Deacons should never recommend their members buy whole life insurance. Families should only buy term life insurance…
Whole life insurance policies are also known as “cash value” policies or “permanent” insurance. There are other variants known as “universal” or “variable” life. All should be avoided.
At their heart, these “cash value” or whole life policies combine a term life policy with a savings account.
Here’s what you need to understand about the “permanent” life insurance policies like whole life and the others. If the purpose of buying term life insurance is to transfer the financial risk of an untimely death to the insurance companies, the insurance companies use whole life policies to steadily transfer that risk back to you.
HOW IT WORKS
They are able to do this by offsetting their death benefit with your cash value.
Whole life policies have two components: death benefit and cash value. ValuePenguin describes how these components work:
A life insurance policy’s cash value is separate from the death benefit, so your beneficiaries would not receive the cash value if you passed away. Cash value that’s left in your life insurance policy when you die is kept by the insurer. A life insurance policy’s cash value is essentially the amount of money you would receive if you decided to give up the policy to the insurer, or surrender your coverage.
Whole life policies are more expensive than term life policies. That’s because you are paying for the cost of insurance (a term life premium) plus the “cash value” savings account portion. Dave Ramsey elaborates:
So, you’re paying for two things here—the life insurance part (the bit that covers your family if you die) and the cash value part (the savings account that supposedly grows your money over time). How much it grows really depends on the type of cash value policy you buy, and what their returns are.
With whole life policies, it costs much more to get the same amount of coverage as a term policy.
The real purpose of whole life policies is to make insurance salesmen richer. The commissions on whole life policies are much more lucrative for the agents because the products are much more lucrative to the insurance companies. In an article titled “Don’t Buy Whole Life Insurance” written by a financial advisor, the author reports:
Life insurance agents will push you toward buying whole life. They always do. Why is that? Well the biggest reason a life insurance agent tells you to buy a whole life insurance policy is because they make more money. A whole life insurance company incentivizes agents in the form of higher commissions. Not only is the commission structure based on first year premium, and whole life insurance premiums are about 10 times to 20 times more expensive than term premiums, but the percentage of first year premium that an agent gets from a whole life policy sale is larger. They make more money because the dollars are higher, and they make more because their share is higher. On top of it, they get residual payments every year as an incentive to keep their clients invested.
Just look at what the ValuePenguin article says: “Cash value that’s left in your life insurance policy when you die is kept by the insurer.”
You can either get the death benefit (by dying), or you can extract your “cash value” by cancelling the policy or taking a loan against it. You don’t get both. The insurance company hopes to take your premiums AND keep your cash value.
TRANSFERRING THE RISK BACK TO YOU
Cash value policies steadily transfer the risk back to the insured. They do this by using your own “savings account” money to partially fund your death benefit in larger proportions over time.
In his book What’s Wrong With Your Life Insurance, Norman Dacey used a hypothetical example to describe how this happens:
Fire insurance companies don’t sell savings accounts. Let’s suppose for a moment that they do, though, and that you have had a £re insurance policy and, in addition, you have for several years been accumulating money in a savings account with the same company. Suppose that just about the time your savings account reaches $2,000, you have a flre at your house and the loss comes to $5,000. The insurance company sends you a check for $2,000 with a note attached identifying it as your savings ac- count, and another check for $3,000 with a memorandum stating that this is the insurance money. You’d probably write back a sharp note in which you’d point out that the fire insurance loss was supposed to be covered by $5,000 worth of insurance and this had nothing whatever to do with your savings account…
You will recall that on that weird fire insurance policy we discussed in the last chapter, the company used your $2,000 savings account to help pay the $5,000 claim. Well, that’s just exactly what the life insurance company does with those extra dollars you give them to put aside for you. If you die, they add just enough insurance to your savings account to make up the face amount of the policy and pay the total to your beneficiary. The savings account cash value grows over the years by reason of the extra dollars you have added and the addition of interest that the company pays on the account. At the beginning of the hundredth year, the savings account on a $10,000 policy might be $9,950 and the actual insurance protection provided by the company only the remaining $50.
This type of insurance, which the companies call “permanent” insurance, is expressly designed to transfer the risk gradually from the company’s shoulders to yours. As the cash value/savings account increases, the amount of annual renewable term insurance provided by the policy that year decreases.
These claims can be verified. An article on whole life insurance explains what can happen if you borrow against your policy: your death benefit may decrease.
Unlike bank loans or mortgages, you do not have to pay back the loan you take when borrowing from a permanent life insurance policy. However, when you borrow the money based on your cash value, the amount you borrow may reduce the death benefit from your policy’s life insurance portion.
A SUCKER’S GAME
Whole life policies are meant to appeal to that portion of us that gets angry and wants to say, “I paid into that policy for my whole life, I never had to use it, and now that I cancel it I get nothing out of it–not even one measly cent of a refund!”
Whole life insurance policies are also meant to appeal to that sense of outrage we get after paying car insurance for decades, yet when we actually get into an accident that totals our vehicle the insurance company barely sends us enough money to make a down payment on a new vehicle.
This sense of outrage is misplaced. It arises from a misunderstanding of the purpose of insurance, which is to avoid financial devastation. It is intended to transfer an unlikely but significant risk to an insurance institution. We pay years of premium to transfer that risk and save us from a remote but possible financial catastrophe. The risk was transferred during the time periods of our life in which it would have had the most severe consequences.
The insurance companies rely on this misplaced sense of debt and misunderstanding to sell overpriced “permanent insurance” policies to individuals on the promise that they also accrue tax-advantaged “cash value” that, according to Northwestern Mutual, “becomes money that you can access at any time for any reason.”
Term life insurance is much cheaper and affordable than whole life or any “permanent insurance” variant. This means families can buy more coverage.
Deacons must be clear about the purpose of life insurance: it is to replace the lost income from a spouse who dies.
It is not an investment vehicle. Whole life policies are sold on their use as tax-advantaged investment possibilities. “You probably won’t need the death benefit,” say the insurance agents, “so use it instead as an investment vehicle.”
This is wrong-headed. Insurance is meant to transfer risk to the insurance company to help you avoid financial ruin from an unpredictable, random catastrophe that befalls your family.
There are also better ways for Christians to invest their money. Whole life insurance policies are very expensive. The old phrase remains true: “Buy term and invest the difference.”
The most efficient use of a family’s life insurance money is with term insurance. It buys the most death benefit for the least amount of money. This is what the head of the household is morally obligated to do.
But term policies also bring in the least amount of revenue for insurance companies. Their agents will always try and push whole life and other “permanent products.” Deacons must warn their congregation members of this threat. They must instruct them to say no.