Buy Term and Invest the Difference Is Still Broken

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Buy term and invest the difference is an academic argument that suggests you should skip the “expensive” whole life insurance et. al. and instead by “cheap” term insurance.  You should do this because it will free up financial resources to then invest in the stock market, which will produce more money for you than the cash value build-up of a whole life or universal life insurance policy.

The idea originated several decades ago around the time mutual funds (as we now know them) first arrived on scene and were available to the public at large (keep in mind that at that time the public at large meant mostly wealthy people).

Despite being picked up by a host of financial bloggers and media types, cash value life insurance continues to maintain a strong position in the financial lives of many Americans.  Additionally, we showed data years ago that invalidates a key buy term and invest the difference claim that most people don't need life insurance when they get older.

We recently revisited this subject reviewing new data on the subject.  Spoiler alert: BTID still can't substantiate with empirical evidence.

Older Americans Traditionally Buy a lot of Permanent Life Insurance

Our original work on this subject used data from the actuarial consulting company Milliman.  The research we cited came from 2007 and showed us that roughly 50% of all universal life insurance policies issued in that year were on the lives of individuals 55 and older.

Older Americans aren't just buying a lion's share of the policies issued, they are paying a lot of premiums to do it.  We discussed a few months ago the fact that permanent life insurance becomes much more expensive if you wait to buy it, and the original Milliman report supports this observation.  According to the same work from 2007, the 55+ crowd paid 75% of all premiums collected by insurers for universal life insurance in that year.  Not surprising statistics as we know permanent life insurance becomes significantly more expensive the longer we wait to buy it.

I want to take a brief timeout and be sure to highlight a significant element to this data and why we were originally interested specifically in it.  The research from Milliman is a huge analysis of universal life insurance spanning an array of topics about the product and what life insurers experience in selling it.  The fact that older Americans purchased 50% of the policies and paid 75% of the premiums in 2007 was but a page or two of the voluminous report (i.e. this wasn't a report focused specifically on older American's buying life insurance versus younger Americans).

Additionally, the data collection comes from surveying major life insurers who issue fully-underwritten universal life insurance.   So we're not talking about small final expense policies intended to cover the cost of a modest funeral.

We're instead talking about the full health questionnaire, collecting blood and urine samples, EKG requirement, etc. underwriting that is a part of most major life insurance applications (at least at that time it was).

But if you were a sharp student or practitioner of finance or financial planning, there is one glaring difference between 2007 and now that might inflate life insurance sales.  Tax code especially focused on the U.S. Transfer Tax laws changed dramatically after 2007 and resulted in far fewer Americans having to worry about Federal Estate Taxes.  So perhaps the 2007 data skews due to Estate Tax Planning.  So that was then, what is happening now?

Older Americans Still Buy a lot of Permanent Life Insurance

The data that brought this subject back to the forefront for us came recently from the Medical Information Bureau (MIB).  The MIB is a repository for life insurance underwriting data.  Put simply every time someone applies for full-underwritten life insurance, a record of that activity usually shows up at the MIB.  Life insurers use this as a way to ensure that applicants aren't concealing past attempts to buy life insurance that maybe didn't go as they hoped.

It also works as a way for life insurers to check on application activity to ensure that the applicant doesn't have a bunch of life insurance already that he/she is trying to hide in an attempt to acquire more death benefit than he/she should have to be reasonably insured against financial loss upon his/her death.

It's also worth knowing that the Medical Information Bureau can work as a way to find life insurance you didn't know a deceased spouse or loved one had.  Individuals can use the MIB to inquire about life insurance underwriting activity for someone who died if they suspect the person had life insurance but no one knows much about it or what company issued it.

In other words, the Medical Information Bureau compiles a lot of data on underwriting activity and it regularly releases broad data on life insurance application activity.  The reporting isn't very detailed (it doesn't need to be) but it reports on things like the number of applications for life insurance made within a given period of time and breaks down the new business applications by age ranges.

The most recent report from February 2019 tracking the one year change in application volume (i.e. Feb 2018 to Feb 2019) shows us that application activity among individual ages 60+ was up for the year by 12.5%.

Comparatively application activity among the 0-44 crowd was down 4.4%.

Additionally, Milliman data from 2015 shows us the average age of a universal life insurance buyer was early to mid-'50s.

I do want to point out a distinction between the MIB and Milliman data.  MIB data tracks all types of life insurance, while Milliman is exclusively focused on universal life insurance.  So we cannot say with certainty that all of the 12.5% year-over-year increase in new business life insurance activity was exclusively permanent life insurance.  But what we can conclude is that 60+-year-old Americans are buying more and more life insurance, which probably indicates they ignored the suggestion that they simply buy term insurance when young and work on “self-insuring” through investing the money they “saved” by not buying permanent life insurance.

Buy Term and Invest The Difference is Intellectually Flawed

The academic construct of buy term and invest the difference suffers the same garbage-in-garbage-out problem a lot of models face.  The equation used to support the idea is too short-sighted to control for multiple variables that play out in practice and unfortunately, most people don't learn how important this nuance is until it's too late.

Sure there are people who, more or less, bought term and invested the difference and appear to have financial resources adequate to claim low to zero need for life insurance while also accomplishing (or at least being on target to accomplish) their retirement needs/goals.  But there is little to no data that suggests this is anywhere close to a majority of Americans.

We also have to question how realistic it is to model our own lives after some of the biggest proponents of this cause.  Suze Orman and Dave Ramsey have both trumpeted buy term and invest the difference, but neither one of them achieved great wealth through merely buying term life insurance and investing the difference.

Their economic achievements have much more to do with their commercial success of advocating financial principles they themselves do not follow than it does with any austere approach to budgeting and investing.

A.L. Williams, the founder of Primerica and one of the biggest and most adamant advocates of buy term and invest the difference achieved incredible wealth through selling expensive term insurance as a replacement to those who owned or were considering a purchase of permanent life insurance.  He arguably is the most successful BTID-er ever amassing a billion dollar net worth in the process.

As for the financial bloggers, several are near the starting out phase of their life so it's difficult to assess where they'll end up, those who have achieved more commercial success find themselves in a position of monetizing a blog that created wealth rather than simply applying thrift and studious saving.

But the biggest flaw in the construct is the fundamental claim that no one needs life insurance as they reach retirement because they can use their savings to “self insure.”  Even Primerica tried to legitimize this idea with its Theory of Decreasing Responsibility.  The problem with the idea is that it depicts what someone believes people should do rather than observing what people actually do and developing a way to deal with it.

The real danger in all of this is the euphoria we often get caught up in when the self-righteous preach.  Sure we might gain an ounce of motivation to tackle the daunting task of organizing our financial lives.  But soon that motivation stalls out and we slide back into our old habits.

BTID is like Trying to Explain Entropy with Arithmetic

There are those who, just as I did when I was younger, will decry my argument and tell me that I'm accepting bad behavior.  Trust me when I say I've argued this same point on similar subjects many more times than most of you have.

I'm older now, and I've come to the realization that I can build the most logically (on paper) airtight argument on whatever subject I wish.  If it conflicts with standard human behavior, my perfect solution is dead on arrival.

This is a common problem afflicts buy term and invest the difference, which at its core is really nothing more than an appeal to cut your spending on other options and use that saving to buy more investments.  It doesn't have to be life insurance.  You could downsize your home, car, or vacation habits and invest the difference.

But most advocates of BTID are less concerned with trimming your spending in other areas and wish instead to make an argument about the superiority of term life insurance and the stock market coupled together to bring you immeasurably more wealth than buying whole life or universal life insurance.  They further support their claim by pointing out that you are supposedly wasting money on the lengthier death benefit provided by both types of permanent life insurance because you shouldn't need it when you are at or near retirement age.

Advocates of this idea have spent many hours presenting spreadsheets that numerically support their claim.  But what happens on paper rarely happens in real life.  And, as I've already mentioned, almost always fails to take into account a multitude of variables exogenous to a model that simply compounding a hypothetical investment year over year at 8% to show someone how much money they'll have at 65.