What type of life insurance is "the best"? In general, that depends on what your purpose for buying life insurance is. It also depends on what you mean by "the best". For most people who want their insurance to pay a death claim, the type of insurance that they will need is permanent insurance. If an individual wants to self-insure (as is often taught as a viable purpose at least implicitly by many financial advisers today), then permanent insurance is again the type of insurance to purchase.

Why then, do many advisers and insurance companies focus heavily on (and endorse) term life insurance? For this, a [very] brief history is in order.

The idea that "life insurance is a temporary need" really started to gain traction with A. L. Williams and his company, Primerica, in 1977. Williams was a high school coach turned insurance agent who didn't like how his father's whole life policy was performing and thought that there had to be a better way. 

Williams observed that whole life insurance represented a bundled product. As such, there was no distinction between the amount of money going to pay for insurance, and the amount of money going to the cash value portion of the policy. This actually works in favor of the policy holder, but that wasn't the way Williams saw it.

For Williams, this whole life product presented a problem, especially during the inflationary times when his concept was being developed and implemented. Not trained as a professional financial adviser, Williams wanted to have costs broken down and thought in simple terms of "insurance" and "investment". Williams saw whole life insurance as a roadblock to his vision.

Whole life, according to Williams, was a "bad investment" that had to be replaced with a "good investment". With this motive, he built his company on the practice of extracting the cash values of mutual life insurance policies to fund dubious investment strategies.

By 1979 a brokerage firm called E.F. Hutton formed its own life insurance division, seized Williams' idea,  and in the early 1980s twisted his "buy term and invest the difference" philosophy into creating the first Universal Life insurance product, which was a 1 year renewable term insurance product with a separate side fund that invested in a money market mutual fund.

Universal Life insurance was initially designed under the inflationary interest rates of the 1980s, and pitched by E.F. Hutton as an alternative to investing in the financial markets. By 1984, many insurance companies followed suit fearing competition could wipe them out. But by the early 1990s, interest rates began falling to all time lows. By unbundling the cost of insurance to form Universal Life, E.F. Hutton completely overlooked the reason whole life succeeded - its built in guarantees.

In contrast, Universal Life offered no guarantees on cash value or death benefit, shifting insurance risk back to the policy holder, and leaving the policy severely vulnerable to interest rate fluctuations. Under more rational interest rate assumptions, these policies were not able to survive and many policy owners faced a tough decision - infuse their dying policy with more cash to try to keep it alive or let the policy lapse losing everything they had put into it. 

...and thus came the more recent attacks on life insurance companies for selling permanent life insurance that wasn't worth the paper it was written on.

What is often not explained to the public at large are the benefits of permanent insurance and the right way to use it for long term financial success.

First, don't listen to insurance agents that lie and tell you that life insurance is a temporary need. These out of context statements usually discount the purpose of the individual buying the insurance policy. An important question to ask a financial adviser is about the cost of death.

Funerals cost money. And, dying triggers income taxes on your gains to your beneficiaries. It can trigger a drawn out probate for some people, but that is becoming rare these days. The income taxes are probably a much greater concern. Of course, there is the fact that you have to somehow try to make your savings do double duty if you ditch your insurance in your old age when you need long-term care, a supplement to your pension, or even just a modest burial fund.

Understanding The Argument for Term Life Insurance

The idea of buying term insurance is that you will invest the difference - the difference being what you would have spent for the same coverage on a permanent policy. As a practical matter, most people never do that. Of the 78 million baby boomers heading into retirement, it is estimated that most of them have a net worth of less than $50,000. I guess they and their adviser dropped the ball somewhere along the line.

Term insurance covers a short-term probability of death. When I say short-term, I mean anywhere between 10 and 30 years. Maybe I should say "temporary". 30 years may seem like a long time, but in the insurance business, it's not. Consider that most people buy term insurance when they are least likely to die - between the ages of 30 and 45. After age 60, term insurance is very expensive and after 65, it's nearly unaffordable. At age 85, for the most part, you simply can't buy it (you're considered "uninsurable").

Some term policies don't offer a guarantee. What I mean is, the policy can be repriced before the term is up. Other term policies terminate at the end of the term while others convert to annual renewable policies at usually unaffordable rates. Unfortunately, this is the point when people usually discover that they'd like to continue coverage, but can't.

But perhaps the most telling problems of term insurance come from consumers themselves. What A.L. Williams and E.F. Hutton never realized is the reason that cash value insurance came about was not because of some evil scheme hatched by life insurance companies. Many policyholders actually had become disenchanted their term policies.

You see, after faithfully paying their premiums for many years, they were eventually forced to drop coverage because when the term ran out, the renewal premiums were too high. Coincidentally, they had to drop their coverage just as they were nearing the age when death became likely. To add salt to the wound, term insurance didn't offer any sort of refund for premiums paid. So, policy holders paid in and many of them got nothing in return. With today's lifespans, 99% of term policy owners will never see any payout from their life insurance (and neither will their families).

To solve the term dilemma, some very savvy actuaries devised a way of increasing and leveling out the premium payments to give policy owners lifetime coverage at a slightly higher premium. The premiums could be level and guaranteed for the life of the insured and coverage could be extended out to age 100. Think of it as a budget plan for insurance (similar to how gas and electric companies offer budget plans - you overpay in the summer and underpay in the winter and pay a level, fixed utility bill). Policyholders would overpay for their insurance in their younger years and underpay as they got older.

These first "term to age 100" policies were the early attempt at whole life insurance. They were designed to earn interest and build cash value to age 100 at which point the death benefit and the cash value would equal each other. The cash value did serve a purpose when those policies were first designed.

In essence, when you bought insurance, you were going through a process of self-insuring. The older you got, the more money you built up in your cash value. The more money you built in the cash value, the less risk the insurance company took to insure your life.

When the death benefit and cash value equaled each other, there was no risk on the part of the insurance company. It's true that cash value insurance was never originally designed to act like a commercial "savings account", even though the products have evolved over the years to accommodate more and more flexibility. Whole life, as a practical matter, functions as a long-term savings product with leverage being provided by the death benefit (should you die prematurely).

In essence, you are still working towards a process of self-insuring but with a great deal of liquidity and flexibility in the policy - which is exactly what most insurance agents and financial advisers tell you that you should be doing with your savings. The problem is, many advisers are telling you to self-insure with financial products that aren't designed to do that for you (i.e. mutual funds, stocks, etc.).

While I think there are many good reasons to move towards a process of self-insuring in certain instances, I am reluctant to say that I think that an individual should absorb every risk that insurance is designed to cover. In the case of modern life insurance, being able to retain, transfer, and/or control your current and future expected savings using one simple contract has become a unique and powerful feature of cash value life insurance. 

The fact that some advisers either don't get it, or simply don't understand the benefits of such contracts, baffles me sometimes.

Comments

[Brianna]

Testing comments

[Aaron]

David, thanks for clarifying that universal life insurance is not a form of whole life. That actually gets to my point that most people should forget about what type of life insurance they want - there is already too much confusion and bad, generalized advice out there. Instead, they should focus on their needs. Why do you need life insurance? What do you need it for?

Once you focus on the need, it is much easier to design a plan around it. Who care what tools a carpenter uses to build your fence? You care about the quality of craftsmanship and the cost - the same could be said about life insurance. You probably know the same set of needs could be met with a variety of life insurance solutions. Why limit agents in their creativity to find you the best possible quotes?

I understand this approach of ignoring the types of life insurance is open to abuse in the wrong hands. That is also why life insurance shoppers should get quotes from multiple agents and sources. Comparing quotes side-by-side brings clarity to an otherwise confusing situation. I'm sure you do something similar in your practice when you send out RFP's for life insurance quotes. The public just needs a way to compare quotes on a level playing field.

[John Fagan]

Truthfully these days term insurance is the best..People are looking for a way to save money and this is it...

[john fagan]

By far I truly believe that term life insurance is the best with todays current economy. You can save yourself some cash as well as be ready for what is coming.

[David C Lewis, RFA]

Hi Tammi,

Thank you for your questions. I have decided to devote an entire post to answer them. You may view it here:
http://www.twintierfinancial.com/the_uncommon_cents/2009/08/whole-life-insurance-vs-term-life-insurance-vs-universal-life-insurance.html

I get the impression that you don't like permanent life insurance, and I addressed that as well.

All the best,

David

[Tammi]

I have two questions. As stated in many of the comments and articles noted, BTID is a concept that shows people how to save their own money so they will not have to depend on the insurance companies to do it for them. They are in control of their own investments which if done properly they will no longer have a need for insurance and will have a substantial nest egg to support themselves through retirement and live debt free.

How does UL policies justify selling anyone an insurance policy that detracts from the insureds cash value until the is nothing left andd leaving them with a $0 death benefit unless they reinvest and say that is better that BTID theory?

How does WL justify charging double the cost of a term policy to help the insured save money but at the maturation of the policy only give the insured either the face value of the policy or the cash value built up in the policy when it is the insureds onwn moneyy they have been saving?

[Lyn]

Dave Ramsey really promotes term life insurance. What's your opinion on his reasoning?

[David C Lewis, RFA]

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@ Brian,

Thank you for your comment. I like to hear differing points of view from time to time.

First things first. When it comes to life insurance, there is no magic, only magicians. And there is no conspiracy theory here either.

To begin with, universal life insurance is not a type of whole life. It is literally "term and invest the difference" combined into one contract. Interest is credited to a cash account, and then mortality charges are deducted from that cash account. As long as there is enough money in the account, you keep the term insurance. If the money ever runs out (or there is no no-lapse provision), then the contract is canceled.

As for your comment about UL contracts, it depends on the type of UL contract you are talking about. Not all of them are "slam dunks".

I don't disagree with everything that Suze says, just her ideas about life insurance. I think a lot of the BTID folks are out there manipulating the numbers, comparing apples to oranges, and consumers aren't really aware of what's going on. Orman perpetuates this idea through the flawed theory of decreasing responsibility.

For example, you can compare a whole life contract to an equity mutual fund, but you're not comparing apples to apples. You would be better off comparing her mutual fund suggestions to other equity based investments, and then I think you'd see there are better alternatives out there than your typical garden variety mutual fund.

For the whole life contract, you are talking about an entirely different risk profile than someone who would buy into a financial product backed by bonds and bond-like investments.

So, I don't "get" why pro and anti cash value folks compare one risk profile to another - disregarding the implied goals and purpose for those risk profiles - and then proceed to say one is inherently better than another. It isn't, end of story.

Additionally, most people's investment time horizons are more than 20 years. So, even if you did want to compare apples to oranges, it's not always going to come out in favor of the equity based investment.

For example, let's say you are investing $200 per month into a whole life contract. You compare that to a "buy term and invest the difference" option where "the difference" is an equity based investment.

You don't need to know what the whole life illustration looks like to figure out a probable course of action on this one. Let's assume that the equity investment is capable of achieving a 10% net rate of return after fees and before taxes (assuming this is tax deferred). Now, this is really stretching what's probable in terms of well diversified mutual funds, but bear with me.

You set aside $15 for your term insurance, and invest the remaining $185. After 20 years, you end up with about $141,653. That's just your savings side. The term insurance cost you $15/month. This is something that Orman often leaves out of the BTID side of the comparison, but always includes in the whole life comparison because it has to be included. But, you need to figure in the real cost of the investment strategy, so add in the term cost too.

After 20 years, you put in $48,000 and got back $141,653. That's an effective rate of return of 5.55%. Can you achieve that kind of internal rate of return net of fees with a good dividend-paying whole life, fixed universal life, or equity indexed universal life contract? Absolutely.

Even after 30 years your equity based investment strategy yielded roughly 6%. And, while this is at the upper end of what a whole life contract could achieve net of fees, it is definitely realistic.

Now, if you are being fair, you're going to compare the same amount of death benefit in both examples, same premium/contribution amounts, etc.. Really, to be absolutely fair, you would compare the whole life with some type of bond-based investment.

Remember, this example assumed that you put 100% of your "invest the difference" into equities. Is anyone really doing that? Don't most financial advisers suggest that you diversify your holdings? If so, then even on the best performing portfolios, you're not seeing 10% net of fees in that "invest the difference" scenario. That's going to start dragging down your 5.55% hypothetical by quite a bit.

You might also diversify your money on the "buy whole life" side of things too, it's really dependent on the individual's goals. If you are going after quality equity based investments, this would help "push up" your returns, but now I'm going off on a tangent.

By the way, where does Suze Orman put the majority of her money? Answer:In conservative municipal bonds and zero coupon bonds (the latter being the exact same place that life insurance companies put their money). But, she is actually getting a lower net rate of return than a good dividend paying whole life policy while criticizing the life insurance industry at the same time for "low returns" on their cash value products.

For whatever reason, she doesn't "get it". I don't know what else to say.
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[Brian]

If Universal Life is such a slam-dunk, why does Suze Orman hate all forms of Whole Life? I can't wait to hear your conspiracy theories or put-downs on her regarding that since you obviously sell Universal Life all day long.

[David C Lewis, RFA]

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@Denise:
Thanks for the comment Denise.
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@Chris:
I agree with what you are saying in certain situations. For example, there is no doubt that Universal life is the KING of permanent insurance IF what you are looking for is death benefit protection. To some extent, if it is done correctly, ULs can do the cash value thing, but I've moved away from that line of thinking not because I don't think it doesn't work, but it gets too complicated for most people.

There are just too many moving parts. In particular, I'm getting tired of stock companies refusal to make a guaranteed column that doesn't lapse on high cash value policies. The fact that the company can increase mortality costs at will scares a lot of people, especially nowadays.
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@Lorne

Yeah, a lot of folks buy into the "buy term" philosophy. It's kind of lame for those who are 35-45 years old. I wrote a related piece on this topic that goes into much more detail: http://www.twintierfinancial.com/the_uncommon_cents/2009/03/buy-whole-life-vs-buying-term-insurance-and-investing-the-difference.html

[Denise]

While there are many advantages, a universal life policy is one of the most expensive life insurance policies available. It is also subject to market fluctuations. An attractive policy for most people is a term life policy with convertability options. This type of policy provides the maximum death benefits against the cheapest premiums. It is available for term periods of 1 to 30 years and many policies offer Return of Premiums (ROP) options. And because life spans have increased, you can also avail of renewability options within a term life policy which allows you to renew a term life policy, without having to undergo the underwriting process again.

Denise @ AccuQuote

[Chris]

Universal life insurance is definitely the better long term choice given the fact that the majority of the population is living to the age of 70-90 years of age. If you think about it, term liife is definitely the better choice (yeah right), that is if you plan on dying during the lifetime of the policy. But in most cases, the majority of the population will fortunitely, yet unfortunately, live longer than the life of the "term" policy. Fortunately because they will get to enjoy life a little (hopefully a lot) longer and get to watch their family members grow up. Unfortunate because the family they've been fortunate enough to spend more time with will now be forced to pay for burial expenes and possibly foot the bills left behind since they couldn't afford the renewal policy premiums. So take your pick!

Term Life: Good rate but little chance for return.

Universal Life: Not so good rate but excellent return.

[Toronto life insurance broker]

Nice article. Few minutes ago I have read article about how "foolish" permanent insurance is. I think every product has pros and cons. Term life is cheap and easy. On the other hand, permanent helps you to save money and you don't have to cry, when you are renewing your policy after 20 years...
Lorne