Recently I've noticed that whole life insurance is generally berated by almost everyone in the known universe. Well, most insurance agents really like it but other than that it’s pretty easy to count the number of folks who really like whole life insurance.
Obviously, we consider it to be an excellent component to an overall investment strategy, and as such I thought it would be useful to elaborate on a few of the applications that whole life insurance can bring to the table. (this could also apply to other types of permanent insurance as well) And I know I'll get beat up for just mentioning the word investment and life insurance in the same sentence. But considering a properly structured cash value life insurance policy as a portion of your retirement savings, emergency fund, or your kid(s) college fund is a solid plan. We can and continue to prove it everyday in our practice.
What I'd really like to do is elevate the discussion on whole life insurance as a financial tool. No, it's not the Swiss Army knife that quite a few authors make it out to be and it certainly isn't the right fit for everyone. But it is extremely useful for the right person/people and under the right set of circumstances.
I think there should be a more honest intellectual debate on the subject and hopefully we're successfully doing that.
In light of that thought I've picked five myths that I've heard most often in regards to whole life insurance. But alas to talk about all five in one post would be more than anyone (including myself) could bear and I'd really like for our loyal followers to actually come back.
So, I decided to just focus on one myth for today.
Whole Life Insurance has really high commissions
Hmmm….
Well, this could be true I suppose in some cases. Of course, how does anyone determine if a commission is too high? Isn't that really a relative number?
Here's what I mean.
Just a couple of years ago I sold my house. In fact, we decided it was time for a move at the end of 2009…we couldn't have really picked a worse time right?
At any rate, that's when the stars aligned for us for a whole host of reasons I won't get into here. Needless to say, I knew that the market was flat at best and at worst I could stand to lose a substantial amount of money in the transaction if not executed properly.
So what did I do?
I hired a realtor. Not just any realtor. No, I hired someone who was serious about their work, wasn't afraid to tell me what I needed to do to get the house sold, and didn't float some pie in the sky listing price just to make me feel good. In fact, she's not the kind of person that makes you feel all warm and fuzzy but she is the kind of person that is extremely focused and organized. I knew she would get the job done.
Now, I could have sold the house myself or I could have attempted to beat up on her and get her to lower her 6% commission but I didn't. Why? After all I understand finance and I do have decent negotiating skills.
But what I know is that she's going to spend a significant amount of money marketing my property, getting the right people in the door (the kind of people who can actually BUY the house) and she's going to get it closed. That was valuable to me, it was worth the commission.
I don't believe there's anything inherently evil about commissions. Every person who's in business earns a net profit…at least that's the goal. If they don't they won't be in business very long. The commission my realtor earned is just her gross profit. From that few thousand dollars she had to pay for her office, her transportation, her staff, advertising etc. If she's like most business owners that we work with, probably only 20-25% of that money actually went into her pocket and then she owes taxes on that amount. Not to mention the fact that because of the mortgage underwriting process it took nearly two months from the contract date to the closing date and that included a great deal of time working out the details with the buyer and keeping me in the loop.
I'm not saying you should feel sorry for her, I'm just saying that's the reality of being in business. So, to act as if any person who earns a commission is somehow gouging everyone they do business with is just not a fair assessment.
Do People Get Gouged Buying Whole Life Insurance?
Now, I will concede that Brandon and I do encounter other agents in competitive situations who really are trying to gouge their clients. They usually justify it to themselves as “I'm worth it” but in our experience they're not. And in truth a properly designed whole life insurance policy(blended with a heavy dose of term insurance and paid up additions) pays significantly less commission to an agent than does a traditional whole insurance policy that doesn't have those components.
Sadly enough, this point has a kernel of truth. A lot of agents that we encounter are driven to sell products that pay them the highest commissions and this can certainly motivate them to recommend strategies that may not be in the best interest of their client. What we typically see is something we've coined as the third dimension of cash value life insurance, I encourage you to read that post if you haven't already, it's one of our best.
You have to realize that a properly structured whole life insurance policy can be extremely flexible. We can modify a contract by adjusting the amount of premium dollar that flows to paid up additions (PUA) via the paid up additions rider, the amount of term insurance that's used in the blend and how long you fund the policy. The PUA contribution is completely optional and really just serves to accelerate the growth of your policy's cash value and subsequently its death benefit. Proper use of paid up additions takes a sluggish, slow growing policy and turns it into a completely viable investment option.
The internal rate of return is nothing to sneeze at. In many cases we see it move north of 5%. Why not consider it as an alternative or portion of your fixed income portfolio?
Why Don't More Agents Take Advantage of the Paid Up Additions Rider?
Well, there's two answers to that question;
1. They don't understand the power of using paid up additions because no one has ever taught them how to use them correctly or
2. Paid up additions don't generate near as much commission for the agent. Sad but true. Example: If a client pays a premium of $10,000 and that's all base premium, no PUAs included, he/she will make anywhere from $7,000 to $9,000. On the other hand, if the agent were to sell the client a policy that had a $2,000 base premium and $8,000 of paid up additions, they'd only make about $2,500-$3500. Now you know.
My point is that a poorly designed policy doesn't make whole life insurance a bad product, it just proves that person you're dealing with doesn't really have YOUR best interest at heart.
As I said, I had originally planned for this post to be something like “Five Common Myths About Whole Life Insurance” but I think I'll save the rest for future posts, in fact, I'll just make it a series.
In reality, FYC has 2 meanings. For the Agent its First Year Commission. For the client its First Year Cash (Value). Not exactly a zero sum game, but there is definitely a strong inverse relationship between the two. I liked the Vanguard Founder’s quote from the PBS Documentary, where he said in all business the business wants to increase profits, which is fair enough in business, but that mentality is not right for ‘this’ business. We need to be profitable, but so do our clients.
But… when I sell a house, I know what the commission is because it is in the contract. Why are commissions such a secret in the insurance industry? And why is it that almost every thing said in the sales pitch is never ever written down …
Mike,
We’re not here to excuse bad sales tactics employed by weak agents/brokers. In fact, we tend to be hyper critical of them. Commissions aren’t a secret for us. We’ve disclosed commissions quite publicly here, and have no problem disclosing them to anyone who comes to us looking to buy a policy.
It’s certainly true that there is somewhat large variance in the way companies choose to pay agents/brokers (i.e. some companies pay a lot more money up front while others choose to pay out compensation over a longer period of time) but allowing commissions to influence what product you present to a client is certainly not condoned by us.
I’m not saying it’s rare, we see a lot of it. It pisses us off just as much as it does the general consumer.
Regarding things not being written down, again bad sales tactic. I personally provide people with notes from conversations I have with them as a CYA measure.
Here is another twist on the real estate agent commission analogy….
The RE Agent’s commission is quoted as a % of the House’s Sale Price…not a % of the annual mortgage payment. The mortgage payment is an installment payment of the Sale Price. If we did this, those RE Agents would be making a HUGE % of the first year mortgage payment.
What if we quoted the Insurance Agent’s commission as a % of the Death Benefit, not a % of the installment payment for the death benefit (ie the premium which is analogous to the mortgage payment)