If you are looking to buy whole life insurance as a way to save for the future there is a huge mistake you might be making. I'm going to try and help you avoid that mistake with five rules you must follow when buying whole life insurance for this purpose. Following these rules will ensure you put your best foot forward with your new whole life policy. Ignoring these rules means you'll likely end up on some discussion forum on the internet somewhere complaining about how horrible whole life is based on your experience buying a policy.
First let me answer an important question you should ask if you're new here. Who am I? I'm the founder of The Insurance Pro Blog. I started it back in 2011 after stumbling upon the unique manipulation techniques very skilled agents used to squeeze as much cash value out of a whole life policy as possible. I've been a licensed insurance agent since 2008, so I know the ropes of this discussion quite well. I work pretty much exclusively designing and implementing life insurance policies to to maximize cash value and have done so since the launch of The Insurance Pro Blog.
So over all the years of doing this first hand, here is my list of absolutely non-negotiable must haves for a whole life policy that seeks optimal cash value.
#1 Must be Participating Whole Life Insurance
“Participating” is an industry term for earns dividends. Whole life insurance can come as either participating (has the ability to earn dividends) or non-participating (will not earn dividends). You do not want non-participating whole life insurance if you seek whole life for cash value accumulation. Dividends are the key driver of attractive cash value accumulation in a whole life policy. Without dividends, we have to seriously question if whole life insurance makes sense as a plan to save for future expenses/goals.
It's extremely easy to determine if a whole life policy will earn dividends. The ledger provided the projects policy values will include a dividend column that shows projected dividend payments of the whole life insurance policy. If this column is missing, you have a problem.
Most non-participating whole life policies will call this out somewhere in the policy proposal (we call these “illustrations” in the the insurance world). Participating whole life policies will generally include a statement about dividends noting something to the effect of: policy values reported assume the payment of dividends and that dividends are not guaranteed. It's a CYA measure insurers use to ensure you realize that cash values in the future may be more or less than originally assumed because dividends can and do fluctuate over the course of several years.
Lastly, you can also check the illustration for a guaranteed and non-guaranteed column. If you see no non-guaranteed column, you are most likely looking at non-participating whole life insurance. Wherever you see a non-guaranteed column, you know you are likely looking at participating whole life.
With one exception…
In some very rare cases, you might run across an unusual product called “Interest Sensitive Whole Life Insurance.” Pass on it if you do. It will have both a guaranteed and non-guaranteed ledger. It's a rare product, but it has no place in cash focused whole life purchases. This product will usually call itself out as such in the name of the product.
#2 Highly Rated Insurance Company
Buying whole life insurance with a goal to accumulate wealth through the cash value build up in the policy is a long term commitment. While it's possible to bail on a company and move your cash elsewhere, I hold the opinion that it's best to avoid the need to do this. You are betting on the company's excellence and ability to continue to deliver year-over-year solid returns to it's policyholders primarily through the company's ability to pay policyholders a dividend. Dividends come from profits generated by the insurance company. These profits primarily feed from investment returns insurers earn on the assets they manage on your behalf as well as from the earnings the insurer achieves on being an insurance company (e.g. taking in more premiums than it pays in death benefits).
Life insurers must prepare public accounting reports on their business operations and file them with state regulators. They are also subject to ratings assignments provided by major ratings agencies (e.g. Standard & Poor's, Moody's, and A.M. Best).
We can use the data from these accounting reports and the ratings assigned by ratings agencies to get a good feel for how healthy the insurer is financially speaking.
Ratings are a synopsis of overall financial health weighting heaviest the perceived ability to meet claims obligations. This means they place a higher importance on the insurance company's capital positions, but ratings methodologies do not completely ignore cash flow the insurer can generate. In addition, ratings agencies all have stress test algorithms they use to test an insurer's assumed ability to withstand a number of economic catastrophes.
Ratings range by letter score where A's are highest and they grade down from there. A a good general rule, we never want to consider a life insurer with a rating from any major agency below A- for the purpose of cash rich whole life insurance. It's far too risky. In fact, even in lower A range of the ratings scale is cause for concern.
#3 Paid-up Additions Rider
The paid-up additions rider is an optional feature on a whole life policy to place additional cash into the policy. This additional cash earns the same guaranteed interest the normal whole life policy will. These paid-up additions also earn dividends, which further compounds the accumulation of cash value inside a whole life policy.
You shouldn't assume, however, that all paid-up additions riders at all companies are identical. While they all have the same basic functionality, the paid-up additions rider can vary considerably from company to company.
The most important feature of paid-up additions you want to worry about is flexibility. Some paid-up additions riders allow the policy owner to change his/her paid-up additions amount at his/her discretion while others require you to pay a static amount year-over-year and changing that amount has serious consequences. While some people may have the ability to commit to a less flexible paid-up additions rider, my experience tells me two very important things:
- People generally want the flexibility for peace of mind because they don't know if they will be able to continue the commitment they originally make to paying whole life insurance premiums.
- Life has a funny way of changing and the more flexibility you have to make more decisions with fewer consequences associated with those changes the better.
The paid-up additions rider is the primary way we get as much money as possible into a whole life policy. So we definitely want it, and we want to maximize the amount we have of it.
#4 Blended Whole Life Insurance
Whole life blending is a process of adding a term life insurance rider to a whole life policy to make a portion of the death benefit term insurance and a portion of the death benefit whole life insurance. Most whole life policies have this feature available. If they don't, you can skip them for the purpose of using whole life insurance as a savings plan.
We want this feature because it helps reduce the base whole life premium, which allows us to fill in more of our premiums commitment with the paid-up additions rider. All whole life policies have a maximum amount of premium they can receive and remain classified as life insurance. Going beyond this limit recategorizes the life insurance contract as a Modified Endowment Contract (MEC). Doing this, sheds several very attractive tax benefits life insurance affords the policy owner.
Blending is a way to reduce the amount of premium comprised of plain whole life insurance, and increases the amount of premiums comprised of paid-up additions. It's a tool we use to get a much extra money into a whole life policy as possible.
Again, it's important not to assume that blending is universal across all whole life products at all life insurance companies. Some have better and worse approaches to this concept.
The least favorable approach to blending is a terminal level term life feature. This looks something like a level term rider for X amount of years. For example, maybe a term life rider that lasts for 15 years and then goes away. This is unfavorable in a majority of scenarios because it could force a death benefit reduction so severe that the policy becomes a Modified Endowment Contract. This might be an unavoidable situation. So heed my warning, stay away from blended whole life where the term rider has a finite expiration date expressed as a number of years in the 10 to 30 year range, unless you thoroughly check with your agent that the policy will not become a MEC upon losing the term blending rider.
#5 Issued by a Mutual or Mutual Holding Company
Life insurers fall into two major styles of company organization:
- Mutual Insurance Companies
- Stock Insurance Companies
As is the case with almost everything, there are shades of grey within these two broad categories.
Whole life insurance works out best for cash accumulation when the issuing company is a mutual or mutual holding company–preferably a mutual company.
Mutual companies place ownership of the company in the hands of the policyholders. The company does not issue stock so there are not non-policyholder owners. This traditionally ensures that the company has no other parties to satisfy and will return the greatest values–through dividend payments–to it's policyholders.
Mutual holding companies are mutual-like insurers that own stock subsidiary insurance companies. They have a mutual-ish insurance company focus, but some access to capital markets that a bona-fide mutual doesn't have. There's a lot of variation in where policyholder ownership exists and the fiduciary obligations are less clear for mutual holding companies–for true mutuals, the fiduciary obligation is always to the policyholders.
Buying whole life from a stock insurance company (extremely rare) when seeking cash rich whole life is not a great idea. Stock companies focus on different styles of product outside of whole life and will generally use fancy accounting rules to limit profits recognized from whole life business in order to shield profits from the obligation to pay whole life policy owners some level of dividends.
Whole Life Insurance is not Universally Whole Life Insurance
Many people assume that whole life insurance at one life insurance company is the same…more or less…at every other life insurance company. This is very untrue. Don't default to the belief that whole life at just any life insurance company is the same as whole life insurance at any other life insurance company. If you do this, you'll be in for potential suffering. Truth is, whole life products can come in specific “flavors” intended for specific goals. Life insurers rarely make the intention of the whole life product obvious to laypeople, so it's difficult to tell if you aren't trained in selecting/designing life insurance policies. A good agent can help guide this process and offer the guidance you need to pick the right policy.
But please don't forget that in addition to selecting the right “chassis” so to speak, you also want all of the five features mentioned in this blog post.