First, I feel the need to provide context for this post. 99% of our clients want to use cash value life insurance as an asset class. Which means people need to distinguish whole life insurance from indexed universal life insurance.
Yes, there are other products.
But none that we feel are worthy of consideration.
Which is better?
What are the pros and cons of each? Why would a person use one versus the other?
A few weeks back I wrote a piece that explained the pros and cons of indexed universal life insurance.
So, I figured it might be helpful to do the same for whole life.
Whole life insurance is the “original permanent life insurance” contract. But what are the benefits and drawbacks to owning it? That’s what we intend to discuss today.
We’ll start first on the negatives.
We hear whole life insurance referred to as a “black box”. And to an extent that's true. It does have some components of secrecy.
The life insurance companies that manufacture this product love being proprietary. And they aren’t crazy about detailing policy details.
To be fair, the folks working in the actuarial department know the details. All they have to do is sign a lengthy non-disclosure agreement.
You wanna know exactly what the company is charging you for that guaranteed death benefit? Tough. Not gonna happen.
You want to reconcile the dividend payment and ensure they didn't make mistakes? Good luck.
Full disclosure and whole life insurance are not synonymous. There are certain ways to pick apart the numbers. You can estimate what's going on, but as far as a detailed breakdown…no.
We are able to reverse engineer some things and approximate but that's about it.
Whole life insurance as we know it today is the great grandchild of level premium life insurance.
You can probably guess how it got the name. It has a level premium.
How can they do that you ask? The premium is level because the company needs to ensure an adequate amount of excess premium to build a reserve.
There is a degree of flexibility that can be introduced to a whole life insurance policy with efficient design. But, in general (of all the products that exist out there) it prefers a more constant and rigid premium structure.
The cash value in whole life policies will be less than premiums paid in early years. Depending on the policy chosen and design used by the agent/broker this may be only a hand-full of years.
Unfortunately, we often see cash values “in the red” for a decade or more. That's a result of poor design.
You can blame that on two factors (I've said them both before):
1. Either the agent doesn't know how to design your policy correctly or
2. They don't care to (because the commission is less for doing it right).
Which is worse? Well, that's up to you. Either way the result is bad. Enthusiasm and good presentation skills are a poor substitute for competency.
Participating whole life insurance policies (the participating part is crucial) share in company profits. This sharing of profits means dividends get paid to policyholders. You can use dividends as you choose.
Two of the most common uses of dividends are:
1. They are used to reduce out-of-pocket policy cost. Often referred to as an “offset” because the dividend can pay a portion or all the premium (if the dividend is large enough).
2. Dividends are used to purchase paid up additions. This speeds the growth of your cash value.
If you want to learn more about how paid-up additions work, be sure to read The Magic of Paid Up Additions.
If you pay all premiums due, the initial death benefit is guaranteed for the insured’s entire life.
Neither the death benefit nor the premium can change. This means despite how things work out for the life insurance company, they're on the hook.
The company promised you a death benefit in exchange for your premium. If you pay the premium, the guaranteed death benefit will be paid to your beneficiary.
Whole life insurance also has a guaranteed schedule of cash accumulation that is detailed in the policy.
You will see that in the “guaranteed” column of the illustration/ledger.
The cash value must accumulate to at least match the schedule of guaranteed values. It can be higher than this amount when your policy pays dividends.
How is that?
Remember earlier when I said dividends could be used to purchase paid-up additions? If you elect to do that, you will see your cash value grow beyond the guarantee.
One other thing worthy of mention…
When you have a policy for a few years, your current cash value becomes your guaranteed cash value.
Let me explain a bit more. If you bought a policy five years ago (for example), you can call the company and get an in-force illustration.
That's just fancy life insurance lingo for a scorecard or performance report.
It will detail your policy values, death benefit and cash value. That gives you the ability to compare it to your original illustration. You can see precisely how your policy has performed versus the projections.
During the last five years you probably received dividends. If you elected to have them buy paid up additions, you will see your guaranteed cash value is ahead of the original guarantee.
That's because whatever your cash value grows to becomes your new guarantee. The current cash value is your new “floor”. Hope that's clear?
Of course it could change if you withdraw money or take a loan from your policy.
The cash in a whole life policy is accessible to you through loans or withdrawals (a “surrender” in insurance speak).
Loans or withdrawals can be made at any time for and for any reason.
The cash value is yours (as the policyholder) to use as you see fit. Many people use it to finance major purchases: cars, investment real estate, etc.
Consider this…you could use whole life insurance as a place to warehouse cash.
You get a return on your cash while waiting for opportunities to come along. When the opportunity presents itself, you call the company and request YOUR money.
They will ask you a couple questions and you'll have the money in hand within a couple days in most cases.
If you'd like to learn more or need clarification, feel free to ask us!
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.