General Life Insurance Topics

The Types of Life Insurance Policies

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Introduction

About eight years before the author of this article became an insurance agent, a song written by Sonny Bono and sung by himself and Cher titled “And the Beat Goes On” hit the Billboard Hot 100 Top 10 music scene eventually peaking at number 6 in January 1967. Who can ever forget the entrancing “ladidadi de, ladidadida and the beat goes on rhythm pounding in your brain? It became one of the most recognizable tunes for Sonny and Cher. It had such an impact on Sonny that the lyrics were engraved on his tombstone when he passed away.

 Whole Life/Term

Early in the inception of the life insurance industry an ongoing discussion revolving around the theme of what is the best kind of life insurance began. Some felt the only kind of insurance an agent could honestly and fairly sell was a permanent type insurance commonly called whole life insurance. This type of policy had a designated death benefit for a beneficiary and a guaranteed cash value provision for the owner of the policy. Others argued a less expensive policy called term insurance which carried just a guaranteed death benefit should rule the day.

 Most recently, radio and TV personality Dave Ramsay has expressed his unhidden disdain for whole life insurance when he compares the “savings” portion of the policy with other investments and draws the conclusion,“Purchasing a whole life insurance policy is the worst vehicle you can use for investment purposes.” He suggests that no one other than those selling the product would consider its purchase and those who did purchase whole life product only got stuck with it. (www.insuranceandestates.com/dave-ramsey-life-insurance)

 Another financial advisor Clark Howard is of the opinion, just buy term insurance for as long a period of time as you feel you have the need for insurance. At the very worst case, buy level term insurance for as long as you can so you can avoid the increasing cost associated with mortality expenses. (www.policygenius.com?blog/clark.howard.whole_life_insurance-term/

Even though they may mean well, one wonders just how much thought went into this advice. What criteria did he use in determining that whole life is not a good vehicle for savings or that in all cases you should just purchase level term insurance.

Whole Life Premise–Savings Myth

Consider this: the premise that whole life is a savings plan is wrong. In the first three to five years of paying premium into a whole life policy, you will see no value you can take from the policy. If it were a savings plan you should be able to withdraw at any time the amount you deposited. I remember early in my career being advised through our life insurance training supervisor in Arizona, that the State Department of Insurance had cautioned agents never to refer to the cash value accumulation as savings because it mislead the buying public as to its true intent. It is much more appropriate and descriptive to refer to cash reserves not as savings but a method for accumulating cash for a cash flow accessible at a future date.

Whole Life–Cash Accumulation Fact

Whole life insurance in its simplest form is an insurance policy with a death benefit available from the moment an application is approved until the day of death. In order to make this possible and to keep premiums from rising as an insured ages, actuarial tables are used to project premiums to be paid over the lifetime of the policy. Since these premiums are intended to cover the ever increasing cost of mortality, the beginning premium is much greater than premium which would otherwise need to be charged at the outset. This leaves on the company’s books excess premiums which are held in reserve for future use. These funds are held in reserves identifiable to each insured’s life insurance policy and are called cash value reserves. They populate one of the non-forfeiture provisions of a whole life policy. This is where I believe those who refer to life insurance as a savings plan or an investment plan go wrong. You have a contractual right to take a loan against the policy, withdraw a portion of the cash value, use the cash values to pay up your policy early, etc. but the money per se is not yours. It is from the general reserves of the company and are identifiable in your policy only as a contractual right to access them. In fact, the insurance company reserves the right to hold your request of accessing the cash value for a period of time determined by themselves.

Whole Life–Living Benefits

One of the benefits which kept the life insurance industry alive during the Great Depression of 1929 was the ability of the life insurance company to manage the “run on the banks.” When the public lost faith in the banks and made a run to get their deposits, the banks were required to honor those withdrawals upon demand. No such requirement controlled the timing of the insurance company to honor a request by the  policyholder for use of cash value reserves.

Here are some examples of successful people who understood the value of whole life insurance policies and how the cash values allowed them to move forward in their entrepreneurial ventures:

  1. Walt Disney borrowing against his cash value insurance in 1953 to help fund Disneyland, his first theme park, when no banker would lend him the money;
  1. JC Penney following the 1929 stock market crash using his life insurance policies as collateral to help meet the company payroll–had he not had ready access to capital, the company may have been forced to close its doors, adding even more people to the unemployment line;
  1. Ray Kroc when building McDonald’s did not take a salary during his first eight years and to overcome constant cash-flow problems borrowed money from two cash value life insurance policies (and also from his bank) to help cover the salaries of key employees. He also used some of the money to create an advertising campaign around emerging mascot Ronald McDonald;
  1. Doris Christopher in 2002 selling her kitchen tool company, Pampered Chef, to Warren Buffet for a reported $1.5 billion. In 1980 she launched the company out of her home with a $3,000 life insurance policy loan;
  1. Foster Farms was founded in 1939 with Max and Verda Foster borrowing $1,000 against their life insurance policy to buy an 80-acre farm near Modesto, CA, and;
  1. Senator John McCain securing initial campaign financing for his presidential bid by using life insurance policies as collateral. His use of his policy as collateral did not have the positive long term effect as the others, but it goes to show you can choose to use your policy as collateral for whatever reason good or bad. 

By the way, each of the above examples had no income tax implications due to the IRS deeming loans against policies to be a return of premium which premium had been taxed originally.

Term Insurance

Shifting area of focus again, let’s look at the other extreme opinion of never buying any life insurance unless it is term coverage. This opinion begs for some answers to questions associated with it:

  • Why purchase a product which may not be effective on the day you need it most? National statistics regarding death benefits paid from term policies shows approximately only 2% comes from term insurance policies? (https://answers.yahoo.com/question/index)
  • It has been said that we don’t have a lease on life but I would counter with we do have a lease on life, we just don’t know when it runs out. Can you imagine how the purchasing style of people would change if we did? My 42 years of selling insurance would have changed from actively pursuing clients and pointing out how life insurance would be beneficial to them to just being an order taker sitting at my desk every day filling out the paperwork necessary for the insurance company to complete its underwriting in preparation for sending out the appropriate death benefit.

However, on the flip side of this scenario would be the insurance company knowing death is imminent would simply deny the request as being an adverse selection against the company. 

  • Why use a temporary solution to a permanent problem? The problem being how to replace future earnings which are needed for an individual’s whole life. In our society we do not have the luxury of just paying our way for 85 years when we will live to age 95. Those last ten years don’t come free!
  • Why purchase an insurance policy which will continue to rise in cost with each term of time it is renewed?  Yes, to begin with the premium being lower is enticing but unless you purchase a term policy which is guaranteed to be in force for your whole life with a level premium, you are going to see premiums constantly rising to meet the mortality risk associated with growing older.
  • Why bet against yourself by purchasing a policy which expires after a set period of time? Again, the dismal statistic of less than 2% of term policies paying any death benefit needs to be carefully considered. With some discipline and planning, a whole life policy can remove the stress of growing older by sending premium ahead to make sure your policy will be in force when you need it most.
  • How much more earnings will be required to make up for the pure cost of term insurance on other investments? In today’s economy, rates of return on investments are quite volatile. It is also still true that the higher the rate of return on your investment, the higher the risk factor becomes on that investment.

Summary

This is not intended to be an exhaustive treatise on the pros and cons of various types of insurance, so my observation to anyone considering the purchase of life insurance is to have clearly in mind what their objectives are before determining the type of policy. Do you have some short term debt like the purchase of a car or major appliance? Do you have a short term loan for financing an upstart business? These types of debt can be devastating to the surviving spouse if the major breadwinner is suddenly removed from bringing in the resources to pay them. Term insurance? Got you covered.

Some other uses of insurance like paying off a home mortgage, funding a buy-sell agreement, paying off college loans, making up the monthly retirement shortfall coming from social security or pension proceeds, or peace of mind knowing you have made a wise financial choice. Whole Life? Got you covered!

What’s the best life insurance to have? The answer is, the type of policy in force on the date of death.

So, “ladadada di ladadada da, and the debate goes on and the debate goes on.” Just don’t think these lyrics are going to be on a life insurance agent’s tombstone.   

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