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I have sold a lot of life insurance over the years–whole life especially. I now have policies on the books that span well over a decade and this gave me a chance to observe how things unfold with these policies over time. Using that experience, I thought it might be useful to discuss the things agents, insurance companies, and various marketers never mention about whole life insurance. Things that a prospective consumer might find interesting.
#1 Whole Life Insurance is Not a Savings Account
Yes, whole life insurance has cash value. And that cash value can be pretty great. But whole life was never designed to function like your personal savings account with constant deposits and withdrawals. I'm looking specifically at you Infinite Banking®, Bank on Yourself®, etc. folks.
I bring this up because a number of people attempt to apply the “if a little is good more must be better” idea to whole life insurance cash value. This often becomes a horrible strategy of attempting to channel as much of one's personal income as possible into a whole life policy with plans to immediately lend it back out a-la self-banking to make use of the dividend accumulation on gross cash values. There are a number of reasons why this won't work–very few of which have anything to do with the accumulation features of the policy's cash value.
The cash value in a whole life insurance policy works best as a place to go for emergencies or opportunities in the short term and larger purchases or retirement income in the longer term.
The important takeaway here is that you don't put money into a whole life policy that you need in the near or near-ish future. Planning to make a major purchase within the next year or possibly two? Best to leave that money elsewhere and use other funds to build cash in a whole life policy. Sure there are some who wish to argue this point with me. But all of them have something to gain from your buying a policy so they aren't exactly disinterested parties.
#2 Your Cash Value will Almost Never be “Right”
The cash value reported in the illustration provided when you buy the policy assumes a specific moment in time. A very short moment in time. A day…actually it's more like a few hours of a specific day. That's not to say that you won't actually achieve the results reported in the illustration–you have a chance of doing better or worse. What I'm saying is that the numbers reflected in the illustration are a snapshot of a brief moment. Your policy statement and the reporting you can check online will report real-time (for the most part) policy accumulations and if you don't look at the precise right moment, the numbers will be different.
This is a common source of confusion for a number of policyholders. For example, many wonder why their policy cash value is lower than the illustration reported immediately after putting their policy in force. The answer is simple. At the beginning of the policy year, the cash value needs to earn the guaranteed interest and dividend (if applicable) before it will reach the reported value from the illustration.
Another confounding element is the refund of premium provision of the policy. When an insurer issues a policy, it can collect the entire year's premium, but it cannot book all of that premium as revenue. Why? Because esoteric insurance law, that's why. So if the policyholder decides to cancel his/her policy mid-year, after paying an annual premium, the insurer owes the policyholder back the “unearned” premiums. These unearned premiums are simply the pro-rata premiums outstanding for the remaining months of the policy year.
For example, if you pay the insurance company a $12,000 annual whole life insurance premium (no paid-up additions just base whole life premium), and you decide to cancel your policy after six months go by, the insurer owes you a refund of $6,000. Insurers will report the refund of premium as part of the cash surrender value of a policy.
The subtle, but important note here is that as each month goes by, the refund of premium amount goes down. Reporting the refund of premium amount with cash surrender value causes some people to question why their cash value is going down each month. In the spirit of whole life functionality (as the policyholder understood it at inception) the cash value is not going down. But the amount owed as a refund of premium is and this causes confusion.
#3 Dividends are Extremely Difficult to Track/Reconcile
Dividends are like magic when it comes to whole life insurance. They significantly boost whole life values–both cash and death benefit. But the way insurance companies distribute dividends among policyholders remains a mostly secretive process that causes much ire. There are methods we can employ to determine if a dividend payment appears correct–but this will never be precise. Best we can do is compare the actual dividend payment against an illustration making sure that it assumes the correct dividend interest rate. This is usually available to us, but not always.
A few problems arise when dividend rates change (and they almost certainly will throughout the lifetime of a policy). This means we need an updated illustration that may or may not be available by the time our dividend payment comes–usually they are, but there's no guarantee that they will be.
Further complicating matters is that most insurers will not pay the annual dividend on a whole life policy until they receive the premium for the subsequent policy year. This fact makes it extremely difficult to use cash value accumulation as a means to track the appropriateness of the dividend payment.
When we are looking at a direct recognition policy, things become even more complicated as the timing of a policy loan could affect the dividend in a way that is nearly impossible to reconcile through an in-force illustration.
Does This Mean Whole Life Insurance is a Bad Idea?
I don't mean any of the above as a means to dissuade someone from buying whole life insurance. I simply find it important to pump the breaks a bit on some of the more sensational sales tactics that pretend whole life insurance is infallible. There are important considerations and appropriate expectations one must have when approaching a whole life insurance purchase. Suggesting otherwise has the potential to bring criticism onto a financial product that does have a lot of positives to offer.