It's hard to figure out what life insurance policy is best. When it comes to purchases focusing on cash value, we want an easy way to compare policies and declare a winner. A naturally obvious way to do this is focusing on anticipated rate of return. But how people go about sorting this out often leads them in the wrong direction.
The return on cash values is driven by unique elements depending on the type of life insurance policy. For whole life insurance, we focus on the dividend interest rate. For universal life insurance policies we focus on the interest rate payable on the policy.
It seems obvious that we simply compare these “driver of return” to evaluate which product will perform best. Unfortunately, life insurance involves nuance that often leads to false conclusions if we do this.
All life insurance policies come with expenses. These expenses to fall within a range of acceptability given the cost of offering you insurance. This range, however, is quite large. Additionally, not all life insurance policies falling under one broad name seek to accomplish identical goals.
For example, some whole life insurance policies seek to provide lower cost death benefit relative to a required premium amount. Other whole life products might seek higher cash value development. The expense assessed on these two types of policies likely differ. These different expense will impact how quickly the cash value in the policy accumulates. So while the dividend interest rate might be the same, one policy has more expenses assessed against it than the other. These higher expenses will negatively impact cash value. The same can happen with universal life insurance.
The dividend interest rate declared by the life insurance company tells us roughly the return on the policy attributable to life insurance company investment income. It's a singular variable in a larger equation that ultimately arrives at the total dividend payout.
There's a good chance that you find this an obtuse way to report on facts and figures for a financial product. I strongly agree with your assessment. But this is a long standing practice among life insurers that is unlikely to change in the near future.
So we must keep in mind that the dividend interest rate leaves out things like underwriting profits and administrative expenses that also affect the final dividend payable to a policyholder. We also do not know if the dividend rate declared assumes any expense adjustments the life insurer might take for the cost of managing the assets. Some insurers report the dividend net of fees, while others report before assessing fees.
We've noted several times here that the only real insightful thing we can do with the declared dividend rate is assess how it changed over time at a specific insurance company. While it's one of many variables that comprise the final dividend payout, it's traditionally the largest influencer of the final dividend payment. For this reason, we track it to determine if policyholders are likely receiving more or less dividends over time.
Universal life insurance makes things easier than whole life insurance. The interest payable on a universal life insurance policy is the interest paid on the cash value held in the policy. So if the policy has $100,000 of cash value and the current interest rate payable on the policy is 3%, the policy earns $3,000 in interest.
It seems, then that we could easily compare interest rates among universal life insurance companies to quickly assess who is better. But again, expenses play a role in adjusting these figures.
So while we can definitively say that 4% paid on cash value is greater than 3% paid on cash value, we do not necessarily know that the net gain in the policy will be higher on the 4% universal life contract if we do not also know the exact amount of expenses deducted from the policy.
Adding additional complexity to the subject is the fact that most universal life insurance policies available for purchase today rarely use just a fixed rate of interest. While the option is available, most universal life policies sold today have an indexed feature. This index feature pays an interest rate on the cash value determined by the movement in an equity market index (e.g. the S&P 500 index) with various adjustments. The fluctuation of these adjustments make it exceedingly difficult for the layperson to compare policies and speculate which one might provide more or less return on his/her money.
Things fall even further off the rails when one attempts to compare universal life insurance against whole life insurance and compare the interest rate payable to universal life insurance to the dividend interest rate of whole life insurance.
For reasons that I've discussed above, the two are not related and there is no substantive observation we can make about the products by comparing these numbers.
Despite this, I understand the temptation to try and draw a parallel between them. We've seen numerous attempts to use these data points to make some evaluation across products. A common one is trying to hold them equal to on another.
This takes shape by requesting that we adjust the dividend rate and the universal life interest rate to match each other. For example, we set the dividend rate on the whole life product at 6% and we set the interest rate assumed on the universal life policy at 6%.
This will lead us to conclusions that have nothing to do with what we can expect from the two policies.
Sadly I don't have quick and easy guidance to offer the individual attempting to make a qualitative assessment when comparing various whole life and/or universal life insurance policies.
The best approach is seeking the guidance of someone with proficiency in the products and the industry. We have a large collection of data on these products, any attempt to unload that on the layperson will result in very little understanding of how the products stack up.
You can DIY this, but it will take considerable time and effort. You'll want as much data as you can get your hands on, and you might find few agents have ready access to it.
Universal life insurance will offer up more data than whole life insurance by default. With universal life insurance, you can access detailed expense reporting on any product so long as the agent includes it in the life insurance illustration. Whole life insurance will require more digging, and you'll need to have comfort with accounting principles to read income statements. This will help you predict the overall health of the life insurer and the likely movement in the dividend.
Lastly, realize that most data points offered up by life insurers on company branded brochures is likely position to spin the conversation in whatever direction favors the company. Sure it can offer some insights into metrics you might want to pursue, but be sure to collect such data either from third parties, or the standardized accounting disclosures all life insurers must provide.
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.