In most interactions with prospective clients who are interested in exploring a whole life policy, there's often a conversation that arises about life insurance guarantees. Given that most of the general personal finance writing out there nearly always presents whole life insurance as a heavy on guarantees it's not a big surprise.
We've written plenty about how whole life insurance can work as a tool to accumulate wealth primarily through the cash surrender value generated by owning a policy and we've often noted that design plays a major role in implementing a whole life insurance policy that works for its intended purpose.
When I think of design, there are a few considerations that come to mind that have a lot to do with esoteric insurance concepts. Given the lack of general understanding, I find myself traveling down the rabbit hole of insurance minutia that quickly glosses over the eyes of all but the most knowledge thirsty consumers of insurance.
But ultimately, there is a very easy and universally understood way to communicate, more or less, what I'm doing when I say I'm “properly designing a whole life policy for cash accumulation.” And that, simply put, means I'm doing my darnedest to cut out life insurance guarantees.
Whole Life Insurance Guarantees
The “massive” expense of whole life insurance comes from its guarantees. The product GUARANTEES that if you pay a guaranteed level of premium for a guaranteed period of time you will have a guaranteed amount of death benefit for your entire life and a guaranteed accumulating schedule of cash value…guaranteed!
On its face, this may or may not sound all that spectacular to you…depends on your world view and frame of reference. But if you begin to think about the complexity of providing these life insurance guarantees you begin to realize that the insurance company is offering guarantees on top of guarantees and then some guarantees to go with the guarantees.
Making such a promised commitment comes with a degree of risk the insurer must address and appropriately charge you for.
Taking Away of the Guarantee
Blending whole life insurance is a fundamental means to designing a policy such that is will excel at cash value accumulation. But blending by its very nature is a process of removing some of the guaranteed death benefit and replacing it with absolutely non-guaranteed term life insurance.
Now, an ardent whole-life-insurance-for-cash-value-only individual cares little about this fact, but those who purchase whole life insurance for different reasons (or perhaps a blend of reasons) must understand that blending whole life insurance does remove the absolute guarantee about the death benefit and now opens the possibility that a portion of your death benefit will go away if you do not or cannot afford to pay an increased level of premium to keep it.
Additionally, it also means that the level of premium that you pay for a given initial amount of death benefit is not guaranteed. Put another way, if you start out with a $1,000,000 death benefit and a planned premium of $20,000, a blended whole life insurance policy cannot guarantee that you will only need to pay that $20,000 to maintain your $1,000,000 death benefit.
Functionally most blended whole life policies probably have more than enough total premium to support the initial death benefit forever and always. If this weren't the case, the death benefit would be entirely too high for the given level of planned premium if the goal is maximum cash value accumulation.
No one who designs a whole life policy using the blending method can in fact guarantee that this will be the case.
You might ask at this point: then why does this matter? The answer is simple. Because not all blended whole life policies necessarily seek maximum cash value accumulation.
Cutting Expenses works in Both Directions
Through policy blending, we can either cut expenses to enhance cash value accumulation per the level of premium contributed to a whole life insurance policy or we can cut expenses to lower the committed premium you must pay for a given level of death benefit.
In either event, the life insurer isn't going to just agree to accept less premium for more death benefit, so if we are going to do this, we have to also concede certain features of the life insurance contract.
So if we use blending as a mean to give someone a level of death benefit at a lower premium to them, it comes with the understanding that this is not a guaranteed offer for death benefit at 75% of the original premium for regular whole life insurance. It is instead an offer to mix whole life insurance with term insurance to arrive at a targeted death benefit amount that may or may not work out for the insured's entire life–read: not a guaranteed death benefit for a guaranteed level of premium paid over a guaranteed period of time.
The Basic and “Supplemental” Ledgers
All cash value life insurance policies in the United States require that the agent/broker soliciting the sale provide the purchaser with a detailed report that explains the policy's features and summarizes functionality through a numerical depiction of possible values using current insurance company data to project said values. We often refer to these documents as “illustrations” because they intend to illustrate the functionality of the proposed life insurance policy.
If you've reviewed a whole life illustration that incorporates blending, you'll notice extra ledgers that appear to differ slightly from the first ledger–usually named the Basic Ledger–that appears in the document.
This secondary ledgers (and sometimes tertiary and so on) has different names, but for the rest of today's blog post I'll refer to them collectively as the Supplemental Ledger because that's the most common nomenclature.
The Supplemental Ledger's purpose is to note that some functionality of the policy as designed differ from the original whole life insurance policy and the life insurer wants you to understand that such varied functionality means you might not have guaranteed results to the extent that you assumed.
The industry takes a decidedly obtuse approach to this disclosure by referring you to the Basic Ledger to discover what functionality is guaranteed and what is not. There's no argument from me that this is less than perfect, but it's the compromise we all came to years ago.
The important point is simply this, the inclusion of a Supplemental Ledger in an illustrations notes that what you see where is likely not guaranteed and you should refer to the Basic Ledger to understand what is guaranteed about the policy. If you notice differences between the Supplemental and Basic Ledgers, you can assume that whatever the Basic Ledger depicts must happen for an intended result and whatever the Supplemental Depicts could happen based on assumptions made with current company data.
Applying this Information to Real Life
I'm not lost to the idea that a lot of what I've written today is rather dense and some might have difficulty figuring out how it applies to the sale or purchase of whole life insurance. Here is my attempt to take the above and apply it to what matters for most agent/brokers and consumers looking to purchase whole life insurance.
First, if you are seeking to use whole life insurance as a way to build wealth through cash value accumulation a lot of this may mean little to you. You should understand that some of the initial expenses assumed could change and this might make your results more or less favorable than depicted in the illustration.
Most importantly you should know that whatever death benefit figures you see may play out higher or lower than projected and if you are using the figures in the illustration as a way to meet life insurance need, it must come with the understanding that results can and probably will vary. Be ready to make adjustments as necessary.
While the premium amount paid for a given level of death benefit in this case is usually significantly higher than even regular whole life insurance would require, the death benefit is still not guaranteed.
Second, if you are purchasing a blended policy because you want permanent life insurance but don't have the financial means you afford the entire regular whole life premium, you have a lot more to pay attention to with this information.
You must understand that the guaranteed death benefit established for a guaranteed premium paid over a guaranteed period of time is off the table when policy blending takes place.
The premium figures the agent/broker arrives at could be adequate but it might not end up being the case. It's extremely difficult for most insurance consumers to truly grasp how realistic this figure is through the lens of death benefit supporting adequacy. My best advice it to inquire how the agent derived this premium amount and possibly collect some numbers from someone else to evaluate the difference. If you find another agent or insurer giving you very different numbers, you should practice some caution about the validity of the numbers.