Argument against Permanent Life Insurance: Low Rate of Return

is the risk worth the reward?

The rate of return argument against permanent life insurance focuses mostly on an irresponsible comparison of dissimilar asset classes.

Chances are good that most of you reading this understand that there is a relationship between the risk of an asset and it’s return; the two are positively correlated. This means the riskier an asset is (i.e. the more volatile it’s returns and the higher the chance you lose money if you buy it) the higher it’s long term rate of return is hoped to be.

People tend to be pretty comfortable with understanding thatbonds are less risky than stocks and therefore tend to return less to investors. There is still plenty of reason to buy bonds instead of stocks and the lower anticipated rate of return hasn’t prevented anyone who wants the diversification.

Logic that Collapses on itself

To follow the logic of bad life insurance returns in it’s normal presentation—essentially that a cherry picked historical data set assuming returns posted by the S&P 500 would have performed better—would be universally applicable to any other financial tool with a lower anticipated return.

All assets with a lower rate of return apparently are terrible and you shouldn’t even consider.

I can do Better with Passive Index Investing

The star student of stock slingers in the media is passive index funds due to their low costs.

There’s no argument from us that this can be a great place to invest some of your money. You won’t get identical returns posted by the respective indices, but you’ll be close enough. There’s also plenty of opportunity to benefit from market rallying years.

But index funds do nothing for a saver when things turn bad and pretending that things won’t turn bad is a great way to ensure a second career after age 65.

Life insurance is not a replacement for stocks in your portfolio it’s a complement and a really good one at that.

Compared to bonds or cash equivalents, we know of no other financial tool that offers the liquidity, high risk adjusted rate of return, reliability, and tax efficiency that life insurance affords its owners. It also lacks certain correlated movements that many of these assets have tended to show to the stock market in recent years (despite the fact they aren’t supposed to).

The Guarantees are Awful

Always tightly woven in to any argument claiming life insurance returns are terrible is a comment or two about the awful guarantees.

While I’m certainly not one to get too excited about the guaranteed column of the life insurance ledger, the guarantee is infinitely higher than that of stocks.

Additionally, the fact that the guarantee increases every year you realize returns better than the guarantee should not go overlooked. With stocks, you are always one bad day away from having all of your gains wiped out.

Silly Argument for Silly People

The claim that life insurance returns are terrible is nonsense and a form of weak thinking mostly intended to confuse and mislead. We’ve proven a few times that historical returns have been quite favorable.

We’ve also shown that despite not being an asset that one should compare to stocks, historically a well designed product has compared extremely favorably to stock market returns.

But life insurance isn’t just about the gross rate of return. There’s a multitude of benefits life insurance affords its policyholders and when factored in the net net return is substantial when compared to other savings/investment choices.


3 Responses to “Argument against Permanent Life Insurance: Low Rate of Return”

  1. VB says:

    I’ve written articles for major news outlets on this subject and buying term to invest the difference always comes out ahead.

    Look at this example:

    If you invested the max IRA contribution of $5,500 into your IRA from 1991 thru last year you have $496,000. Using the Money Chimp calculator to determine the annual growth rate.

    If you invested that same $5,500 into whole life insurance with a 5% return you’d have $239,000.

    Investing in the market makes you about a quarter of a million dollars richer. Looks like those low returns from whole life insurance are pretty bad.

    • Brandon Roberts says:

      Hello VB,

      I thought I was pretty clear about life insurance not being a replacement to stocks, but let’s address your comments nonetheless.

      First and foremost you’ve made a fatal error in your assumptions about market returns and how they translate to actual investment gains. The Money Chimp calculator will only tell you the lump sum investment CAGR for a given time period. You chose to make an example that uses periodic investing. These are two very different ways of investing and the results vary pretty dramatically. We’ve talked about this before; you and anyone else who wants to read more about this can find that article here.

      I also think you made a counting error as I can’t get the same results that you state when I do the math. I think you mistakenly counted your timeline as 23 years when it should be 24. Using 23 I get your results, but your timeline is actually 24.

      Going back and using the data from Money Chimp to calculate a CAGR for a systematic investment such as the one you described in your example, the actual balance at the end of 2014 is $452,230.95, which is less than the incorrectly calculated $496,000 balance you claimed (it should have actually been $552,787.10 by my math–simply using the FV function in excel). The effective CAGR is 8.88% not the 10.21% I get from Money Chimp which assumes a lump sum investment. Please note something here, this is a difference of over $100,000 and I would think makes a substantial difference in the way one might analyze and set course for future planning if they knew the true difference. Riddle me this, how many years would the average American have to work to net this $100,000 difference?

      But lets get a little deeper into the weeds. The assumptions above (both your inflated CAGR assumption and the actual systematic investment correction) assume two things that are flawed:

      1. There are no expenses to the investment

      2. You can invest directly in the S&P 500

      The first one is pretty self explanatory, adding some degree of expense (which would absolutely happen) reduces the results.

      The second one isn’t quite as self evident so let’s simply point out that you cannot invest directly in the S&P 500. While I won’t say it’s absolutely impossible to create an investment portfolio that 100% mimics the S&P 500, I’ll note it would be nearly impossible especially for the time period we’re talking. Best one could do is find an index fund, which have always lagged the actual performance of the S&P 500 (so again a downward adjustment would be necessary).

      Also, your hypothetical completely ignores the fact that in 1991 you could not place $5,500 into an IRA, the maximum from 1991 to 2000 was $2,000.

      Now to life insurance…

      I’m not exactly sure where the 5% figure comes from, but we have data that shows the actual CAGR on a policy in existence for most of this time period is much higher. Here is the link to the article that shows a 7.76% effective CAGR on a historical whole life policy.

      If we assume this CAGR we get much more than the $239,000 you suggested, we get $382,758.85 But since you also apparently counted the years wrong there, the actual end result assuming 5% should have been $256,999.04 that’s $125,759.81 more using the proper assumed CAGR given actual historical results.

      Anyone else notice that you overstated stock market investment performance by ~$100,000 and understated the whole life performance by ~$100,000?

      So the true difference between them (assuming you magically pay no fees in your nearly impossible 100% investment in the S&P 500) is $69,472.10. That’s whole lot less than the quarter of a million dollars you claimed.

      And then there’s taxes. As you should know, the whole life policy can completely avoid tax liability upon distribution. The IRA would not. And I know you didn’t mean to suggest this was a Roth IRA because those weren’t available until 1998. The taxability difference quickly diminishes the ~$70,000 difference pretty quickly.

      So please, feel free to come back and tell me how buying term and investing the difference comes out ahead (since you’re obviously so well versed on this subject…after all “major news outlets” appear to trust your judgement on this subject) By the way, not sure you noticed, but you totally forgot to deduct some money from the IRA contribution to pay for that term life premium.

  2. Insurance Guy says:

    The other thing to consider with Buy Term and Invest the difference is the client has to actually invest the difference. Will the client have the discipline to put that amount into their investment or more likely does the strategy turn into Buy Term and spend the difference.

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