In an article titled, “Four Reasons Whole Life Insurance Is Not Worth It,” Holly Johnson, writing in The Simple Dollar, confidently tells readers:
“Instead of pouring money into a whole life insurance policy and hoping it pays off, I would much rather keep more of my money in my own hands. That way, I can continue saving cash, maxing out our retirement accounts, and investing in real estate.”
Sad is the fact that she was taught erroneous information about how whole life insurance works. But, perhaps even sadder is the fact that her confidence about that, which doesn’t come without great expense and, perhaps, a valuable life lesson.
For years, critics have confused people about the essential nature of whole life insurance, and investors have paid a terrible price for that advice in both excessive risk and sub par investment returns compared to a strong participating whole life insurance policy.
Especially damaging is the advice from trusted consumer advocacy groups, like Consumer Reports. A 2015 Consumer Reports article titled “Is whole life insurance right for you” advises its readers:
“If you’re wealthy, you can probably gamble on whole life… If you’re struggling, go with term.”
Indeed, Johnson cites that article in her article as an authoritative source of information about whole life insurance. But, as I discussed in an earlier blog post, such information and advice is not serious, and cannot be serious, nor is it truly helpful to the vast majority of individuals seeking financial security and independence.
(Related: Whole Life Insurance Critics Aren’t Serious)
That financial advisors remain ignorant — whether innocently or otherwise — about how whole life works is a travesty of the highest order.
A quick trip down memory lane reveals the advice given to eight-year-old Virginia O’Hanlon in 1897 by the New York Sun about Santa Claus is strangely relevant here:
“Virginia, your little friends are wrong. They have been affected by the skepticism of a skeptical age. They do not believe except they see. They think that nothing can be which is not comprehensible by their little minds.”
Clients need to hear, in unequivocal language, “Yes, whole life insurance is worth it.” That their skeptical friends and advisors are wrong, and that they can trade in their fears, doubts, and uncertainties, with safety, protection, and certainty.
Indeed, the essential nature and unsaid truth of whole life insurance is so obvious and straightforward, it’s often missed by those looking for complex financial solutions and those willing to sell complex financial plans to their clients.
The Unsaid Truth About Whole Life Insurance
Contra Consumer Reports, whole life insurance is not a “gamble.” Point of fact, it is the complete opposite of gambling. Life insurance companies sell certainty. Prospective policyholders come to insurance companies with an uncertain financial future. They trade that great unknown for a known premium and guaranteed future outcome. Life insurance companies are willing to make 30, 50, even 100-plus year promises (for especially young insureds) in exchange for said premium.
No other financial institution makes such long-dated promises because no other financial institution is in a financial position to do so.
This is why whole life insurance is potentially the single-most valuable long-term financial product available to consumers. Among the various financial products available which offer something resembling a guarantee to investors, none offer a lifetime guarantee of savings, a lifetime guarantee of a death benefit which is higher than the savings amount, and a reasonable expectation of dividend income.
None except participating whole life insurance, that is.
And, that is the enduring story of whole life insurance. It is inescapably intertwined with advanced mathematics — an eternal story, promising an unbreakable guarantee of the future. The guaranteed cash value, guaranteed death benefit, and guaranteed level premiums of whole life insurance ensure policyholders never have to guess about their financial future. Whole life insurance’s big and not-so-secret promise is to make the uncertain, certain. It protects individuals against financial loss while simultaneously providing financial security for an entire lifetime.
That this simple fact of whole life insurance is often left unsaid or unacknowledged is unfortunate.
Contrast this with the empty promises of speculation. For years, investors were promised 12% average returns from the stock market. In hindsight, they earned far less — in many cases, less than 6% after taxes. In some cases, even less than that.
In 2017, Fidelity analyzed 22,400 retirement plans, monitoring the performance of 15.3 million investors and published its results in a special report. Fidelity’s investor database is one of the largest known databases of its kind. At the end of 2017, it reported the 10-year median annual return for investors was just 5.80%, before taxes. These investors were committed to remaining invested for the long-term — only a small percentage of these investors took hardship withdrawals or 401(k) plan loans. Despite their loyalty to the markets, these investors were rewarded with risk and lost capital. Even so, they remained faithful, which speaks to the idea that committed investors tend to “stick with it” and some even believe they have earned more than they actually have from their investments.
The published trailing returns of many equity mutual funds foster this belief by suggest investors are earning double-digit returns. Often, the sobering reality is investors are earning far less than advertised. This was highlighted more recently by the latest DALBAR study, which found the average equity mutual fund investor earned just 3.88% annual return over the last 20 years. Investors who placed their money in more diversified mutual funds, where money is spread out across multiple asset classes, fared worse — just 1.87% per year over the last 20 years.
A promise of high rates of return causes investors to save less. If investors expect to earn 12% returns from their investments, they don’t need to save nearly as much as if they earn 4%. But, planning on a 12% (or even 8%) rate of return, and receiving 3% to 4% returns instead, destroys an investor’s financial plan, making it impossible to retire with any sort of financial security.
And, despite the widespread belief by investors that they will be in a lower tax bracket when they retire, the Center for Retirement Research at Boston College found that taxes on income drawn from retirement accounts can eat up 25% to 33% of a typical investor’s retirement savings, assuming income taxes never increase from today’s relatively low rates.
Risk Tolerance V. Risk Capacity
Part of the problem investors face today isn’t financial. It’s emotional. It’s the faulty notion that risk tolerance matters. Risk tolerance is how an investor feels about risk. And yet, feelings do not necessarily jive with facts. Investors are routinely asked to assess their own risk tolerance, often through subjective risk tolerance questionnaires. They are asked, for example, how they would feel if they experienced a 40% decline in their portfolio value. They answer while sipping a latte in a plush office, in a leather chair, in a comfortable room with relaxing music. What they experience “in the moment” of a market crash almost never corresponds with their initial feelings about said crash beforehand.
This raises an obvious question: do subjective risk tolerance questionnaires matter? A risky investment may not feel risky to the investor, and yet it may be risky, nonetheless. This phenomenon has plagued investors for decades.
Contrast this with risk capacity — the amount of risk an investor must take to meet his or her investment goals. Or, said another, perhaps more useful way, the amount of risk an investor can afford to take to meet their investment goals. When reframed this way, risk capacity becomes an objective calculation of how much money investors can risk to meet future goals.
Meaning, if the guaranteed future value of an investor’s savings is insufficient to pay all future expected expenses, an investor likely cannot afford to take any risks. Investors can reasonably take risks when they have guaranteed savings sufficient to cover necessary future expenses. Of course, implied in this view is the idea that investors need insurance for financial security and independence.
Putting Whole Life Insurance Front and Center Would Fundamentally Change the Financial Planning Industry Forever, and Restore Trust in the Financial Services Industry
To achieve this sort of financial security, an investor would benefit from putting a high premium participating whole life insurance policy front and center in a financial plan. High premiums, and high guaranteed cash values, allow investors to pass financial risk onto a life insurance company. Each dollar of guaranteed premium, and the resulting guaranteed cash value, frees up riskable money which can be invested in speculative investments (if he so desires). The client has put enough money into life insurance when he is fully insured for his human life value — the present value of all his future income.
But, this extensive use of whole life insurance to guarantee a future savings and death benefit would require a complete overhaul in how financial advice and financial planning is delivered to clients. That change, which overturns decades of financial planning dogma, can seem potentially threatening. But, what is the alternative? Investors today are retiring in waves, wholly unprepared for what awaits them. Subsequent generations need not share in their fate.
For today’s investors, the choice is simple: Do you want certainty about your future or do you want to speculate and gamble with it?
David Lewis is the founder and owner of Monegenix. He designs insurance-based financial plans, financial calculators and apps for business owners and professionals.