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Why life insurance shouldn't be considered an investment.


Why life insurance shouldn't be considered an investment.

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This article was first posted September 1, 2012.

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In the recent past Retire Early has covered the high cost of Single Premium Life Annuities and a new offering, the Gauranteed Life Withdrawal Benefit. Like most life insurance products, these schemes make sense for very few retirees.

You'll often hear a financial advisor or insurance agent recommend some form of a life insurance product (e.g., whole life, universal life, variable universal life, etc.) as part of an "investment plan". It's rarely a good idea. Life insurance products invariably carry much higher fees and expenses than an equivalent investment alternative purchased elsewhere. If you need life insurance, by a term life insurance policy. If you're looking for an investment, makes sure you limit fees, commissions, and trading costs to an absolute minimum.

The difference between whole life and term life insurance.

Term insurance covers you for a specific period of time (say 20 years.) Whole life includes an investment component which is funded by charging the customer a much higher premium. This investment pool should keep your annual premium level over time.

The difference in cost is often substantial. For example, a 40-year old male has the choice between a $250,000 Met LIfe universal life policy with a premium of $3,000/year versus a 20-year renewable term life policy with an annual premium of $350/year. You could build a lot of wealth over 20 years with that $2,650 difference. If you still need life insurance at age 60, renewing for another 20 year term will cost about $1,900/year (in today's 2012 dollars).

Why are the investment costs of a life insurance policy so high?

The investments costs of a life insurance policy are high because insurance companies have lots of overhead.

    Administrative Overhead and Profit. Insurance companies typically occupy high-rent, luxury office towers, maintain fleets of well-upholstered private jets for the highest echelon of management, and sometimes even pay multi-million dollar compensation packages to failed executives. For example, angry shareholders of The Hartford (NYSE: HIG) forced the retirement of long-time CEO Ramani Ayer who worked his management magic to deliver a more than 50% decline in HIG's stock value over his 12-year reign. Absent any executive compensation restrictions imposed by the US Government's bailout of The Hartford, Mr. Ayer received over $4 million in compensation for 2008.

    Distribution and Marketing Costs. Sales commissions of up to 105% of the first year's premium amd then 6% annually thereafter if you keep the policy in force, advertising costs, and incentives like this week-long retreat at the 5-star St. Regis Monarch Beach resort in California (including a $23,000 bill for massage and spa services) apparently add quite a bit to the cost of a life insurance policy. There are no happy endings for customers underwriting this largess.

It's important to focus on costs.

Even a portfolio of low fee index funds with a combined expense ratio and trading costs of 0.20% annually would take over 6% of your wealth over 40 years. A life insurance product with a 6% annual commission and annual fees and trading costs of 2.50% would take half of your wealth over the same timeframe.

With any investment, your first focus should be on what the promoters of the scheme are skimming off the top in fees, commissions, and costs. Whole life insurance in its various forms fails this test almost every time.

Resources for further information

NY Times: Why Life Insurance is Not an Investment, Carl Richards, April 12, 2010.

CNN Money: 5 things to know about permanent life insurance, Linda Stern, March 16, 2010 .

Smart Money: Whole Life Insurance or Term? , April 5, 2012.

Forbes: Should You Use Life Insurance as an Investment?, July 19, 2011.

$10,000 Lesson On Variable Universal Life (VUL), June 29, 2007.

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Copyright 2012 John P. Greaney, All rights reserved.

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