Let me first address everyone who read that titled and thought, “But you just don’t understand it.” You may be right. Though, I studied life insurance in college (my teachers were practicing life insurance sales reps), I trained for a short time with an insurance company, and I have had permanent life insurance pitched more times than I can count.
Life insurance should provide for my family if I die
I had the opportunity to chat with a friend who happens to be life insurance rep for awhile last night. One of the arguments that I made was that whole life insurance is often pitched to young people who can’t afford the high premiums at this stage of life. He retorted that I can buy policies for only a few hundred dollars a year. The problem with this argument is that as a young person, the death benefit for my family is first and foremost my concern.
For example, leaving my family only $50,000 in the event of my death is unacceptable. Even leaving $250,000 is unacceptable. Meaning, in order to buy a whole life policy with a large enough benefit will cost $1000s each year. I wish I had that much under the mattress, but I don’t.
I have seen young couples sold on the fringe benefits of a whole life policy while the sales rep neglected the fundamental reason for having life insurance – security for my family. Usually, the sales process goes as follows. First, the rep meets with a family and gathers information about their goals, finances, and money available to invest. The rep will also spend a little time talking about insurance products as a primer for later. During the second meeting, the rep presents an analysis of the family’s finances and goals and begins discussing how life insurance will help them reach those goals. All kinds of printouts showing huge cash values and death benefits are presented. The entire presentation is designed around the dollar amount available to invest, not around whether or not the death benefit is sufficient if the provider dies tomorrow.
So the family signs up, pays in, and prays that tragedy doesn’t strike.
To my friend’s credit though, he mentioned that for young couples, he recommends buying term life with sufficient coverage in combination with a small whole life insurance policy. Over time, the couple can increase the amount of the whole life policy and phase out the term life. I would be much more prone to taking this approach, assuming I wanted whole life.
The costs are higher, but I’m not sure about the value
The reason my friend and I even started our debate last night was because I stated last Saturday while at the golf range that I don’t like how much life insurance companies charge. As a rebuttal, my friend created a spreadsheet outlining how much a life insurance rep makes on a whole life insurance policy as compared to stock based investments. His goal was to show that the commissions are cheaper.
In his financial model, he assumed that a consumer pays 1% annually for investment advice. However, if you assume that a consumer doesn’t hire a financial planner (which many can do with out) and invested in a mix of index funds with low fees like the ones offered by Vanguard and Fidelity, then the consumer pays $1000s less in fees with the investments. If you further add in what the insurance company is making on top of the payout commission to the sales rep, then a consumer saves anywhere from two to three times more than the management fees from mutual funds over 15 years.
So using his model, I demonstrated that buying term and investing the difference, assuming that you know what you’re doing, can save you a lot of money over 10 or 20 years.
Whole life insurance can be a complex financial instrument
Before my friend starts egging my house, let me state that I do believe that whole life insurance can play an important role in some financial plans. The problem is that to properly incorporate it, a consumer needs a competent, experienced advisor. Many so called “financial planners” receive little to no training and are set loose on the population. Several large and popular financial planning firms take average consumers, promise them riches if they start selling permanent life insurance policies, and tell them to go. Rarely are these people trained enough to understand how to use permanent life insurance as part of an overall financial plan.
If you are interested in permanent life insurance, ask for referrals and shop around. Find an advisor who understands how to make life insurance just one part of your plan. Don’t let one well-prepared pitch suck you in.
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