Cash value life insurance ownership has fallen off a cliff in the United States. According to LIMRA data, nearly four in five individual life insurance policies issued in 1990 were some form of permanent insurance. By 2002, permanent had dropped to about half of all life insurance policies. Between 1990 and 2009, the amount of total life insurance coverage provided by cash value policies declined by exactly 50% to just 26%. What happened?
The first explanation is that the Internet happened. In a convincing study published in 2002, University of Illinois professor Jeff Brown and Austan Goolsbee of the University of Chicago found that the Internet had a profound impact on the market for term life insurance. The mid-1990s saw the first appearance of the now ubiquitous life insurance price comparison sites that dropped a bomb on the term insurance market. In five minutes a consumer could shop for the best price on a $500,000 term policy and save hundreds of dollars in premiums.
The average price for a term policy fell by 27% between 1992 and 1997. What happened to whole life prices during this period? Nothing. So whole life’s closest market substitute got a lot cheaper in the span of a few years. And prices fell even faster in states like California where more residents used the Internet (sorry Alabama).
They also found something else that was interesting—prices paid for term fell by 35% for buyers under 30 and only by 14% for buyers over 45. Prices paid were also lower for buyers in high-skill occupations.
Consumers who were more sophisticated and comfortable using the Internet got the best deals. If cash value policies became comparatively more expensive, we might also expect that these younger and more technologically savvy consumers would be the first to abandon them. This leads to the second explanation for the decline in cash value demand—the almost universal demonization of permanent life insurance by personal finance gurus, including Suze Orman and Dave Ramsey. Access to the Internet meant that finding these opinions was easier than ever.
Personal finance writer Pamela Yellen calls it the “Orman-Ramsey vise” that has a death grip over popular audiences who now won’t even consider a cash value policy. Orman has turned “buy term and invest the difference” into a mantra when viewers ask about buying life insurance. The Internet and the popularity of personal finance television and radio shows make it cheaper and easier than ever to gather opinions and information. Most of this information is not kind to the cash value product.
I’m sympathetic to such skepticism about cash value products for the average household. Most young households need a lot of coverage to be adequately insured against the unexpected death of a breadwinner. Cash value policies cost more when you’re young because you’re prepaying for coverage in later years. A 2012 study by the Society of Actuaries and LIMRA found that whole life policy lapse rates were highest for owners in their 20s and decreased for older households, while lapse rates rose with advanced age for term policies. Term seems to be a budget buster for older households, and cash value may be too expensive for younger buyers to fit into their limited income. Cash value policies may lead to insufficient (or no) coverage among the young families who need protection the most.
If you subscribe to the Orman-Ramsey point of view, the Internet heralded the new age of enlightenment for life insurance. Prices went down for the products that are most appropriate for the average consumer who doesn’t have an estate planning need, hasn’t run out of alternative sheltered savings options, and doesn’t own a business or have a strong desire to leave a bequest. The sharp drop in term life insurance prices and the movement away from cash value must have helped more Americans get the coverage they need for their family. Or did it? This is where things get complicated.
Barry Mulholland, a Texas Tech assistant professor and my co-author on a study of this shift, has been looking closely at what drove the drop in whole life insurance, coming up with some surprising results. First, there is some good news. The face value of all individual life insurance policies doubled during the term insurance boom from $5.4 trillion in 1990 to $11 trillion in 2011. The bad news is that the number of American households owning any life insurance fell from 177 million to 151 million during this same period. That’s over 25 million more households that are unprotected.
How did this happen? The law of demand says that when prices of term life insurance go down more people will buy it and insurance coverage should increase. But that’s not what happened. More people bought term policies, but fewer bought cash value. Rather than substitute term for cash value, many chose no insurance at all.