Recently, a few people have contacted me with this question. News outlets are reporting much higher numbers of life insurance death claims in the United States and in other countries. What does that mean for using dividend-paying whole life insurance from a mutual insurance company as a financial foundation for your family? (And mine?)
In other words: Is this going to jeopardize the plan?
It’s a great question, and one that I would be asking myself if I was just getting into this.
Short answer: I am not worried about it.
Of course, that is not a sufficient explanation. This is actually quite the complicated question, though. There are several components that must be understood, in order to appreciate why my answer isn’t just blowing smoke.
Disclaimer: I am not an employee or an executive of any life insurance company. What follows is my personal opinion, informed by independent study of life insurance products and my direct experience selling life insurance.
What Kind of Company Are We Talking About?
First of all, life insurance companies are not created equally!
What kind of history do they have? What kinds of products do they focus on? Are they a stock company, or a mutual company?
I have a firm belief that a focus on long-term planning helps you make the best decisions in the present. This is all the more true of a company that exists to fulfill future obligations. Each of the questions I asked above, when answered, reveal an attitude towards planning for the future.
Is the company new, or old? Have they been in major financial trouble before? What major events (depressions, recessions, pandemics, wars, and so forth) have they survived? If applicable, what is their dividend history? Are their executives trustworthy? Generally speaking, longer history and better handling of tough times are what you want here. A lack of financial shenanigans from executives is preferable, too!
Of course, another question worth asking: Do they have a good track record for paying life insurance death claims?
This is an extremely technical aspect. Consider for a moment a life insurance company that only offers Term Life insurance. Let’s say they sell any term length between 10 and 30 years.
That means that if the policy owners continue to make premium payments, the maximum time that the insurer is “at risk” to pay the death benefit is 30 years.
The vast majority of Term Life insurance policies never pay out. Though I have no primary source for this, a number that is generally circulated among financial professionals is “99%.” Even if the number is lower, we can infer why it would be a very high percentage. Young, healthy people buy life insurance when it is cheap. They are insuring so their new mortgage, new car, their kids’ education, and household income needs are met in the worst-case scenario: their untimely death. This risk is low, but not zero—isn’t it worth a few dollars to make sure your spouse and kids won’t have to worry for money, just in case?
Term is Attractive
This all seems eminently reasonable to the young couple—why pay higher premiums for a different type of life insurance? They are just getting started in life. Watching their expenses is smart! They have heard radio and television personalities like Dave Ramsey and Suze Orman recommend over and over: “Buy term and invest the difference!”
As the couple ages, their financial need for this coverage decreases somewhat, in theory. The kids grow up. They gain other assets that could be used to cover for such an emergency. Their incomes are higher. The mortgage balance is lower. Several years into their term life policies, they think: “Do we really need to keep spending this money every month?”
And so, the policy is cancelled. The insurer keeps all the premiums paid so far, and is “off the hook.”
Now, I ask you: Does this life insurance company have an incentive to carefully steward every dollar it takes in from premiums, so that it can pay death claims as they are filed?
Well, what about Universal Life, and its various permutations? Universal Life (UL), Indexed Universal Life (IUL), Variable Universal Life (VUL), Guaranteed Universal Life (GUL), and so forth all share a common characteristic: They shift the risk off of the insurance company and back onto you, the policy owner!
Look at any standard UL contract and you will almost certainly find that the death benefit goes down late in life.
This is because UL is based on annually-renewable term. To explain: Life insurance gets more expensive as you age. It has to, in order for the product to work! As people pass away, there are fewer people left to pay premiums and all of them have an increased risk of death every year that they age! If 1,000 25-year-old people buy life insurance, the rate of death increases very slowly at first, and then rapidly as the insured individuals get closer to average life expectancy.
Comparing Term Life and Universal Life
What Term Life, Universal Life, Whole Life, and so forth represent are different strategies to deal this this basic fact.
So, let’s analyze those differences further. Let’s assume you are in good health. If you buy a 15-year Term Life policy, Universal Life policy, and Whole Life policy on your 25th birthday. By going even deeper into each of these, we can better understand Whole Life policies at the end. Let’s look at each:
Cheap, level premiums for 15 years. No cash value, no change in death benefit over time. At the end of 15 years, the policy is “over.” If the insured wants to get a new policy with the same death benefit, the premium will be much higher since they are now age 40. If health, habits, or occupation have changed, there is also a chance they may not be able to get a new policy at all. But hey, it’s cheap!
Generally low to moderate premium required to start the policy, and then premiums are flexible afterwards. Flexible premiums are interesting because you can “over-fund” or “under-fund” a UL policy. It sounds great on paper, but this can lead to a policy that “falls apart” much sooner than you want it to. If it’s funded adequately, the death benefit generally remains level for a period of years, and then starts to go down. This is because the Cost of Insurance (COI) is going up every year, and the entire policy is propped up by an assumed “interest-crediting rate.” Interest is credited on the policy’s cash value, after expenses are taken out. To quote a widely used book for life insurance agents:
“Interest rates [in a UL policy] can be (and have been) intentionally elevated to a level above what an investment portfolio actually supports, but they work for the insurer by compensating with higher levels of mortality charges and expense deductions.”– from “Essentials of Life Insurance Products,” C.W. Copeland and Glenn E. Stevick, Jr.
UL outcomes can vary widely, depending on your behavior. It’s not to say that there is never a use for a UL policy at all, but it does not in any way lend itself to the long-term accumulation of wealth. Besides, who wants a call at age 60 from the life insurance company, saying that unless you can pay quite a bit of additional premium, the policy you paid into for 35 years will have to be cancelled? (Full disclosure: At the time of this writing, one of the policies I own is a UL policy, because of our uncommonly high need for death benefit coverage. I am happy to provide details on this to anyone who asks. We intend to eventually replace the entire death benefit total with other policies.)
IUL, VUL, GUL, etc.
So far I have focused on standard UL. You may ask: What about Indexed Universal Life (IUL) and Variable Universal Life (VUL)? Without making this article much longer than it already is: Let me just say that these products add in stock market risk to the product described above. These are incredibly complicated products, to the point that it is hard to fully comprehend what you are signing up for.
Guaranteed Universal Life (GUL) is another of the many varieties of UL. GUL policies charge higher premiums than standard UL policies, in order to guarantee a level death benefit to a certain, specified age, provided you make every premium payment on time. Run an illustration out to an advanced age—say, 90 years old—and you may wonder, “Why not just get a whole life policy?”
Indeed. This brings us to the last of the three types of life insurance we set out to compare: Whole Life.
Highest premium, cash value that is guaranteed to increase every year, and (depending on structure whether dividends are paid by the company, and the use of those dividends) death benefit that grows over time. Premiums are level for the entire duration of the policy, either until the death of the insured or reaching the end of the contract (generally age 100 or 121.) The insurance company assumes the risk. Dividends may be used (if the owner desires) to pay the premiums. How dividends are used can be changed at any time, and as often as the owner desires.
Reviewing all of this, you may think a company focused on UL is the most solid choice when it comes to long-term planning. After all, they have pushed much of their risk back to their insured persons!
However, I would argue that those policies are more likely to lapse than whole life policies, shortening the overall time horizon of the company’s planning.
We will talk more about Whole Life as we review the last of the questions we set out to answer.
Stock or Mutual?
Let’s start with explaining what each type of company is.
A stock company is what most people are familiar with. Stockholders own a stock company. Often, that stock is publicly traded. Think Amazon, Google, Tesla, et cetera.
Speaking broadly, stockholders buy stock because they expect the price to rise. This puts the company under intense pressure to deliver good news with every quarterly earnings report. To a certain extent, they must keep an eye on the short term.
Customers own a mutual company. In the case of life insurance companies, that means policy holders. When you have a “participating” product, you are a part owner of the company itself. (By the way, Whole Life is generally “participating” and Universal Life is generally “non-participating!”*)
In a mutual company, then, the “stockholder” that must be kept happy is you, the policy holder. That means long-term planning to ensure life insurance death claims are accounted for and dividends can be paid. (Some mutual insurance companies have been paying dividends for over 100 years in a row!)
(* There could be some exception to this, but I am not aware of one.)
Bringing It All Together
So, are life insurance death claims spiking right now an issue?
A properly long-term-oriented company will be fine. If this is not a spike in deaths, but a long-term increase, they will raise premiums for future buyers. But that cannot affect existing or whole life customers’ contracts. The policy itself contains a clause explaining that the insurer cannot change the terms of the contract, once issued. (Though, there is a limited time that they can alter the policy or cancel it if you materially misrepresented your insurability or other details. For example, if you lied about your age.)
If you are curious about the other mechanics of whole life beyond simply providing a death benefit, please see the other articles on this blog that look at those topics. When you have questions, I am here to help!