Norman Dacey. “Art” Williams. Suze Orman. Dave Ramsey.
What do they have in common?
Other than being famous and controversial figures, they also happen to be some of the fiercest critics of whole life insurance. What they promise to consumers is a comprehensive education on life insurance, but what they deliver instead is inauthentic, sophomoric advice. Their ideas and criticisms aren’t serious.
If you raised an eyebrow after reading that last sentence, let’s consider the types of arguments these (and other) critics raise against whole life insurance.
Most arguments revolve around just a few key issues:
- Premiums for whole life insurance.
- Commissions paid to agents on whole life insurance.
- Rate of return on whole life insurance.
- The need for life insurance after retirement.
Premiums for Whole Life Insurance
An attack on whole life often begins with a bizarre comparison of whole life insurance premiums with term insurance premiums. After acknowledging that whole life insurance is a product which combines life insurance with a savings or investment fund, critics then tell their audience that term life insurance premiums are much cheaper than whole life insurance premiums. And, because of that, you can buy much more term life insurance per dollar of premium than you can whole life. Therefore, term insurance is “better.”
If only it were that simple. As all critics freely acknowledge, whole life insurance combines life insurance with savings. Because of this, premiums will always be higher because of the savings element of the policy. This is the meaning of the phrase “buy term and invest the difference.” The “difference” is the money that goes into the savings portion of the policy.
The implication is that a better form of savings exists elsewhere, outside of a whole life insurance contract. Now, that’s a legitimate idea worth pursuing, but the implication being made by critics isn’t that premiums are higher due to the savings element but rather because whole life insurance is somehow a more expensive form of insurance than term insurance.
A more realistic view is presented in Albert Easton and Timothy Harris’ stand-out textbook “Actuarial Aspects of Individual Life Insurance and Annuity Contracts,” wherein the authors write:
“Whole life is sometimes considered to consist of two pieces, the reserve and the net amount at risk; the difference between the reserve and the amount of the death benefit. When considering whole life in this way, the policy is described as consisting of two benefits: a savings account and decreasing term insurance.”
Easton and Harris’s view isn’t new, nor is it simply the subjective opinion of two life insurance actuaries. In 1979, the Federal Trade Commission published a Cost Disclosure Report on life insurance, making it explicit that embedded within the bundled whole life product are two different, but complementary, components:
“Although the premium for a whole life policy remains the same as long as the policy is in force, the actual amount of death protection bought by the level premium declines each year as the cash value increases. For example, a 35-year-old man will pay approximately $200 a year for a $10,000 whole life policy. At age 70 this policy will have a cash value of approximately $6,500. Thus, the person is actually only buying $3,500 of insurance.”
This is the meaning of the cash value in a whole life policy. It is a reserve against the death benefit which helps defray the cost of insurance by decreasing the amount of it in the policy over time.
The concept of “net amount at risk” is uncontroversial in the life insurance industry, and yet it remains largely unacknowledged (or unknown) by critics. What Easton and Harris explain, and what the FTC made explicit, is fundamental to the structure and functioning whole life insurance — it is built on a decreasing term life insurance chassis, and it is inseparable from the savings element, because whole life insurance is a “bundled” insurance product. The insurance is bundled with a rising cash value to ensure the cost of insurance does not rise to unsustainable levels.
Indeed, the 1979 FTC report states that, “It should be noted that all forms of insurance are expensive after age 65.”
Level term life insurance is generally not sold beyond age 65 for this very reason. And, term policies which contain renewable provisions beyond age 65 are typically annually renewable policies, meaning the premium is guaranteed to increase each and every year. Those increases are substantial and reflect the cost of providing term life insurance at ages where the statistical probability of death is higher than at younger ages.
What readers can glean from this is that the total cost of insurance is intimately tied to mortality tables, not product type. What differs between product types like whole life, universal life, and term insurance is how the costs and other policy charges are amortized over the life of the contract. Term insurance is typically a 10- or 20-year policy whereas whole life can stay in place until the insured reaches age 120. If there is a difference in the appearance of life insurance costs, it is because term insurance is a short-term policy — shorter relative to whole life insurance.
Contrary to what the critics say, high premiums are desirable in a whole life policy, because high premiums necessarily lead to a large cash value — a large amount of savings.
Commissions Paid to Agents
According to Suze Orman, “Many agents love to steep people into ‘permanent’ life insurance plans… What they don’t often mention is that the commission they earn on a permanent policy is a lot more than what they will get if you buy the term policy.”
Of course, as written, Orman is right. Any full-fledged rebuttal to her appears to be a strawman, since she never mentions any other costs associated with buying term life insurance. Important to note here is that term life insurance is never purchased in a vacuum. Policyholders never choose between whole life insurance and term insurance. They choose to buy whole life insurance or buy term and invest the difference.
To reiterate, whole life insurance is a combination of insurance and savings, while term insurance is simply insurance. Because of this, people who buy term insurance must accumulate savings on their own, outside of the whole life policy. Meaning, they must buy investments and incur some kind of expense for said investment. Although Orman never mentions investing, what’s implied by the idea of “cheap term insurance” is also the idea that “investing the difference” is cheaper than paying commissions on a whole life policy… except that it isn’t.
For the breakdown for commissions for both whole life and term plus investment fee, click on these links to see a set of commission charts.
Commissions on whole life insurance are typically paid one of several ways. The lowest compensation level for an insurance agent is sometimes referred to as “street comp.” Typically this is 50% or 55% of the premium paid on a life insurance policy in the first year. Subsequent year commissions are substantially lower. An experienced agent may earn overrides, which increases his or her total compensation for selling the insurance. Overrides apply to both term life and whole life insurance, and they can substantially increase an insurance agent’s income.
If a 35-year old male, standard, non-smoker policyholder had $10,000 per year to allocate to whole life insurance or towards a “buy term, invest the difference” strategy, the tables above show that an agent earning “street comp” on whole life would net $9,800, amortized over 30 years. An agent earning high overrides on the policy, might earn total compensation of $18,550 over 30 years.
If that 35-year-old male instead chose to buy term and invest the difference, and he earned 6% annual returns on his investment, and did not pay an investment advisor any money to help him, and had an ultra-low expense ratio on his mutual fund, and no other investment or administrative expenses, then he would pay a total of $15,601 (assuming low term insurance commissions) or $16,960 (assuming high commissions on term life insurance). That is the only scenario when total fees and commissions are potentially lower than the commission costs for whole life insurance. Even so, they aren’t substantially lower than an agent earning high overrides on a whole life policy. And, if the agent is earning “street comp,” the commissions and fees are higher for buying term and investing the difference.
Of course, many investors do pay an investment advisor for at least some advice. This would mean the total fees and commissions would likely exceed commissions on a whole life policy by a wide margin. In this example, a 1% advisor fee combined with low-cost mutual funds results in over $83,000 in total fees paid over 30 years, and that’s just for the investments. If an investor somehow manages to earn 12% on his investments, the fees top $194,000 over 30 years, compared to commissions of just $18,550 for a well-compensated life insurance agent.
What we can learn from the above illustrations are two facts:
- Fees and commissions on whole life insurance are tied to premium payments.
- Fees and commissions from investments are tied to investment account balance.
Naturally, investment fees rise as the investor’s investment balance grows. This is to be expected. But, what is also to be expected is that whole life insurance commissions do not rise as the cash surrender value of the policy increases. Commissions are paid only on a percentage of the premium paid.
Even so, these commissions are not out of line compared to a combination of term life policy commissions plus expenses for mutual funds. In fact, in many instances (and especially when the investor uses an investment advisor that charges fees for assets under management), the fees are a good deal lower on whole life insurance.
The reason for this isn’t intuitive, though perhaps it should be. Life insurance companies, greedy for customers, must offer competitive commissions to agents, but must also remain competitive to investors and potential policyholders in the broader marketplace. If they didn’t do this, whole life insurance would disappear in a heartbeat. Hidden in plain sight is the obvious truth that, for every buyer, in every marketplace, there is a seller. The life insurance business is no different. Life insurance agents (i.e. the sellers) are matched to life insurance policyholders (i.e. the buyers). Without agents, there are no policies to sell. Without policyholders, there are no policies being sold.
Insurance companies are not stupid. They know they are competing for always scarce investment dollars. If those dollars flow into mutual funds, it means fewer dollars flowing into whole life insurance premiums. Even when commissions are high, they can never be “too high,” as some might suggest, else this would collapse the life insurer’s whole life business.
The very thing whole life insurance critics chastise the life insurance industry — and life insurance agents — for is the one thing that keeps life insurers competitive: the profit motive. Specifically, commissions.
The Rate of Return on Whole Life Insurance
In a video titled “Why Is Term Insurance Better Than Whole Life Insurance?” uploaded to YouTube in 2016, Dave Ramsey confidently stated that, “On average it’s [whole life insurance] making 1%-1.5% — horrible rate of return… It is one of the worst financial products on the market today.”
Though he doesn’t mention it, Ramsey’s most likely source for this rate of return claim is the 2015 Consumer Reports article, “Is whole life insurance right for you?” In that article, Consumer Reports cites the guaranteed return on whole life insurance as 1.5%. They also state that the possible future return on whole life cash values is 3.5%.
It’s not entirely clear where Consumer Reports obtained this information, but the fact that Consumer Reports, and Dave Ramsey, cite a fixed rate of return as the maximum potential for whole life shows the unseriousness of the critique. Most whole life insurance policies sold today are participating whole life insurance. Participating refers to how interest credits are added to the policy. Participating policies are named so because they participate in the experience and performance of the life insurance company. In other words, when a whole life policyholder buys a participating whole life insurance policy, they’re not just buying a product. They’re buying a business.
It should now be obvious to any casual reader why Ramsey’s and Consumer Reports’ claims can’t be true. For, if the claims were true, it would be the first example of a business — and, more broadly, an entire industry — running a static operation for over 100 consecutive years and, in some cases, for over 150 consecutive years. The critics imply life insurers are static, unchanging, entities and thus project static future values on their products.
The reality is the opposite. The life insurance industry is dynamic and changes and evolves over time, and it is because of that fact that participating whole life insurance returns have never been static and will likely never be static in the future.
It’s true that whole life insurance has a guaranteed cash value which grows at a predefined rate for the life of the contract. But, it is also true that mutual life insurers pay dividends to their participating whole life policies — dividends which change over time. And even though specific dividend payment amounts are not guaranteed, all mutual life insurers have paid dividends to their policyholders for over a century. That they do is a function of the fact that they run profitable businesses which run huge surpluses — surpluses which must be returned to policyholders in the form of those highly valued dividend payments. These dividends, which are usually used to purchase paid up additional insurance, grow the death benefit and cash value of the policy.
Life insurance companies project future dividends based on their current business operating environment. But, once again, that environment changes over time. Thus, using a static assumption of future whole life policy performance misses the bigger picture, and the truth, that dividend rates and dividend scales can and do change over time. Which means, projected future values on whole life insurance change over time.
This is most apparent looking at historical dividend rates.
For example, policyholders who bought a whole life policy from a major mutual life insurer in 1978 and held it to 1998, realized an incredible return. In 1978, the dividend interest rate at MassMutual, for example, was 7.80%. The company’s total dividend scale also reflected reasonable to low operating and mortality expenses. By 1986, the dividend rate skyrocketed to 12.20% and the mortality and operating expenses did not have a net negative impact the overall dividend scale. As a result, policyholders received far more than the guaranteed rate, far more than 3.5%, and far more than originally illustrated by their insurance agent.
Now, on the other hand, policyholders who bought whole life from MassMutual in 1990 and held to 2010, saw dividend rates (and the total dividend scale) drop during that time, from 10.50% to 6.70%. While mortality and operating expenses generally improved during this time, it was not enough to offset a falling dividend rate. Those policyholders still made far more than the guaranteed rate in the policy, however… far more than 3.5%, but realized lower-than-originally-illustrated returns. This was not unique to MassMutual. All insurance companies saw declining dividends rates and scales during this time period. And it had nothing to do with the life insurance policy, per se, but rather the inescapable reality of falling interest rates in the bond market. Life insurers use bonds to provide the guarantees of whole life insurance. They also use bonds (among other investments) to generate excess interest for dividend payments. It should be no surprise, then, that falling bond rates would eventually impact dividend rates.
The trend reversed course in 2012, pushing the dividend interest rate at MassMutual up to 7% and then to 7.10% before falling to 6.70% and then 6.40%. Other mutual life insurers experienced similar types of fluctuations in their dividend rates, some more dramatic than others.
Once again, what can be concluded from this is that dividend payments are not guaranteed and change over time with interest rates, investment performance of the insurer’s other investments, and overall company performance, including the number death claims paid and savings on operating expenses. Saying that whole life insurance pays a low rate of return is a gross oversimplification, lacking in context. And, when compared with other financial products of similar risk profile, it is simply not true that whole life pays a low rate of return. In fact, even when compared to conventional investment products, there are periods of time when whole life insurance has outperformed traditional investments. More on that, later.
The Guardian Life Insurance Company of America is another example of how dividend rates change over time. It publishes its dividend rate history from 1959 to 2018 (as of this writing). Its dividend rate in 1959 was 3.30%. If Dave Ramsey and Consumer Reports had used its then 3.30% projected future return assumptions for The Guardian, they would have been way off.
Guardian consistently increased the dividend rate during the 1960s, 1970s, and 1980s, to peak at 13.25% in 1984, before slowing and gradually falling to 5.85% in 2018. So, for 30 years, policyholders consistently received more than they were promised (i.e. the guaranteed rate) and even more than the projected dividends at the start of the policy.
But, even without reading the historical dividend studies from these insurers, one could easily deduce that life insurance companies are not static entities. Like all businesses, they change over time. They grow, they shrink, and they’re constantly investing to preserve the mutuality and return as much surplus as is feasible to policyholders to drive down the net cost of insurance and provide maximum value to policyholders in order to keep those policies on the books.
MassMutual and The Guardian aren’t outliers, either. Reports from independent analysts, like the late Roger Blease (Blease Research’s “Full Disclosure”), show 20-year historical returns on whole life insurance exceed the 1.5% guaranteed return cited by Ramsey and Consumer Reports.
Indeed, one such report looked at policies issued in 1984 by 8 mutual life insurance companies. The policies were issued on males, rated non-smokers, aged 45 and males aged 55. Blease Research tracked the actual performance of those policies up to 2004 — 20 years. In every case but one, the participating whole life policies returned no less than 3%, and in most instances, policyholders received an annual compound return on cash values of between 4% and 5%.
Blease Research’s Full Disclosure reports span many years, with many different starting and ending points, and each report consistently shows that returns on participating whole life insurance exceed the guaranteed illustrated rate, but ultimately depend on when the policy is purchased and how long a policyholder holds onto it. The 20-year return on whole life, for example, is higher than the 10-year return. And, for brave policyholders willing to stick it out for 30 or 40 years, the returns can rival more conventional investments.
A prime example of this was highlighted on the blog of the Internet-famous “White Coat Investor.” The “White Coat Investor,” AKA Jim Dahle, is an emergency room doctor turned amateur financial guru. While Dahle spends a lot of time blogging about non-insurance related issues facing doctors, he also has one of the largest collections of blog posts on the Internet dedicated to criticizing whole life insurance. Dahle is fond of beating up on whole life insurance and the insurance agents who sell it. However, even this critic had to admit the long-term return on whole life insurance wasn’t too shabby.
In his January 2013 post titled, “A Whole Life Insurance Success Story,” Jim Dahle tells us that:
“I recently had an email correspondence with a reader who had read through the posts on the blog about WL. He calculated out his return on his whole life policy and found it to be 7% after just 29 years. His initial email was asking me to show him where his error was because he was sure after what he had read that his return couldn’t really be 7%. I quickly confirmed that, indeed, his return was 7%.”
So far, so good. The policy was issued by Northwestern Mutual — a stalwart mutual life insurer. Despite the fact that Northwestern Mutual has seen its dividend trend downward over the last 30 plus years (as have all mutual life insurers), Northwestern has managed to return a significant amount of its surplus back to its policyholders as a dividend. And, for the 29 years leading up to the date of Dahle’s post, that return has been a very competitive one. Dahle considers this a whole life insurance success story, but quickly follows it up with:
“It’s relatively easy to see what kinds of returns stocks and bonds have made over the last 29 years. Just to keep it easy, let’s look at the Vanguard 500 fund and the Vanguard Long-Term Treasuries fund returns since inception (1976 for the 500 fund and 1986 for the treasuries fund.) Their returns were 10.51% and 8.6% respectively. I’d argue that if you used 1983 as a start date, the returns would be even higher, since treasury yields from 1983 to 1986 fell from 10.5% to 7.50 and the S&P 500 had returns of 22%, 6%, 31%, and 19% from 1983 to 1986… you could have invested in ANY combination of stocks and bonds in 1983 and had a better return than the whole life policy, by at least 1.5%.”
Let’s check the math on that. This post was published in 2013, and Dahle tells us this policyholder bought his policy in April of 1983.