Term Life vs Whole Life Math

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Term Life vs Whole Life Math

Post by kpanghmc » Fri Feb 19, 2010 3:05 pm

Does anyone have the math (or a link to an article with some math) showing why buying Term Life and investing the difference comes out ahead of Whole Life? I know that this is pretty much agreed upon (except from those whose interests lie in selling Whole Life), but I'm having a hard time tracking down an explanation that gets into the nuts and bolts of why it's mathematically better.
Kevin

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Post by HomerJ » Fri Feb 19, 2010 3:25 pm

It's pretty simple... It's all about the fees and expenses...

$1,000,000 in life insurance

Whole Life will cost $12,000 a year... fees will eat up 2%-3% of your returns each year (let's say 2.5%)

Term Life costs $1000 a year... You invest the other $11,000 at Vanguard where fees eat up 0.20% of your returns each year...

If you make 8% per year on your investments in either scenario....

After 30 years,
Whole Life method's 1st year premium is worth (1.055^30) * $12,000 = $59,807
Term Life method's 1st year savings is worth 1.078^30) * $11,000 = $104,702

Pretty simple... Fees matter... Not just when looking at Whole life, but all investments... That's why we avoid load funds, or funds with high expenses...

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Re: Term Life vs Whole Life Math

Post by mephistophles » Fri Feb 19, 2010 4:00 pm

kpanghmc wrote:Does anyone have the math (or a link to an article with some math) showing why buying Term Life and investing the difference comes out ahead of Whole Life? I know that this is pretty much agreed upon (except from those whose interests lie in selling Whole Life), but I'm having a hard time tracking down an explanation that gets into the nuts and bolts of why it's mathematically better.
The math is is very simple. With most whole life policies, the insurance company keeps 100% of your premium payments for the first two or three years. You quit at the end of this period and you get zero return on your money.

With term, you pay a fraction of the cost of Whole Life in premiums. The insurance company keeps all your premiums also, but since you are buying pure protection you look at it like auto or home insurance.
ole meh

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Post by kpanghmc » Fri Feb 19, 2010 4:12 pm

What about the death benefit? It's my understanding that Whole Life will continue to pay the death benefit regardless of when you pass. So in rrosenkoetter's example, let's say you die after 31 years, with Term you have the money that you saved $104,702, but with Whole Life you have the $59,807 plus the $1,000,000? Is that correct?
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Post by letsgobobby » Fri Feb 19, 2010 4:27 pm

kpanghmc wrote:What about the death benefit? It's my understanding that Whole Life will continue to pay the death benefit regardless of when you pass. So in rrosenkoetter's example, let's say you die after 31 years, with Term you have the money that you saved $104,702, but with Whole Life you have the $59,807 plus the $1,000,000? Is that correct?
right, and my own calculations have shown that (say in the example of a 30 year term policy) between years 30 and 40 or so, whole life can actually come out ahead of BTID. I want someone to show me that's not true, so I don't make dumb decisions with my money.

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Post by Chuck » Fri Feb 19, 2010 4:53 pm

I've had to do the calculations after the fact (already have a whole life policy), which is a little different than deciding whether to buy one or not, but interesting anyway.

I was sold a whole life policy several years ago, when I didn't know what was going on. I'm sure I lost a bunch of money. I don't know how much, and it doesn't matter because I can't get it back.

Nowadays, if I take today's cash value and subtract last year's cash value, and the premium, and the stated dividend (which is around 4%) I get about $290, which is the cost of the death benefit. (I wish the annual statement summarized it as such, but I can derive those figures.)

A 20 year term policy would cost about $450. So ignoring what I've already lost in the past, I currently have a tax-deferred 4%, and reasonably cheap life insurance. If I needed the money, it would be another story, but for now I just consider it part of my bond allocation. I would not buy a new whole life policy, but the math doesn't favor getting rid of the one I have. (Someone tell me if I've done this wrong!)

I'll concur, though, that overall it was not a win. When I'm old I'll have little need for insurance, so I'll probably cash it in after the kids finish college.

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Post by HomerJ » Fri Feb 19, 2010 4:54 pm

kpanghmc wrote:What about the death benefit? It's my understanding that Whole Life will continue to pay the death benefit regardless of when you pass. So in rrosenkoetter's example, let's say you die after 31 years, with Term you have the money that you saved $104,702, but with Whole Life you have the $59,807 plus the $1,000,000? Is that correct?
That $104,702 compared to $59,807 is the value of the FIRST year's savings\premium after 30 years...

You have to add up all 30 years...

2nd year, you pay $12,000 - that amount grows for 29 years
Whole Life method's 2nd year premium is worth (1.055^29) * $12,000 = $56,689
Term Life method's 2nd year savings is worth 1.078^29) * $11,000 = $97,126

3rd year, you pay $12,000 - that amount grows for 28 years
Whole Life method's 3rd year premium is worth (1.055^28 ) * $12,000 = $53,734
Term Life method's 3rd year savings is worth 1.078^28 ) * $11,000 = $90,098

You have to add up all the years... After 30 years, that $11,000 a year savings will be worth more than a million dollars, and you won't have to DIE to get it. Meanwhile for those 30 years while you were building your portfolio, you still had the full million life insurance from cheap term.

You won't need a million dollar life insurance policy anymore because you'll have more than that in the bank.

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Post by Chuck » Fri Feb 19, 2010 5:00 pm

rrosenkoetter wrote:Whole Life will cost $12,000 a year... fees will eat up 2%-3% of your returns each year (let's say 2.5%)
I don't know where this 2.5% number comes from. I have a whole life policy, and the only percentage I see is the annual dividend, which is about 4%. Are you thinking about a VUL with wrapped investment accounts? I'm by no means a fan of whole life insurance, but as per my previous message, I had to decide whether to keep or cash in my current whole life policy, and I can't see a reason to kill it today. (2.5% annual expenses would convince me in a heartbeat.)

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Post by HomerJ » Fri Feb 19, 2010 5:06 pm

Look, the real problem with whole life is that you have almost NO idea how well you're doing... It's hard to tell how much of your premium is going towards commisions, how much is going to pay for the insurance part, and how much is being invested for you...

The insurance company is basically saying... "trust us... we won't screw you over"

Good luck with that...

Keep insurance and investments separate... Look at life insurance as a expense, just like car insurance, and house insurance... Pay for cheap term... and save the difference as a pure investment, where YOU control where it is invested and YOU control the costs...

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Post by HomerJ » Fri Feb 19, 2010 5:14 pm

Chuck wrote:
rrosenkoetter wrote:Whole Life will cost $12,000 a year... fees will eat up 2%-3% of your returns each year (let's say 2.5%)
I don't know where this 2.5% number comes from. I have a whole life policy, and the only percentage I see is the annual dividend, which is about 4%. Are you thinking about a VUL with wrapped investment accounts? I'm by no means a fan of whole life insurance, but as per my previous message, I had to decide whether to keep or cash in my current whole life policy, and I can't see a reason to kill it today. (2.5% annual expenses would convince me in a heartbeat.)
Okay, maybe that number is wrong... Do you know what your expense ratio is?? That's the point... If you don't know, then you certainly shouldn't be "investing" in it.

They give away the first year's premium as a commision... That certainly eats into your returns, eh? They have got to get that money back from you somehow...

Then they have to take part of successive premiums to pay for the insurance part... How much of that premium goes there? You don't know... they won't tell you... How much gets invested? What's the expenses?

I would never invest in a product that doesn't disclose those things.
Last edited by HomerJ on Fri Feb 19, 2010 5:16 pm, edited 1 time in total.

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Post by Chuck » Fri Feb 19, 2010 5:15 pm

rrosenkoetter wrote:The insurance company is basically saying... "trust us... we won't screw you over"

Good luck with that...
That's a good philosophical point of view. One I agree with. But you made a mathematical argument with numbers. I just want to know where you got those numbers from, is all.

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Post by kpanghmc » Fri Feb 19, 2010 5:20 pm

I'm willing to believe the wisdom of the masses, which overwhelmingly favors Term Life over Whole Life. I'm just surprised that I can't for the life of me find any concrete numbers to back this up.
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Post by HomerJ » Fri Feb 19, 2010 5:27 pm

Chuck wrote:
rrosenkoetter wrote:The insurance company is basically saying... "trust us... we won't screw you over"

Good luck with that...
That's a good philosophical point of view. One I agree with. But you made a mathematical argument with numbers. I just want to know where you got those numbers from, is all.
I read it somewhere... obviously every policy is different...

There are plenty of mutual fund companies who have no problems with charging 1.5%-2.0% fees and they have to disclose their fees!!

What do you think insurance companies charge when they can hide their fees?

Did a quick google search on whole life fees. This is from smart money (not saying it's a reputable source, just the first link I clicked on)

The key to a whole life policy is its internal rate of return -- the yield on the policy after all fees and charges are subtracted. A competent analysis can determine at a minimum whether the weight of the fees and charges built into one of these policies will ever allow a worthwhile return. Such an analysis will also pinpoint the minimum amount of cash value that you can derive from a policy at any given time interval.

Some financial planners, actuaries and accountants can perform internal rate of return analysis on your policy.


You have to get a accountant to do an analysis to figure out what the fees really are.... and that's only after the fact... What they do is look at your returns, look at your premiums, calculate equivalent cost of term life, and figure how much you made on the money that SHOULD have been invested for you...

I can't imagine anyone handing money to a company without knowing how much they are charging for their services... but that's what we do when we buy whole life...

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Post by Chuck » Fri Feb 19, 2010 5:37 pm

Here's some numbers from my actual real-life annual whole life statement:

Cash value: 50,706
Last year's cash value: 43,996 (6,710 increase)
Premium: 5,287
Dividend: 1,713

My math:

Dividend rate = 1713 / 43996 = 3.9% (simple, not compounded)
Premium plus dividend = 5287 + 1713 = 7000
Cost of insurance = 7000 - 6710 = 290

rrosenkoetter, you are right that it's basically sausage, and I don't know what's in it, but the performance doesn't say run away. Not today anyway. I can always cash it out and redeploy it if a better opportunity comes up, but what's paying 3.9% these days?

To kpanghmc, I agree with rrosenkoetter that you should not buy a whole life policy. The penalty in the first couple years is huge. You pay a lot and don't get much. Even if you've calculated that you'd break even after 30 to 40 years, think about how long a wait that will be! Or if you need to cash it in sooner, it will be at a loss. Term + invest is way more flexible.

It's possible that I will get over my loss aversion and cash it in tomorrow and buy a term policy. I think about that more and more all the time. This could be you in 10 years. If I could go back, I would not buy a whole life policy, no questions.

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Post by kpanghmc » Fri Feb 19, 2010 5:42 pm

Yes, I already have a 30 year term life insurance policy. I'm perfectly happy with it, mainly because everyone tells me I did the right thing and I understand how it works. However, a coworker asked me about my decision and I really couldn't find any math comparing the money you'd have after X years if you used term vs whole.

What I'm really trying to see here is if you had two options, a 30 year term insurance policy or a whole life policy, how much more in premiums would you pay over the course of those 30 years. It seems like there would be a "sweet spot" for whole life insurance holders immediately following those 30 years because the death benefit would pay out and probably overwhelm the amount of money you would have saved by going with term for those 30 years. Maybe I'm wrong, I can't say for sure unless I have the numbers, which I can't seem to find...
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Post by Chuck » Fri Feb 19, 2010 5:54 pm

Most whole life policies intend to "mature" when you are some old age. That is, the cash value is supposed to be equal to the death benefit when you are something like 110 years old. If you live to that age, they just give you the money.

Since most people die before they're 110, they have to be skimming quite a lot to be able to pay the death benefits. So not all the benefit is going into your cash value. The only way you will come out ahead financially is to die substantially before your actuarial life expectancy, and as has already been mentioned, that's not the way you want to "win."

I don't know what you mean by "immediately following those 30 years because the death benefit would pay out." The death benefit only pays out if you die. That shouldn't be your plan.

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Post by letsgobobby » Fri Feb 19, 2010 6:13 pm

Chuck wrote: I don't know what you mean by "immediately following those 30 years because the death benefit would pay out." The death benefit only pays out if you die. That shouldn't be your plan.
yes, but it happens to even the best of us.

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Post by mephistophles » Fri Feb 19, 2010 6:28 pm

Sorry folks, but this whole thread is the blind leading the blind. All that does is confuse the issue.

Fact 1. The only people who know the mathematics inside a whole life policy are the actuaries who create the policies. Even the actuaries do not know if their math will hold up as they make many assumptions in developing these policies. A huge factor affecting performance is dividends (in participating policies) and that is nothing more than an educated guess.

Fact 2. All buy term and invest the difference scenarios involve making numerous assumptions which are not even educated guesses.

Fact 3. I follow the Taylor Larimore approach that says keep everything as simple as possible. Quite frankly, many diehards complicate the heck out of everything, often to the point of absurdity, and to no good end.

Fact 4. If anyone paid attention to my first post in this thread they would agree that they would "never" buy an investment with a sales load of 100% for the first three years.

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Post by nisiprius » Sat Feb 20, 2010 4:40 pm

mephistophles wrote:Sorry folks, but this whole thread is the blind leading the blind. All that does is confuse the issue.

Fact 1. The only people who know the mathematics inside a whole life policy are the actuaries who create the policies. Even the actuaries do not know if their math will hold up as they make many assumptions in developing these policies. A huge factor affecting performance is dividends (in participating policies) and that is nothing more than an educated guess.
Thank you so much, Meph. I was literally going to say both of those things, but lost my nerve.

All the term policies I've had were participating policies, and the dividends were hugely important and utterly unpredictable. In particular I had a small term policy from the Wisconsin State Life Fund and literally only had to pay a premium every three years or so--most years I'd just get a notice saying the dividends had completely covered the premium and I owed them $0.00!

By the way... I am a strong believer in "buy term and invest the difference" but I did find it interesting to discover that the phrase emerged, originally, as sales propaganda from investment companies. Prospect: but little me, I'm not rich, where would I get the money to invest in your high ER load fund? Evil salesperson: Buy term and invest the difference.

More specifically, another Boglehead identified it with a particular company:
mickeyd wrote:A.L. Williams (later Primerica) used that sales pitch in the 70's and got a lot of folks to cash in their WL policies and buy term insurance and also buy an annuity from the salesman. If the salesman was later mutual fund licensed, they could than convert the annuity to a MF. Commissions all around.
That's not to say "buy term and invest the difference" is wrong--but don't forget that it's a slogan.
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Post by bmelikia » Sat Feb 20, 2010 6:11 pm

I have a whole life policy that my mother purchased for me at my birth. I'm today 25 years old. I wonder. . .does it mean that since I've had this whole life policy for 25 years that its now ok for me to continue with it?

. . .just curious since I heard u guys say that the first couple years of owning whole life is a waste. . .
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Post by mephistophles » Sat Feb 20, 2010 6:16 pm

Thanks nisiprius. "Buy term and invest the difference" was definitely a marketing slogan used to replace in-force whole life with term and a side fund. Ironically, the term policies and side funds sold by the replacing salesmen usually were terrible. The sales loads on those term policies and deferred annuities, and/or mutual funds were horrific.
Today, no slogans are needed. Buy term, as needed, as part of your overall security program. Invest as much as you can using Boglehead principles. Keep it simple.
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Post by mephistophles » Sat Feb 20, 2010 6:20 pm

bmelikia wrote:I have a whole life policy that my mother purchased for me at my birth. I'm today 25 years old. I wonder. . .does it mean that since I've had this whole life policy for 25 years that its now ok for me to continue with it?

. . .just curious since I heard u guys say that the first couple years of owning whole life is a waste. . .
Many, many older posts recommend that one keep whole life policies that have been in force for a number of years. The up front sales charges have been paid. Older policies with good companies may have a positive cash flow, for death or investment, better than other fixed vehicles. That being said, each person's situation is different and there could be good reason to end your older whole life policy. It depends on the situation.

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Post by trico » Sat Feb 20, 2010 7:16 pm

Nobody metioned anything about buy the term insurance and lose the rest. Which I am sure a lot of investors have done.

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Post by Fbone » Sat Feb 20, 2010 8:06 pm

trico wrote:Nobody metioned anything about buy the term insurance and lose the rest. Which I am sure a lot of investors have done.
And realized 6 months after term expired that you have a further insurance need at age 65.

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Post by actuary » Sat Feb 20, 2010 8:55 pm

The commission and expense for whole life policy can be minimized. Many people in this forum don't understand whole life insurance and don't know the commission structure. So they think whole life policy is expensive. Agent's commission is directly related to the base face value of the policy. If you minimize the base face value and maximize the paid up addition to the supplemental face value, the commission is minimized. Every mutual company provides this design to the customers through the blending ratio initially set when you take out the policy. Most of the time, the agents just set the base value equal to the total face value so that they can maximize the commission. That's why the commission is 70% to 100% of first year premium for these high commission WL policies.

I personally have three whole life policies from different mutual companies with different design and purpose, each over $1M face value. My wife has two and we also have a joint policy for estate planning purpose. I only paid the agent about $400 commission in the first year for each policy. Each policy provided me over 5% net IRR every year in addition to the protection. I always view these as guarantee cash value account with investment grade bond yield in a tax efficient wrap, plus the death benefit protection.

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Post by grabiner » Sat Feb 20, 2010 9:27 pm

Fbone wrote:
trico wrote:Nobody metioned anything about buy the term insurance and lose the rest. Which I am sure a lot of investors have done.
And realized 6 months after term expired that you have a further insurance need at age 65.
This is an unlikely situation. Once you retire, you will need to have a stream of income, so you will need either a large investment portfolio, or a pension or annuity. If you still have people depending on you for support, you can give them survivor benefits of your pension or annuity.

Even if you are still working at 65, you aren't likely to have beneficiaries dependent on your continued work, particularly if you invested the difference between what term and whole life cost. If you die at 65, your beneficiaries may lose a few years of your salary, but they will also lose far more years of your expenses. And if you bought term and invested the difference, instead of buying whole life, the return on those investments would probably cover the lost few years of salary.
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Post by Fbone » Sat Feb 20, 2010 10:30 pm

grabiner wrote:
Fbone wrote: And realized 6 months after term expired that you have a further insurance need at age 65.
This is an unlikely situation. Once you retire, you will need to have a stream of income, so you will need either a large investment portfolio, or a pension or annuity. If you still have people depending on you for support, you can give them survivor benefits of your pension or annuity.
What exactly is unlikely? Having a $1 million+ portfolio or having no retirement savings at all? Pension or no pension?

I guess we live in different classes. Few people in my class has a pension or any significant retirement savings. Often upon the death of the husband the spouse is left almost destitute.

In any case, my comment to trico assumed the person made poor choices and had no retirement investment.

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Post by Piyushk34 » Sat Feb 20, 2010 11:46 pm

How about 30 year term policy for 1 million dollars with return of premium (ROP) guaranteed? I am 32 years old and I was quoted $740/year level premiums for 30 years for $1000000 or $1458/year with ROP. I like the 2nd option because its best of both worlds. I can get high coverage for lower price than whole life and unlike term life I can have my premiums back after 30 years if I don't die. Any opinions?

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Post by HomerJ » Sat Feb 20, 2010 11:56 pm

actuary wrote:I always view these as guarantee cash value account with investment grade bond yield in a tax efficient wrap, plus the death benefit protection.
Wow I like the sound of that! Just rolls off the tongue!

We ALL should get whole life!

:shock: :shock: :shock:

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Post by HomerJ » Sat Feb 20, 2010 11:59 pm

Fbone wrote:
grabiner wrote:
Fbone wrote: And realized 6 months after term expired that you have a further insurance need at age 65.
This is an unlikely situation. Once you retire, you will need to have a stream of income, so you will need either a large investment portfolio, or a pension or annuity. If you still have people depending on you for support, you can give them survivor benefits of your pension or annuity.
What exactly is unlikely? Having a $1 million+ portfolio or having no retirement savings at all? Pension or no pension?

I guess we live in different classes. Few people in my class has a pension or any significant retirement savings. Often upon the death of the husband the spouse is left almost destitute.

In any case, my comment to trico assumed the person made poor choices and had no retirement investment.
Well then, they didn't invest the difference then...

Are you actually saying whole life is a good idea because it forces otherwise stupid people to save? Because I hear that from the insurance salesmen too...

"Hey you're a big moron with money... I know it, you know it... Let's lock you into this whole life forced savings vehicle to make sure your irresponsible self actually saves some money... Of course, there is a fee for us playing Daddy for your child-like idiot self"

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Post by HomerJ » Sun Feb 21, 2010 12:14 am

Piyushk34 wrote:How about 30 year term policy for 1 million dollars with return of premium (ROP) guaranteed? I am 32 years old and I was quoted $740/year level premiums for 30 years for $1000000 or $1458/year with ROP. I like the 2nd option because its best of both worlds. I can get high coverage for lower price than whole life and unlike term life I can have my premiums back after 30 years if I don't die. Any opinions?
So after 30 years, they'll give you back $43,740 ($1458 x 30)

But if you bought the straight term, and invested the difference ($714 a year), you could have

6% return = $60,170
5% return = $50,088
4% return = $41,880

So you can see what they're doing here... Guarenteed 4% return ain't that terrible I guess... Not that great over 30 years though... What's a 30-year Treasury bond pay?

The insurance companies aren't looking to make you a deal... They're pretty sure they can make more than 4% over 30 years... You're thinking, Let them take the risk, I'll just take the guarenteed 4%... Yeah, well, if the insurance companies DON'T make more than the 4%, they may go under... They can't pay everyone 4% on their money, if they're only making 3%... so there's still risk for you...

And you also have to consider what if you die before year 30... so it's not really guarenteed... You lose it all if you die early with the ROP plan... You keep the side investments if you die early with the straight term...

Up to you...

I like to think of insurance as an EXPENSE... like car insurance or house insurance.. Term isn't even that expensive... I pay it and put it out of my mind... I'm not going to try to MAKE money tangling with insurance companies and their goobly-gok contracts. They will win everytime.

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Post by Dynastar » Sun Feb 21, 2010 12:20 am

actuary wrote: I personally have three whole life policies from different mutual companies with different design and purpose, each over $1M face value. My wife has two and we also have a joint policy for estate planning purpose. I only paid the agent about $400 commission in the first year for each policy. Each policy provided me over 5% net IRR every year in addition to the protection. I always view these as guarantee cash value account with investment grade bond yield in a tax efficient wrap, plus the death benefit protection.
It might be possible to get a good deal if you really know the system. I used to write code (in APL, ack) to help test UL, VL, and WL illustration systems for one of the verrrry big insurance companies. The calcs are not straight foreword at all, and your average consumer is not going to be able to find the edge cases where WL policies might work out well. Their friendly local insurance salesperson sure isn't going to find those cases. Maybe if they take a few years off and pass those SOA exams, then they can find some good WL deals. :D

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Post by Piyushk34 » Sun Feb 21, 2010 12:31 am

rrosenkoetter,

Thanks for pointing that out. I was seriously considering buying term with ROP. I will reconsider my options.

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Post by mephistophles » Sun Feb 21, 2010 12:38 am

actuary wrote:The commission and expense for whole life policy can be minimized. Many people in this forum don't understand whole life insurance and don't know the commission structure. So they think whole life policy is expensive. Agent's commission is directly related to the base face value of the policy. If you minimize the base face value and maximize the paid up addition to the supplemental face value, the commission is minimized. Every mutual company provides this design to the customers through the blending ratio initially set when you take out the policy. Most of the time, the agents just set the base value equal to the total face value so that they can maximize the commission. That's why the commission is 70% to 100% of first year premium for these high commission WL policies.

I personally have three whole life policies from different mutual companies with different design and purpose, each over $1M face value. My wife has two and we also have a joint policy for estate planning purpose. I only paid the agent about $400 commission in the first year for each policy. Each policy provided me over 5% net IRR every year in addition to the protection. I always view these as guarantee cash value account with investment grade bond yield in a tax efficient wrap, plus the death benefit protection.
Are you saying that whole life, in any form, is a good investment as a cash accumulation vehicle for living needs? Are you suggesting that young people with families invest in whole life or blended whole life instead of buying straight term? Why didn't you provide full disclosure by saying that the product you are discussing is a blend of whole life and term, with non-guaranteed dividends hopefully replacing the term down the road? Why did you use language, suggesting a 5% internal rate of return in addition to death benefit and then comparing whole life to a bond? If you are an actuary with an insurance company, and you talk this way, what on earth are you telling your agents to say in their sales talk? Or, are you an agent, pretending to be an actuary who is here to promote whole life insurance?
ole meph

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Post by Fbone » Sun Feb 21, 2010 2:31 am

rrosenkoetter wrote:
Are you actually saying whole life is a good idea because it forces otherwise stupid people to save? Because I hear that from the insurance salesmen too...
What I'm saying is if your death will leave your spouse or other dependent destitute and homeless then you need some kind of insurance. Whether you are 35yo or 65yo it makes no difference.

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Post by actuary » Sun Feb 21, 2010 6:06 am

mephistophles, please don't imagine something I didn't say. All I said was how I purchased the policies for my family and the actual performance of my own policies. I didn't say whole life policy is good in any situations and certainly don't agree it is for everyone. I just don't agree on the comment about "whole life policy is expensive". There are methods to minimize the agent's commission and I explained the commission structure in my previous post. I don't work for any life insurance companies and I don't sell (never sold) any insurance products.

And yes, I passed all those actuarial exams many years ago to get my actuarial fellowship certificate. That's how I know the in and out of the system. If you ever walk into any SOA (Society of Actuaries) meetings and asked the actuaries their own life insurance policies, almost everyone of them has at least one participating whole life insurance policy from the mutual companies (no, not from their own employer for risk diversification purpose, same thing as you don't own your employer's stock in your portfolio). Of course, the commission is minimized for all these policies.

And you are wrong about the WL policies design I personally used. I don't rely on the dividends to replace the term portion. I used plenty of paid up addition to replace the term portion. Cash value and death benefit amount for paid up addition are guaranteed and there is a built-in guaranteed interest rate and mortality cost for PUA printed in the actual policy based on the insured's underwriting class. My policy has a 4% guaranteed interest rate in the PUA. After the mortality cost, the net guaranteed return is about 3.5% per year. Dividends just enhanced the performance of the policies on top of the guaranteed growth. I only purchased policies issued by the top mutual companies and they paid generous dividends throughout the years. So the actual net IRR is over 5% every year for my policies. Once the dividend is credited to the policy, it becomes guaranteed and subject to the same guaranteed growth provided in the policy.

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Post by HardKnocker » Sun Feb 21, 2010 1:31 pm

I've recently seen advertisements by life companies touting the returns of whole life, comparing them to the S&P 500. Are these the same companies that were pushing Variable Life when the market was hot?

Yes.

But weren't those Variable Policies tied in to mutual funds like the S&P 500 stocks.

Yes. Hmm... :wink:

Whole life insurance has very practical uses in estate planning and in some sophisticated pension funding schemes.

Other than those situations it basically serves as the annuity for your insurance agents personal retirement plan.

When you buy a whole life policy the insurance company takes your first year premium, pays out 55% of it to the agent, takes another bite out for themselves, "buys" some death benefit for you. Every year after that some more of your premium goes to the agent, the company, death benefit for you, and basically a savings account for you.

At some point in the distant future, the earnings from the savings account may pay for the premium on your whole life policy. Big deal.

Now the agent will tell you that this "forced savings" will provide you with money in the future. You could surrender or borrow from the policy. People who wouldn't ordinarily save will have the money saved for them. However what they don't tell you is about all the people who lapse their policies (stop paying) because they can't afford them or just get sick of paying for it. Will those people have savings? No. So either you save yourself or you pay Acme Life extra to save for you.

Which person are you? Do you need Acme Life to hold your hand? Will you pay the premiums for 15-25 years? Will you floss your teeth every night?

This is how your agent plans to retire. On the residuals from "permanent" insurance. It can be very lucrative but it's not an easy sell.

Now think about it. Why not just buy some death benefit yourself (term insurance), bypass the agent's retirement plan, and put the difference in your own savings account?

Buy life insurance for death benefit. Invest the difference yourself. If you are really nervous about where to put the money go for a CD. You'll still be ahead. And when your CD gets big enough, you won't need that policy. You'll be self-insured.

I have term insurance. I save money. Within ten years my term policies will reach the end of their fixed premium periods. At that point I will self-insure because I have money.

Selling whole life is a great business. If you are good at sales I recommend you go into selling it and make a good income or work in some other capacity for an insurance company. You could even sell term insurance but they won't encourage it unless you also push to convert those term policies to whole life down the road.

If you are really a good salesman you might talk your "clients" into buying more whole life with their dividends. Your
retirement annuity will be bigger.

When you buy your term insurance look for a good deal. The company really isn't too important as long as they have decent rating. Why? Because insurance companies pay into a program to insure themselves against defaulting on policies. It would be bad for business if insurance companies didn't pay out when you died. Wouldn't it? Really bad press. This "insurance" doesn't protect those cash values in whole life policies though so if you really wanted to fund your agent's retirement plan then you should buy from a highly rated company.

Otherwise get a deal.

I'm just terrible aren't I? :wink:
“Gold gets dug out of the ground, then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility.”--Warren Buffett

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Post by mephistophles » Sun Feb 21, 2010 3:34 pm

Actuary, let's try this again.
First, minimizing the commission on a whole life policy does little to reduce overall costs and sales loads. I know the large mutuals very well and they typically pay 50% first year commission, 10% renewal in years 2-4, and 2-3 percent after that. And yet, the insurance company typically credits no cash value to the policy for two or three years. They keep 100% of all premiums paid. This means, the insurance company keeps 50% of the first year premium and 90% of the premium in years 2-4 and 97% of the premium in years 5-10. The simple fact is that the insurance company, not the agent, keeps the vast majority of all premiums paid into the policy.
Second, whole life policies are always expensive when compared to pure term. Your blended whole life product is a combination of whole life and term and is far more expensive than pure term.
Third, your statement that your three million plus of whole life provides you with "over 5% net Internal Rate of Return every year in addition to the protection " is an outright fabrication and is untrue. Also, comparing the guaranteed cash value in a whole life policy with investment grade bond yield in a tax-efficient wrap is totally bogus. It just ain't so.
You may have passed your actuarial exams some years ago but the information and advice you supplied here is totally flawed.
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Re: Term Life vs Whole Life Math

Post by White Coat Investor » Sun Feb 21, 2010 3:45 pm

kpanghmc wrote:Does anyone have the math (or a link to an article with some math) showing why buying Term Life and investing the difference comes out ahead of Whole Life? I know that this is pretty much agreed upon (except from those whose interests lie in selling Whole Life), but I'm having a hard time tracking down an explanation that gets into the nuts and bolts of why it's mathematically better.
I can't make myself read another whole thread about this but here's my take on the math.

Whole life:

You pay for the insurance portion of the policy, but get a bad price because of the increased complexity and the lower competition compared to the term market.

You pay for the investment portion of the policy. But this doesn't go completely to your investments. Part of it goes to insurance company expenses and profits. Then they take the rest of the money and invest it in stocks and bonds, just like you would. So there is a drain there, just like with a high ER mutual fund.

Term life:

You pay for the insurance portion of the policy.

You invest on your own, keeping costs low.



You don't even need to think about what the commission is. Just realize that you can invest in the exact same stuff as the insurance company without paying them their cut. By keeping their cut, you make more. In investing, you get what you don't pay for. Simple math, back up by my own personal experience where I had a whole life policy I held for 7 years and didn't get back to even.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

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Post by speedbump101 » Sun Feb 21, 2010 4:23 pm

This thread is showing possibilities of going down the same road Allan Roth's $100k challenge did... 244 postings later and there is still no consensus... I don't know a lot about insurance, other than it sure can stir the emotions.

http://moneywatch.bnet.com/investing/bl ... blog-river

SB...
"Man is not a rational animal, he is a rationalizing animal" -Robert A. Heinlein

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Post by HomerJ » Sun Feb 21, 2010 9:09 pm

Nis... why did you delete your post!? It was awesome...

So simple and perfectly stated...

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Post by will23 » Sun Feb 21, 2010 11:23 pm

actuary wrote: And yes, I passed all those actuarial exams many years ago to get my actuarial fellowship certificate. That's how I know the in and out of the system. If you ever walk into any SOA (Society of Actuaries) meetings and asked the actuaries their own life insurance policies, almost everyone of them has at least one participating whole life insurance policy from the mutual companies (no, not from their own employer for risk diversification purpose, same thing as you don't own your employer's stock in your portfolio). Of course, the commission is minimized for all these policies.
It is good you said "almost everyone", since I guess I am one of the actuaries that keep this from being true. Most of the actuaries I know would also agree that whole life is one of the policies that "is not bought but is sold". Some of these actuaries probably do own WL policies.

One basic question is whether the insurance company or policyholder will do a better job investing. A person with enough money to contribute to a vanguard IRA or after tax annuity has an advantage (IMO) over the life insurer investment department because the life insurance regulations reduce investment options and carry reporting and compliance costs.

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Post by HardKnocker » Mon Feb 22, 2010 7:55 am

Whole Life is a dinosaur.

It dates from the days of yore when investment options for the public were very, very limited.

Those were the days when being a life salesman were really great. Ah, the good life.

You could tell people whole life was an "investment". Well it still is a good investment - for the agent and company. But it's against the law to tell the public it's an "investment".

Regarding actuaries owning whole life policies, many life salesman also own policies. If you're going to sell it you better own it.

Would you buy a Cadillac from a guy who drives a Toyota? Where's the credibility?
“Gold gets dug out of the ground, then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility.”--Warren Buffett

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Post by actuary » Mon Feb 22, 2010 2:03 pm

The fact that most agents don't know how to (or simply don't want to) construct a low cost whole life policy doesn't mean it is not possible to construct a low cost policy.

Here is how I construct my own policy to minimize cost and enhance the performance. The actual net IRR% is indeed over 5% in addition to the death benefit.

The first thing is to find out the minimum base amount allowed by the insurance company. Usually this can be confirmed from the DOI public filing information even though the agents do not want to let you know the minimum amount.

I have three policies. The policy with the lowest base death benefit amount is only $1,000, which means I can set the base DB=$1K and set the supplemental DB amount = $999K initially. I checked with the DOI in my state this morning. The lowest base amount is still $1,000 for the product I used years ago. The other more popular product from the same company has increased the minimum base to $15K. My other two policies have a larger minimum base amount with a 1:19 blending ratio ($50K base, $950K supplemental) from different mutual companies.

Most of the agent's commission and company sales expense load are generated from the base face value whole life portion (the premium of this portion is called base premium). Most of the agents sell whole life policy with 100% base DB amount equal to the total DB amount. That's why the general public opinion is "whole life policy is expensive".

After I paid the base premium (very small due to the minimized base DB amount), the rest of the premium goes to two parts, the term portion and the paid up addition (PUA) portion.

In the first year, the term portion equals to the supplemental amount, but it will be lower and lower every year because I use the PUA to replace the term portion. The premium that goes to the term portion is called TIB (Term Insurance Benefit) premium, this is usually just the mortality cost based on the insured's underwriting class and age, the commission is very small and is usually less than the regular stand alone term life insurance policy. When I purchased my policy, I also confirmed this based on the Commissioner's mortality table and the industry's preferred class mortality table.

The premium that goes to the PUA can be separated into two parts (inside addition and outside addition). If the purpose is mainly for cash value growth, then 100% of this part should go to the inside addition to replace the term portion. If the purpose is for higher leverage of death benefit amount, then the % will vary depending on the insured's age and underwriting class to obtain optimal result. PUA is very good because there is almost no commission in this part. In my case, I only need to pay 2% state premium tax and 1% federal deferred acquisition tax the first time I purchased the PUA. After that, there is no expense load and the cash value is guaranteed to grow specified by the policy. The PUA is also eligible for dividends. So the dividends generated from the PUA can be further used to purchase more PUAs to replace the term portion. I asked the agents to run several illustrations for me when I purchased the policies so that I can decide the optimum premium amount I should put into the PUA because of the MEC limit.

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Re: Term Life vs Whole Life Math

Post by Chuck » Mon Feb 22, 2010 2:57 pm

EmergDoc wrote:You don't even need to think about what the commission is. Just realize that you can invest in the exact same stuff as the insurance company without paying them their cut.
EmergDoc, I know you are growing tired of these threads, but you are making a difference. This little nugget may be the thing that finally gets me to dump my whole life.

Edit: Policy. Whole life policy. Not considering suicide over this.

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Post by mephistophles » Mon Feb 22, 2010 3:08 pm

actuary wrote:The fact that most agents don't know how to (or simply don't want to) construct a low cost whole life policy doesn't mean it is not possible to construct a low cost policy.

Here is how I construct my own policy to minimize cost and enhance the performance. The actual net IRR% is indeed over 5% in addition to the death benefit.
.
Are you using IRR for surrender value, or death benefit?

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Post by actuary » Mon Feb 22, 2010 7:50 pm

mephistophles, the IRR is based on cash surrender value. This is not difficult to achieve when you look at the interest rate environment 10 years ago or 20 years ago and I squeezed out every bit of possible commission and expense load out of my policy.

EmergDoc, I always look at how the insurance company invests for the products they sell. This is my first step to see if I can do better on my own. In my case, I have permanent insurance need and I just can't beat the low cost whole life policy I construct by "buy term invest the difference". I can't replicate the guarantee the policy provides and I need to pay income tax on the interest of the bond portfolio and use it to pay term insurance premium. In addition to that, I have much more flexibility when we need to choose the company defined benefit pension payout for me and my wife.

It all depends on how you use the product to your full advantage and don't let the insurance companies take advantage of you.

I will give you another example. I usually don't like any annuity products when I look at the underlying assets the insurance company invests and the high spread/commission from the product. But 13 years ago, I purchased two fixed annuities for myself and my wife (each with $5,000). This annuity has an 8 year surrender period, a 4% minimum guaranteed interest rate and non-rolling provision. In simple English, I can put large amount of cash to this annuity after 8 years and withdraw the money at any time without surrender charge because of the non-rolling provision. Guess what happened during the last 3 years, these two annuities become our savings account. We maximized the amount to the state guaranteed limit for each annuity, get a 4% guaranteed interest rate, tax deferred until we withdraw money and we can withdraw the money at any time. If I put a lot of money to these annuities 13 years ago, the insurance company and the agents would certainly earn a great profit and commission from me. But instead, I only put $5000 in each and essentially purchase a long term interest rate guarantee. So it all depends on how you use the product.

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Post by grabiner » Mon Feb 22, 2010 8:28 pm

Fbone wrote:I guess we live in different classes. Few people in my class has a pension or any significant retirement savings. Often upon the death of the husband the spouse is left almost destitute.
In that case, if the husband is still alive and no longer working, the wife is even worse off, as they have extra expenses (two people to feed, house, and care for) and they don't have the husband's life insurance.

It's certainly better to buy whole life than to buy term insurance and throw the difference away, but that's not a fair comparison. If the husband in the above situation had term insurance and spent the difference on Treasury bonds or CD's (reinvesting the interest), the couple would be better off with the term insurance, as the savings would provide a lot of income without any need to cash in the whole-life policy.
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Post by nisiprius » Mon Feb 22, 2010 8:46 pm

grabiner wrote:It's certainly better to buy whole life than to buy term insurance and throw the difference away, but that's not a fair comparison.
Precisely.

The "forced savings" argument holds little water, because for as long as I've been alive it has been trivially easy, in any number of ways, to arrange for savings to be taken automatically out of my paycheck or out of my checking account. Even before the introduction of the 401(k). "Investing the difference" can be done at least as easily as paying an insurance premium.
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Post by mephistophles » Mon Feb 22, 2010 8:47 pm

[quote="actuary"]mephistophles, the IRR is based on cash surrender value. This is not difficult to achieve when you look at the interest rate environment 10 years ago or 20 years ago and I squeezed out every bit of possible commission and expense load out of my policy.

Actuary, you said earlier that --"So the actual net IRR is over 5% every year for my policies"

My question is what would be the total premiums paid, and the total cash surrender value of your policy each year for the first ten years. I have never seen any life insurance policy pay out this kind of return in the early years.

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