a form of gambling. The products are sold at the younger ages where death is unlikely. Rates increase sharply with age and coverage is not available near life expectancy where payout is most likely. Insurers also underwrite each applicant individually, medically and financially. You’re required to disclose insider information. If you're a smoker or otherwise unhealthy, you pay more or get rejected.

If you’re honest, healthy and financially sound, you’ll likely get insured. More important, your claim is very likely to be paid. You have peace of mind. That’s not true for mortgage life insurance from your lender.

Uncertainty

The mortgage life insurance your bank offers you works differently. Buying insurance makes sense since you wouldn't want your family to lose their home if you pass away. You might sense pressure to buy coverage from the bank. That’s called tied selling and is illegal. Yet you’re vulnerable. If you refuse, will your mortgage be approved at a preferred rate?

If you buy, you're getting what is called creditor insurance. The bank is the creditor which means you're the debtor. Creditors worry about protecting themselves, not you. They also make nice profits from this type of insurance.

Since there are so many mortgages and so few claims, underwriting you at the time you buy is expensive. Why not underwrite you at the time of the claim? That makes financial sense to the creditor but what about you? You don't know if you're insured until the exact point the money is needed.

Did you notice the inconsistency?

The bank does extensive financial underwriting for your mortgage because they're concerned you might default (and inconvenience them). They don't bother to do insurance underwriting because that would cost them now and the risk of claims is low. Put differently, they're more worried that you'll default than die. Do you have the same priorities?

Consequences

The perils of buying mortgage life insurance from the lender are well known. Here are seven articles for background:

1. Mortgage insurance not always a sure thing (CBC Marketplace video, Feb 2008)
2. Mortgage insurance vs life insurance (Canadian Capitalist, April 2009)
3. Perils of a mortgage life policy (Toronto Star, April 2007) + addendum (Ellen Roseman)
4. Don't buy insurance from banks (Ellen Roseman, April 2009)
5. Post-claims underwriting (Money Smart blog)
6. Why am I denied insurance coverage? (Thicken My Wallet, May 2009)
7. Why I won’t sell mortgage insurance (Dave The Mortgage Planner)

Protect Yourself

You protect yourself by buying your own insurance elsewhere for flexibility. You then decide where the proceeds go. You'll probably want to cover debts like your mortgage and leave money for your family to replace the income you provided. You'll likely save money too.

Insurance advisors range in quality. You won't get true peace of mind unless you take the time to select an advisor you can trust. That’s key to getting your claim paid.

There's one weak reason to buy mortgage life insurance. If your claim looks reasonable but is getting denied, the media may help. The bank may then make a business decision to pay to avoid bad publicity.

Post-claim underwriting is not consumer accountable but is still with us. Buyer beware.

Links

• Tips for first-time home buyers (new)
• Two types of insurance you may have but can never own  (new)
• Three keys to getting your claim paid
• What happens during a paramedical exam for life insurance
• The effect of banks selling you insurance online
• Three steps to keeping financially solvent
• How the wealthy feel about their advisors
• image courtesy of Svilen Milev (Bulgaria)

Podcast 127 (4:50)

direct download | Internet Archive page | iTunes

PS Before ditching your mortgage life insurance, be sure you have a replacement securely in place.

THE FINE PRINT TAKETH AWAY … EXCEPT IN LIFE INSURANCE

We’re sceptical because even the simplest offers have fine print. You're enticed but the many conditions take away the charm.

Not only do you spend money to get the offer, you often spend money to use the reward.

A Common Example

Here’s the fine print in a free movie ticket offer from a pizza chain.

1. the buy-one-to-get-one-free condition
2. limited provinces
3. limited theatre chains
4. no IMAX films
5. no IMAX digitally remastered presentations
6. no VIP room
7. no 3D films
8. no Real D 3D films
9. no non-feature film entertainment
10. no advance tickets
11. no midnight performances
12. no reward points
13. no pass-restricted movies
14. no refunds
15. not redeemable for cash
16. no reselling
17. no extensions
18. no reproductions
19. not combinable with other promotions, coupons, vouchers or special discount offers

If you get through all that, be sure to go to a participating theatre by the April 29 expiry date.

Okay, some conditions won’t affect your life. Yet someone felt the need to spell them out. There’s no warning that the movie might be a waste of your time even for free and that you’ll be subjected to commercials. That doesn't warrant a mention?

The Surprising Exception

We’re so used to fine print that we don’t notice one surprising exception. In Canada, personal life insurance contracts routinely guarantee everything except

1. government actions
2. investment returns
3. the availability of investment options

Fine print: Products differ and practices change. We’re looking at what’s common to help you in discussions with your advisor.

Government Actions

Provincial governments set the premium tax rates. They range from 2% in most provinces to 4% in Newfoundland. These rates are far below normal sales tax and the federal government doesn’t add a surcharge.

Insurance contracts are usually guaranteed to be tax exempt based on the tax rules when your coverage takes effect. Governments can change the rules but they might compromise and allow existing contracts to operate as before.

Investment Returns

Permanent life insurance plans allow tax-sheltered investment growth. With whole life, the insurer makes all the investment decisions and you get the rewards and penalties for their judgement. With universal life, you pick all the investments and take responsibility for the returns.

The insurer can often remove investment choices from a universal life plan. For example, if the S&P 500 disappears so will indexes based on it. That’s fair but the new indexes might have higher management expenses --- they rarely go down.

The Guarantees

Whole life has the fewest guarantees and is more like insurance on your car or home. You foot the bill for higher claims by others, pricey computer programming (remember Y2K?) and lousy investment returns.

In contrast, term life and universal life insurance routinely guarantee whatever the insurer can:

• premium rates per $1,000 of coverage
• administration expenses
• tax exempt status (under the rules in effect when you got your contract)
• no new conditions or restrictions

Something to think about when you’re back from the movies.

Links

• Check your pizza literacy (new)
• What's worse than fine print? (new)
• The best tax sheltering in Canada
• The four steps in wealth management
• The two drawbacks of investing in life insurance
• How advisors fool you (and what you can do)

Podcast Episode 64 (4:43)

direct download | Internet Archive page

PS The movie coupon expires on a Thursday, which means you can’t see the new Friday releases like A Nightmare on Elm Street or Furry Vengeance. Thank goodness.

Lease or Buy? How Life Insurance Compares With Getting A Car

If you routinely lease your car, you get access to new features such as better fuel economy, integrated Bluetooth, integrated GPS navigation, better headlights, more airbags, all wheel drive and run-flat tires. You can change from sporty to family-friendly to stately, depending on your age and needs.

Car prices may not even increase to keep pace with inflation. This year, Mercedes Canada dropped the price of the E350 to the level of the now-discontinued E300. So you actually get more for your money. That's the power of competition.

Leasing Insurance
You can also lease your insurance. Unlike cars, insurance products change little. As people live longer, the mortality component of the insurance premium decreases. However, lower investment returns and higher expenses boost the costs. Let's assume that the overall premium does decrease. You won't see the savings.

Say you got coverage three years ago at age 40. For new coverage, you'd pay the higher prices for a 43 year old. If your health deteriorated, the price could be much more. You might get denied coverage. Since companies pursue ever-cheaper ingredients, new insurance contracts may subtly weaken guarantees or add new conditions. Instead of sugar, you might get corn syrup. Would you or your advisor notice? With a new contract, conditions start anew. For example, death benefits are generally not paid for suicide during the first two policy years.

Before dumping your current life insurance for a shiny new contract, take a careful look at the consequences --- especially if a different advisor is encouraging you to switch.

Residual Value
Leasing a car leaves you with a residual value and an option to buy.

Leasing life insurance leaves you nothing at the end of the term, generally 10 years.  You usually have an option to convert to permanent coverage at your now-higher attained age. This is especially valuable if you now need insurance for life and your health has deteriorated: you pay normal prices without new underwriting.

When leasing, you can experiment with cars you wouldn't like to own for long. You can pick an unusual colour like bronze/orange or an unusual shape such as the BMW X6 SUV/hatchback. If you're flexible, you can save money by getting a less popular vehicle or a demonstrator.

With insurance, you get fixed prices. That puts the onus on the insurer to be competitive rather than on you and your negotiation skills. That's great for those of us who hate that aspect of getting a car. You also see extra cost gimmicks like the accidental death benefit, which lets you gamble on the cause of death. With cars, you're offered stain protection

Conclusion
If you've decided to get a car, there are arguments for buying new, leasing new or buying old. If you've decided to get life insurance, your choices are simpler. You can't buy old. That leaves buying permanent coverage or leasing temporary coverage.

Links

• Buying versus leasing versus buying a used car (Edmunds.com)
• Small cars: is 'safer than ever' safe enough for you? (includes crash test videos)
• Oblivion: what happens if my insurer crashes and dies?
• Do you pay your car mechanic for effort or results?
• Irrational behaviour: is a BMW twice as good as a Hyundai? 
• image courtesy of R John Schuler (Germany)

Podcast 60 (4:12)

direct download | Internet Archive page

PS You need insurance on your car but you don't need insurance on your insurance

How Advisors Really Prepare Term Life Insurance Proposals

If you have a short-term need, term life insurance provides the most protection for the fewest dollars. You may think you can buy on price. That's generally true. Advisors say they'll survey the market to pick the right proposal for you. Some do and some don't. Here's what really happens.

Run Computer Illustrations
At The Sony Store, you can't buy Samsung, Panasonic or Nakamichi. Some advisors only sell products from one company. They give you get no choice. You rarely get the lowest price either. Since the advisors are captive and need commissions, the insurer gets sales without being especially competitive.

Independent advisors often conduct market surveys using comparison tools. You can do this online yourself. Beware of biases. Comparisons may not consider all products available since an advisor is only contracted with selected companies. Do you think they'll show products they don't sell?

Some advisors do show all products and then explain their recommendations. This prevents another advisor from showing you a cheaper option.

Coke or Pepsi? Like most of us, advisors have personal biases. Some insurers provide better support. Some pay more compensation. Some give better ongoing service. Some are better at paying claims. Some are better-known (e.g. more like GM than Subaru). Some are more financially stable. Some host better conventions.

Since there are so many insurance companies, it isn't practical for your advisor to deal with all of them. It's not advisable either. Because forms and procedures differ among companies, mistakes can easily be made. Companies also disappear, but you're protected against that.

Risk Classes

Insurers generally charge different rates based in expected claims

• males pay more than females
• smokers pay more than nonsmokers

Now there are further distinctions by health: regular (higher), preferred (lower) and elite (lowest). Since your advisor can't which class you'll be in, you'll probably see comparisons for the regular class. If you're found to be healthier, you'll get the pleasant surprise of a lower price. That's better than thinking you'll qualify for elite and having to pay more. 

If your health is even worse than regular or if you take part in dangerous activities like race car driving, you'll face a temporary or permanent surcharge for that extra risk.

Since companies assess risks differently, your advisor might ask you to apply to several insurers. 

After The Term
Circumstances change. You may find you that you need permanent insurance. Most insurers anticipate this and let you convert your temporary protection to pricier permanent coverage up to a maximum age (say 65). You don't even require proof of good health. You simply pay the higher premiums for the new plan based on your current age.

Your advisor may anticipate your changing needs and select a term plan from a company with good permanent plans. Your term coverage may cost a bit more in exchange for these valuable options.

The Proposal
Your advisor may take the time to prepare a simple easy-to-follow summary of the different products. Others skip that step and show you computer-produced illustrations for selected companies and let you pick. Others select a company for you and only prepare proposals for that one. These advisors may bring printouts for different coverage amounts to help with your budgeting.

Despite the simplicity of term life insurance, you'll see differences in the advisor approaches. Since products and prices are similar, you'll generally get a reasonable solution. The deviations hurt most with a complex product like universal life.

Links

• Oblivion: what happens if my life insurance company dies?
• Why you can't and don't buy on price
• Does Warren Buffett "buy term and invest the difference"?
• Why insurers won't insure you
• Secret 7: The best tax sheltering in Canada
• The power of redundancy
• image courtesy of clix (Brazil)

Podcast 59 (4:33)

direct download | Internet Archive page

PS Paying premiums monthly is great for budgeting but usually costs more than paying annually.

Canadian Life Insurance Sales in 2007

Canadians bought staggering amounts of individual life insurance in 2007

• $1.1 billion of premium (up 5% over 2006)
  
• $180.0 billion of face amount (up 5%)
  
• 652,617 policies (down 3%)
  

These figures from research organization LIMRA exclude group life insurance, generally provided by employers.

The Four Products
There are four main life insurance products, each with different characteristics. Here's a ranking by level of flexibility.

1. Term life for temporary needs (no tax-free investment growth)
   
2. Term to 100 for permanent needs (no tax-free investment growth)
3. Whole life for permanent needs and tax-free investment growth
   
• insurer overcharges but provides a refund (called a dividend) if
• mortality is lower than expected
• expenses are lower than expected, or
  
• investment returns higher than expected (the insurer makes the investment decisions)
  
4. Universal life for permanent needs and tax-free investment growth
   
• the insurer guarantees the mortality rates and expense charges for life
• you select the investments, how much you deposit, how often you invest
  

The Distributors
Life insurance is distributed primarily by

• career agents: restricted to products from one company
  
• independent advisors: select products from multiple companies

Let's dig deeper into independent advisors by looking at

1. what Canadians are buying
   
2. the average policy
   
3. growth trends

What Canadians Are Buying
Here is the market share for 2007 by new premium

1. Universal life: 67% (grew 12% in 2007)
   
2. Term life: 22% (grew 13%)
   
3. Whole life: 8% (dropped 4%)
   
4. Term to 100: 3% (dropped 18%)
   

If you look at the spectrum of choices, you see that 89% of premium goes to low-cost simple solutions (term life) and customized high-end solutions (universal life). There's very little in between.

If we rank by number of cases instead, the distribution is term (49%), universal life (32%), whole life (14%) and Term to 100 (5%). This pattern is probably what you expected.

The Average Policy
The average policy in the growing segment has the following characteristics

• term life: face amount of $388,035 and premium of $869
  
• universal life: face amount of $272,025 and premium of $3,947
  

The declining categories are remarkably similar

• term to 100: face amount of $85,806 and premium of $1,085
• whole life: face amount of $84,496 and premium of $1,033

In real life, you'll see wide swings that the averages mask. If available, I would have used medians (the midpoint when items are ranked from smallest to largest).

Growth Trends
If we look at the last quarter of 2007, we can see the momentum in premium growth:

• term life: +5%
• universal life: +20%

That's enough numbers for now. Let's see how 2008 turns out.

Links and Sources

• Canadian Individual Life Insurance Sales - Technical Supplement (LIMRA, 4th Quarter 2007)
  
• Does Warren Buffett Buy Term and Invest The Difference?
  

Does Warren Buffett "Buy Term and Invest The Difference"?

“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

Free Promises
Some insurance is free

• Travel insurance with your credit card
• Extended warranties with your credit card
• Ontario Place rain-free guarantee
• 30 minutes or your pizza’s free guarantee

This is possible because the benefits are limited and claims are infrequent.

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?

How The Government Helps
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.

Surrender Values
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:

“Berkshire purchases 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

Why Doesn't Everyone Know
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.

Online, most anyone can publish most anything without verification of facts. Wouldn’t you want to get other opinions? If you search using keywords like “buy term and invest the difference” you’ll find many articles on that alternative to permanent insurance. A good starting point is wikipedia. You won’t find consensus, though.

Using life insurance for tax planning requires specialized knowledge that few have. So teams are used (see The Financial TRAIL To Taming Your Financial Risks) with experts in risk (insurance), accounting, investments and law.


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

As a result, the tax advantages disproportionately go to the wealthy and the general public doesn’t even know.

What's Right For You?
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.

Links

• The perils of whole life insurance (new)