It occurred to me somewhat recently that all my praise for cash value life insurance has left some unanswered questions regarding execution. This is purely a function of precious little time and the needs for a more diverse range of topics. This week I'll be rolling out a two part series on the subject (two so that we can spend ample time sorting out how it's done with whole life and universal life insurance). And since whole life is way trickier, we'll start there.
I've stated before that most agents and brokers don't understand what it truly takes to focus on cash value and income potential when it comes to whole life insurance. But I've spent little time explaining why that might be.
Few new agents are allowed the time to really understand the products they sell. Even fewer care (sad, but true). But even in the face of that reality, I won't lean on that as my primary reason for why agents/brokers don't understand this. The big reason: it's really unintuitive.
So, compound the pressure a sales manager places on a new(er) agent with the fact that it takes some serious depth of knowledge (this rabbit hole is long and winding) and you have an understandable explanation behind why a lot of agents (and I'm not just talking rookies) don't get this concept.
I want to also open up the box and talk compensation for a minute.
Because there's a good chance that consideration fuels this just a bit. For reasons we'll see near the end of this post, lack of understanding isn't the only driver behind what's going on.
Agents/brokers are paid based on commission and some products/designs pay better than others. It's unfortunate to have to admit (and I've admittedly not wanted to call this out publicly) that sometimes this strategy is overlooked because there's simply less money in it.
In order to understanding exactly what whole life “blending” does for us, we need to first have some idea of what Technical and Miscellaneous Revenue Act of 1988 did to the cash value life insurance world. This piece of legislation established what is known as the Modified Endowment Contract (or MEC).
A MEC is created whenever a life insurance contract receives enough premium to pay for all of the policy's future benefits within a period of 7 years. That wasn't my most articulate moment, so to elaborate further, a MEC occurs when a product could become a paid up policy within 7 years. For more details see the link in the paragraph above.
The additional term insurance allows us to place additional premium in the policy.
Thinks of it this way.
There's only so much money that can flow into the contract in a given year, and the basis for that restriction is the policy's overall death benefit. We use term insurance to increase the threshold of cash that can enter the contract each year. We use term insurance because it's cheap and can be replaced by the death benefit that is established by paid-up additions.
The ability to access additional paid-up additions are coveted because PUA's have much lower expense loads than base traditional whole life insurance.
If you checked out the link above, you'd know that MEC testing considers net premiums leaving no allowance for expense loading, so anything that allows for premiums with lower expense factors means a leaner dollar in with respect to our limitations.
It's important to make the following distinction. The cash value build up in a standard whole life contract is mostly coincidental (gasp).
It's true, that doesn't mean that buying whole life for permanent death benefit's sake isn't useful. It does mean that if an agent sings whole life's praises as an asset play, and then designs your policy to be 100% base premium, he or she is either ill-informed or mischievous.
When you look at an illustration, you want it to look for something like this:
This shows us what portion of your outlay goes towards base whole life premium and what portion will go towards paid-up additions (we want as much going to paid up additions as possible).
So, if you're are evaluating an illustration or a life insurance proposal, it's important to pay attention to how much is going into paid-up additions.
This particular policy looks like it has a very expensive term insurance cost. In truth a large portion of that stated premium is also paid-up additions as the rider is designed to replace the term insurance death benefit with paid-up additions by design.
Meaning a good portion of the nine and half thousand dollars you see there is paid-up additions and not just term premium.
There are certain exceptions concerning 10 Pay whole life products. Some of these will allow paid-up additions beyond 10 years, but there is typically a limitation based on the base whole life premium.
In these cases, it often makes sense to have the majority of your outlay base premium for the first 10 years (10 pays are High Early Cash Value products that have lower expense loads than traditional whole life).
This will prevent certain funding restrictions in later years.
Knowledge is a big one and quite frankly a lot of agents just don't get it–even after I explain it to them.
Blending is traditionally thought of as a way to cheapen a whole life premium by adding some term insurance to it. It's also often looked at as something that “hurts” policy performance because often time dividends will be used to pay the term premium.
If the blend is done in the traditional sense (to make the outlay as low as possible) this drag on policy performance is certainly true.
But when we approach this from the perspective I'm talking about (to increase the MEC limit so as to stuff as much cash as possible into the policy) the opposite is true. If you don't believe me, feel free to contact me and I'll prove it to you beyond any reasonable doubt.
And now it's time to go there. Some agents don't get it, and some agents don't want to get it. Why?
Because policy blending pays less. In some cases a lot less.
Here's how it works.
Go back up to the picture above showing the planned outlay as it's broken down by base whole life premium and the paid-up additions rider. The base whole life premium is where the money is at for the agent, paid-up additions pay the agent the equivalent of Mutual Fund A shares (i.e. a lot less).
Why give up all that money if I convince you that regular whole life will be just fine?
After all, I have a mortgage to pay, kids to feed, and company conferences for which to qualify. And it's a heck of a lot easier to get there if 100% of your outlay is stuck in base whole life premium.
This doesn't mean there will never exist a time when not blending will make sense. If you need the policy for death benefit only, then blending doesn't really serve you all that well. Participating whole life policies that purchase paid-up additions will out-pace inflation most of the time quite favorably, so from a pure death benefit perspective it'll make perfect sense.
There may also be times when more base premium breaks into a higher dividend band which may outperform a richer blend with more paid-up additions. It won't likely outperform in the short run (i.e. you'll likely need to be out 40+ years to benefit from it).
There are some circumstances where it might make sense, and this is why taking time to review plans and review multiple carriers' products is a good idea.
That's pretty much all you need to know about designing whole life for cash accumulation purposes.
Next time we'll discuss how we design Universal Life Insurance for cash accumulation. The process is traditionally very different for a few reasons. Good news is, we'll have all the details for how cash value life insurance as an asset class works when it comes to universal life insurance.
Brandon launched the Insurance Pro Blog in July of 2011 as a project to de-mystify the life insurance industry. A specialist in the design and application of life insurance cash accumulation features, Brandon is one of the foremost authorities on the subject of coordinating life insurance cash values in a financial plan.