(Complete Show Notes Below)
In the 60th episode of the Financial Procast:
So today we’re going to get into something we should’ve gotten into a long, long time ago. Admittedly it’s a tad embarrassing that we’ve not compared whole life insurance and universal life insurance side by side either on The Insurance Pro Blog or the Financial Procast.
We only talk about it with our clients and prospective clients every day. Why ever would we think that it’s a topic of interest to our community?
On a pretty frequent basis, we are faced with helping people who’ve spent a fair amount of time reading any number of a couple different books that seek to inform readers on the wonders of cash value life insurance.
Typically we are being asked by these well informed folks to help them design a strategy that will work for their particular situation. By the way, I should add that we love working with people who are well informed.
Sadly that’s not the case with many agents, they’d rather their clients and/or prospective clients be completely uninformed. Why you ask? Ahhh….because it’s much easier to sell what they want to sell.
Very sad but very true.
But I digress.
Back to the discussion at hand—we believe strongly in providing equal opportunity to both whole life insurance and universal life insurance when designing a plan. The issue is that “the books” tell people that one is better than the other…most of the popular books on the subject come down on the side of whole life insurance.
And my “Mutual Upbringing” indoctrinated me to believe that ALL universal life insurance was B-A-D. Why? Cause it’s that product that second tier life insurance companies came up with to screw customers out of their money.
I know that sounds like I made it up…but I’m not.
Nope…no way to say that definitively.
There are too many variables to consider with every situation:
1. How old are you?
2. Do you have an income objective i.e. are you looking to generate retirement income from your policy in the future?
3. How long are planning to fund the policy?
4. What’s your budget for funding the policy?
It’s not a matter of which one is better—it’s which type of policy is better for you.
There are undoubtedly better guarantees and certain other things that are set in stone from the very beginning. However, because of those guarantees you are potentially sacrificing some higher return down the road.
Ultimately stability is the key to whole life insurance. The guaranteed column on a whole life insurance ledger doesn’t fall apart as long as you pay the premium as planned, don’t take out too much money or doing something else to hose it up.
Some criticsms of whole life insurance include: it’s rigid, the mechanics are really obscure, it’s essentially a black box with all sorts of secret stuff inside and generally unforgiving in that it you can’t pay your premium—your policy will lapse.
Our experience is that even the most poorly designed policies don’t necessarily run into any difficulty if you can’t make a premium payment. Now, if you’ve only had the policy for a month, you’re not going to have a lot of options but I'd say in my experience that’s a low probability event.
Now, if your whole life policy is designed correctly—as we design them, your total premium commitment will likely be much lower than what you’re actually putting into the policy.
Most of our whole life insurance policy designs take advantage of blending to accomplish this goal. We reduce the base premium of the policy by adding in term insurance which in turn allows you to maximize the amount of money we can stuff into paid up additions (PUAs). For more detail on that, read Does Blended Whole Life Really Work?
By using this design strategy, you significantly reduce the premium commitment as anything you are applying to paid up additions is completely optional. The catch is we have to plan for the PUAs on the front end, otherwise you won’t be able to take advantage of them.
This gives us so much flexibility in the future, however, there still remains a few other options for paying premiums if the need arises.
1. You can use cash value in the policy to pay the premium (assuming you have some)
2. If the policy is old enough, it’s possible that your dividend is large enough to pay your premium (woohoo!). Now this is not likely something your agent will tell you, but it should be evident on your annual policy statement the amount of your dividend and such will be clear to you whether it’s enough to cover your premium.
We admit that there is a lot of obscurity in a whole life insurance contract, every company that sells a participating whole insurance policy cloaks all of the internal costs and expenses. It can be difficult if not impossible to know certain things—like “did the company pay me the dividend they should have?”
While it is a concern, I really don’t think it’s valid. The danger is small as the insurance industry is hyper-competitive and any company who blatantly violated their policyholders would be destroyed.
The big benefit is flexibility. There’s actually no stated premium with universal life insurance—just an amount that you should pay each year that’s associated with the expenses of the policy and as long as those are covered you’re a-okay.
Universal life insurance also has a higher potential for yield…theoretically and it’s often times referred to as the unbundled product as it is very transparent. In fact, all of the costs and expenses are disclosed within your policy—with whole life insurance, those items are always cloaked in mystery.
What’s the beef?
There are very little in the way of guarantees. Yes, there is a guaranteed minimum interest rate and there was a time when this rate was very decent…think 4% or %5. Nowadays, not so much it’s as low as 1% or 2% in some cases.
What else? Well, the expense charges and mortality costs can increase. In fact, the mortality costs do increase on a regular schedule. Some of the whole life hacks will say, “The mortality costs spiral out of control”.
Here are some other highly contested items in this debate:
Criticism: The rising cost of insurance (a favorite of the whole life hacks)—because the cost of insurance is going to increase every year you own it, the policy becomes infinitely more expensive.
Truth: It doesn’t happen…if the policy is funded correctly. The expense assumed to put a given death benefit on a person doesn’t vary from one product to another. It’s NOT more expensive for someone who dies with a universal life insurance policy than it is for someone who owns a whole life insurance policy.
The building of a policy is no different, the only advantage whole life insurance has is that it requires you put more premium in the policy. Remember universal life doesn’t require any certain premium and this is really why it gets a bad rap. Most of the universal life insurance policies that have run into problems did so because there wasn’t enough premium being paid to the policy.
Agents trying to sell universal life insurance as a cheap alternative to whole life insurance created the problems for universal life insurance. They were using the hyper-inflated interest rates of the early 1980’s (which is when universal life first hit the scene) in the design of the policies and when interest rates fell it caused problems for those policies.
Remember, universal life insurance is interest rate sensitive and the returns on cash value are used to offset the rising mortality costs. So, if the projections on cash value growth are not achieved you’ll have to pony up more premium to cover the expenses.
So, how do you know if you’re funding your universal life insurance correctly?
If you get an illustration for a whole life insurance policy that states the premium is $5000/year for a $250,000 death benefit, you should plan to fund a universal life insurance policy with a $250,000 death benefit with the same $5000. Remember the costs aren’t really different between the two, just your ability to vary the premium.
If an agent every tries to tell you anything different…run.
Universal life insurance isn’t bad, it's just that some policies have been sold by agents who used poor sales tactics to make a sale. I can attest to the fact that we've seen some equally egregious mistakes made by agents selling whole life insurance, however, whole life policies tend to cover the poor design very well.
Criticism: Look at the guaranteed column, this policy falls apart when you’re 65.
Truth: That assumption is based on the fact that the interest rate has been dropped to the lowest possible guaranteed rate and that the insurer is now assessing highest possible charges for both insurance and administrative costs.
Despite what the whole life insurance hacks will tell you, insurance companies can’t just raise their expenses because they wanna make more money.
In fact, they have to seek regulatory approval to do this which means that they have to prove that their mortality costs have exceeded their actuarial projections.
Historically, most insurers have been found to “overassume” the expenses in their projections (which is exactly what one would expect an actuary to do) and actually return the expense to the insured as an interest bonus.
Insurance companies don’t just raise costs and expenses willy nilly. They don’t just decide they need to make more money, so let’s make everything more expensive.
Again this is another one of those things that is a fact—yes the interest rate could drop to the minimum guarantee and the company could raise the expenses in the policy. However, it’s not a valid concern. It’s never happened and we can’t see a place where it ever would.
The plan of attack is not about which is better, it should be about which one provides more benefit to me and my situation. You must compare, take all the variables into consideration and put it on a level playing field.
Our suggestion to you—be open.
Brantley is a practicing life insurance agent and has been for nearly 18 years. After years of trying to sell like his sales managers wanted him to, he discovered that people want to buy life insurance if you actually explain the benefits.