Indexed Universal Life Insurance

[dczech09]

Just to be clear, there is no reason why you shouldn't be able to earn 2%/year for 30 years without any stocks at all so market fluctuations would be irrelevant.

Agreed. You could do that with a good money market mutual fund. If the economy was a little better, than savings accounts

[Wayde]

=disneysteve;319546]Okay. Let me take a different approach (not that I expect you to change your mind but let's do it anyway).

I'm always open to different thought processes. The only way to grow in anything is to be open minded and soak everything in...weed out the bad and keep the good.

Instead of the 20-year policy, let's have our 53-year-old woman take the 30-year policy for $90/month. That leaves her $150/month to invest. If she earns just 2%/year for 30 years, she ends up with $74,407.67. Anybody who can't manage 2% over 30 years simply doesn't know what the hell they are doing.

Yes, Insurance companies knows this...that is why they build in other benefits. The Whole Life policy that she purchase pays dividends. In 30 years she will have an estimated $125,844 coverage instead of the $75,000. The $75,000 is guaranteed.

So again, if she dies while the term policy is in effect, her kids get 75K plus what she has saved. If she outlives the term, she then has virtually the same 75K anyway plus it continues to grow until she does die.

No matter how you slice it, the term policy wins, again unless I'm missing something major here.

It's not the Term and invest the difference method that is in question. It's the suitability. You can do all the numbers you want but remember, it's not all about the numbers. Suitability accounts for everything including the numbers.

Forget a 20% market drop. She wouldn't have much if any money in the stock market so it wouldn't matter.

Well, that is not a good philosophy. Any money lost is not good. It doesn't matter if a client invests a little or a lot. $1 to some people means nothing, to others it could mean milk for the baby. (A little drastic, but that's just how it is.)

[Wayde]

=dczech09;319548]This is exactly why whole life may be "appropriate" but not necessarily "best alternative." Even a 2% rate of return (which is quite frankly sad) would still out pace the whole life policy and give a slightly greater benefit (that still grows) after the term expires.

I like what you stated here. "Appropriate vs Best Alternative" This is called suitability.

Also, if she needed to liquidate a little money here or there, she can do that with her savings. Heck you can get 2% in a simple savings account if you're savy. So liquidity is not an issue. And she wouldn't even have to take out a loan.

I, like most of you, used to believe that loans are bad...but now that I've done the numbers it makes more sense to take a loan than liquidate the cash. (It will take some time to explain this so maybe in another topic)

Also in regards to a 20% market crash- DS's hypothetical rate already takes that into consideration. Just for a quick FYI, my studies from the S&P500 inception through the end of 2011 showed an average annual return of 8.53% and that takes into consideration MANY market crashes. I know 30 years is a significantly shorter period of time, but you get the point.

Now that is a great point. S&P averaging 8.53% since inception. Now, I've been doing some research on the Index Universal Life Policies and that's what they use for Interest Crediting method, the S&P Index.

In your hypo situation, the woman is not getting anything in return for the extra premium except a policy that is pretty much guaranteed to pay a death benefit. That is great and all, but it is not the best thing. The one thing I did like is that you only considered the whole life policy for its insurance benefit. You never tried explaining how the cash value could supposedly benefit the woman if she "used it the right way." In fact, you never referenced the cash value at all. Just the insurance coverage.

This is another topic that will take a lot of time to cover. Let's do that in the near future.

And as DS showed, the term does the same thing (just for a limited time) after which saved money takes off form there.

Yes, but remember..."what ifs" is something, myself as her consultant, is not willing to bet on with her age, her risk tolerance, and other financial data and suitability.

[Wayde]

And rightfully so that he didn't mention it. If she chose to borrow any of her cash value, then upon her death, her kids wouldn't get what she wanted them to get since the cash value loan would get repaid from the death benefit.

Yes, like any money...once spent it is gone and needs to be re-saved, re-earned, or in this case re-paid.

[disneysteve]

I'm glad you came back to this, Wayde. I would like to get some better explanations of your answers.

The Whole Life policy that she purchase pays dividends. In 30 years she will have an estimated $125,844 coverage instead of the $75,000. The $75,000 is guaranteed.

How are the dividends calculated? So this policy has a 75K death benefit that rises over time? If that's true, then to accurately compare the WL to term, we need to know the rate of return for that dividend payment.

It's not the Term and invest the difference method that is in question. It's the suitability. You can do all the numbers you want but remember, it's not all about the numbers. Suitability accounts for everything including the numbers.

I'm not understanding how the WL is more "suitable" in this case since it seems to provide less money in the end and there is virtually no risk to a portfolio earning a 2% return. However, that will partly depend on the answer to my previous question about the dividend structure.

Well, that is not a good philosophy. Any money lost is not good. It doesn't matter if a client invests a little or a lot. $1 to some people means nothing, to others it could mean milk for the baby. (A little drastic, but that's just how it is.)

I'm not sure what you mean here. I was saying that you could safely and easily earn a 2% return without getting involved in the stock market. You could do it with guaranteed/insured investments with zero market risk.

Yes, but remember..."what ifs" is something, myself as her consultant, is not willing to bet on with her age, her risk tolerance, and other financial data and suitability.

Again, I don't understand how going the route with the lower return and higher cost is more suitable. That's taking a much bigger risk with the client's money.

When you sell these WL policies, do you sit down and show the client examples like the one I gave earlier illustrating how she would come out ahead by buying term and investing the difference?

[jpg7n16]

It's not the Term and invest the difference method that is in question. It's the suitability. You can do all the numbers you want but remember, it's not all about the numbers. Suitability accounts for everything including the numbers.

That begs the question then, how are you defining suitable?

I would define it as coverage for an appropriate timeframe.

If you are recommending 60+ years of coverage to someone who only needs 30 years of coverage, that is unsuitable IMO.

[disneysteve]

That begs the question then, how are you defining suitable?

I would define it as coverage for an appropriate timeframe.

If you are recommending 60+ years of coverage to someone who only needs 30 years of coverage, that is unsuitable IMO.

Also, if you are selling someone a policy that costs more and yields less than another policy, that is also unsuitable IMO.

This woman might need "coverage" for more than 30 years. She is young at 53 so she may well outlive a 30-year term policy. The question is if she'd end up with more money in the end by going with the term and investing the difference so that she would essentially be self-insured after the 30 years.

Very, very few people truly need life insurance for their entire lives because very, very few people have anyone financially dependent on them that long. I'm actually not clear why this particular woman needed life insurance at all with grown children but we don't have all of the details so we can't comment one way or the other.

[bp019j]

A little late to this thread. In full disclosure I am an life insurance agent and am passionate about what I do....and pride myself on helping clients find the lowest possible 'cost of insurance'...the real expense, not the premium amount. I consider myself fortunate having a fixed income institutional background prior to becoming an agent. It definitely helped me see through the 'smoke & mirrors' tactics that go on in the industry.

Think Devin (PayCzech's Money Blog) shared the Breadwinners' Insurance website, which offers tons of great information on how the life insurance industry works. Cool, and thanks for sharing.

The problem I have with Indexed Universal Life Insurance - like every other permanent life insurance product - is how they are sold! The very unfortunate thing is that many agents do not understand the products they are selling. It might not actually be their fault either, but rather the life insurance company, or general agency they are working for/with. The agency/insurance company provides new agents with sales training, and sales managers sell to newbies on how they can make a ton of money in the business....especially if they listen to what these managers say and do.

Let's face it the sales managers are slick, and often don't understand the products themselves. It is even worse if they did - but HEY they are great salesmen and can sell ketchup popsicles to ladies wearing white gloves. No one is training new agents about the ins and outs of how life insurance carrier's operate, and how the products work. It is shame because now is a great time to be in the industry, and the industry struggles to attract new talent. The distribution model can and will likely change.

It is terrible, and unfortunately the regulators/congress do nothing to rectify it. Go ask Joe Belth, insurance professor at the University of Indiana, editor of the Insurance Forum and author of 'A Consumer's Guide to Life Insurance'. He tried to make changes in the industry some 40 years ago - and was shut down!!!

If people think Wall Street is corrupt, take a good look inside some of the large life insurance carriers. What they are doing to uninformed policyholders is absolutely wrong! A big problem, in my opinion is some people buy life insurance protection and put their policy in a safe and lock it up. Never reviewing their policy - ever. Life Insurers know this and love it, after all that is where their profits come from. The pricing on premiums for new policies factor approximately 9 out of 10 individuals will let their policy lapse! That is pretty sad especially considering how vital life insurance is for many young families with dependents, a mortgage, etc.

I imagine there are a great deal of baby boomers across the country who are sitting on ticking time bombs ready to implode...because they bought universal life policies in the 80's when interest rates were double digits....Illustrations at policy issue, more than likely showed the interest being credited to their cash value account at 8%...making it seem that same 8% interest credit would be sustainable. And by the way it is okay to use illustrations to compare policies today, even after the society of actuaries did research and concluded that illustrations were not accurate...(an illustration is just a financial projection based on an assumed rate)....Meanwhile interest rates declined during that same 30 year period....universal life insurance offers premium flexibility and was more popular back then b/c individuals were dumping their whole life policies to earn 11% in a certificate of deposit (CD)...and when someone coined the phrase 'buy term invest the difference'. Life insurance carriers needed to do something about consumers dropping their whole life insurance, or borrowing from their whole life contracts to put the money in a higher yielding savings account. That is why Universal Life was created, to offer the potential for a higher interest credit in the cash value account.

Variable Universal Life was over sold in the 90's, go figure....The Go Go 90's, how can one go wrong with a VUL policy and earn stock market returns in a tax deferred growth account. The problem is, like the housing market, the stock market doesn't only go up. When the stock market goes down, the VUL policy becomes a double edged sword - where the policyholder's cash value is being eroded by high expenses and stock market losses.

Which brings us to 1997/1998 when the insurer's finally got it right, maybe - only time will tell. Voila, Indexed Universal Life....The stock market goes up - SCORE there is enough incentive to be excited. And if the market drops in any given year, policyholders will sleep well at night knowing they did not lose any money from the stock market decline. Here is the problem, in my opinion illustrations are being used and some agents, NOT ALL are using a 8% return for the index (sans dividends)...We all know that, even an average rate of return close to 8% is pretty difficult to earn over a 10, or 20 year period. Keep in mind some agents are not disclosing what could happen if the market is sideways for 5 years, or down consecutive years. The cash value account could be eroded due to policy expenses.

As mentioned I am a life insurance agent and take pride in what I do. My belief is there are great uses for both term and cash value policies. It just depends on how the policies are designed, sold and how big the commission check is to the agent. An informed consumer will be able to make good, educated buying decisions when it comes to any financial product or service.

Signing off for the evening.

All the best SavingAdvice members.

Timothy Hider
Founder of Momentum Risk Transfer

[dczech09]

Timothy, thanks for the input!

Just to be clear to others, I am not against cash value policies. If they are sold and purchased as an insurance policy (which is what it is supposed to be) then great. The one thing that drives me crazy is when they are sold as an investment.

I remember a while back, I was sitting at an agents office and business. As I was waiting in the lobby, I overheard a life insurance agent in the office talking to a client. The agent was selling one of their standard whole life policies and called the cash value an investment. I had such a hard time restraining myself because what the agent was saying was completely off-base.

The only reason why cash value exists is regulation and in the event that the policy is canceled early. It was never meant to be an investment, is not an investment, and is sold as an investment improperly all the time.

And yes, I would agree with Tim that it is not necessarily intentional. A lot of agents do not understand the products that they sell. I would love to create a educational workshop for agents that explains how these policies actually work mechanically. I have done a lot of research and have a pretty good understanding on the ins and outs.

[bp019j]

Might not be a bad idea, Devin. Cash value policies can be awesome when properly designed. The reason why they have a bad rep is how they are sold!

[disneysteve]

Timothy, can you please give us just one specific example where a whole life policy is a better choice than a term policy?

[bp019j]

Thank you for your interest, DisneySteve. Whole Life, as it is often sold with excessive sales commissions is a complete rip-off. Would never argue that! We tend to talk about term vs. cash value life insurance. Cash value life insurance is often misunderstood, and many never consider it's tax privileges - tax deferred growth, and the potential for tax free distributions. We believe there are good uses for both term and cash value life insurance policies.

Cash value products consist of : whole life, variable universal life, index universal life and universal life

There are TWO sides to every story.

• Buy term and invest the difference

,

• Why rent with 'term' when you can own with 'whole life'

,

• whole life is more expensive than term.

And plenty of misrepresentations, misconceptions and potential fraudulent sales activities (Search news story: Lawsuit of life insurance agent in Myrtle Beach, SC) <-- Unfortunately this stuff goes on and this guy should be sentenced for many years.
in the life insurance industry. Let's be clear that it stems from the insurance companies themselves. The truth lies usually lies somewhere in between these two stories.

Let's break it down like this:

Term Insurance - Pay the annual premium and death benefit protection will be there for the duration of the policy term period. There are generally options to convert into a permanent, or cash value policy at any time during this term period.

Whole Life - Considered permanent with death protection for your entire, or 'whole life'. Whole life is comprised of term insurance and a cash value savings account. There is generally a Guaranteed Interest Credit of 4% for the cash value savings account. Dividends are not guaranteed. The premium for whole life policies is greater than term life, but the premium is not the cost of insurance.

Premium = sales loads, claim costs, admin & premium taxes, capital costs

A blended policy (Term + Whole Life), with minimal commissions is how it should be bought, not what is often sold.
See article POLICY DISCLOSURE: AN OVERVIEW from Breadwinners Insurance website.
Reference Table 10

Not sure if that answers your question. I welcome your thoughts, comments and criticisms.

Timothy Hider
Momentum Risk Transfer

[disneysteve]

Not sure if that answers your question.

You didn't address my question at all. I didn't ask you to define Term and Whole Life. My question was this:

Timothy, can you please give us just one specific example where a whole life policy is a better choice than a term policy?

[bp019j]

Timothy, can you please give us just one specific example where a whole life policy is a better choice than a term policy?

Whole life is a complete rip-off, considering how it is sold - with excessive sales loads.

It was a very vague and open-ended question. Here is another attempt to answer your question.

To be clear for everyone viewing this post, a decision about whether or not a cash value policy is appropriate for any individual is based on that individual's situation, resources, objectives and judgments. There are good uses for both term and cash value life insurance policies.

Here is how I view life insurance:

There are two types of life insurance: pure term insurance AND term insurance with cash value. The difference between the two is the cash value and it's tax privileges.

What if one could purchase pure term insurance with pre-tax dollars?
or
If the expenses by the pure term insurance can be recouped?

Here are cash value's tax privileges:

Many know that the cash value account grows on a tax deferred basis. They may not be familiar with a cash value policy's total premiums, (an investment portion + expense portion) form its tax cost or basis.

For example: (this may be an example of where a cash value policy is better than a term policy).

Important Note: To keep things simple I am not considering premium taxes, other minor expenses and tax rates so that the tax privileges of cash value life insurance can be seen and understood.

An individual needs 300,000 of life insurance protection for the next 20 years.
They have a budget of approximately 1,000 per year to allocate for insurance and investing.
or 20,000 total.

Suppose the cumulative term costs are 8,500.
Let's also assume the separately invested 11,500 difference grows to 30,000.
At the end of the 20th year the individual would owe taxes on the 18,500 gain (30,000 - 11,500 basis).

In contrast, let's say the individual allocated the full 1,000 per year to cash value life insurance. With similar investment returns and equal costs this individual could have the same 30,000 at the end of the 20th year. Yet only owe taxes on 10,000 (30,000 - 20,000 basis).

If the individual chose the cash value policy they would have greater value after surrendering the policy at the end of the 20th year. This is because their larger cost basis (20,000) shields an additional 8,500 from taxes.

Alternatively, the cash value policyholder now has options. If they do not wish to surrender their policy, pre-taxed dollars in the cash value account can be applied toward the cost of coverage.

Consider Ed Slott, CPA and recognized national IRA expert view on cash value life insurance.
His view is that cash value life insurance is one of the best long term savings vehicles.

Happy saving!

Timothy Hider
Momentum Risk Transfer

[disneysteve]

Timothy, tell us what happens to the cash value if the policyholder dies while the policy is in effect. Let's say he dies in year 19. How much will be paid out to his beneficiary?