Life insurance is a tool, not an investment, so choose wisely
Term life insurance vs whole life insurance. Which is a better choice for you? Term life insurance policies serve a purpose. So do whole life insurance policies. So does Endowment life insurance. But what do you need? Even a good product, bought for the wrong purpose, will fail.
The purpose of term life insurance is to protect your family for a specific time period. If you buy the right term life insurance, it does the job beautifully well. On the other hand, whole life insurance has two purposes. The first is to protect your family. The second purpose of whole life insurance is to make insurance companies and agents lots of money.
When you buy insurance (whole or term), the insurance company knows what your odds are of surviving during the period of the insurance. For example, let’s assume you are in excellent health, you are 35 years old and you want Rs100,000 worth of insurance. The insurance company sells you (and 5,000 other 35-year-old people) Rs100,000 worth of coverage. Let’s assume the insurance company knows that out of 5,000 35-year-olds, 20 are going to die this year. That’s what actuaries figure out. That means that it’s probably going to cost the company Rs2,000,000 in claims this year. Makes sense? So it needs to collect that much in premiums. Now, this is called mortality cost, and those go up each year. Why? Because as you get older, your mortality risk increases (the chances of you dying go up.)
So the mortality cost might be Rs400 this year, but since a 36-year-old has a slightly higher risk of dying than a 35-year-old, the insurance company is going to pay out more money for every 5,000 people they insure each subsequent year. If you are very advanced in age, the premiums get really expensive. That’s why some folks consider guaranteed issue life insurance, but senior term life insurance is usually a better bet.)
You can either buy annual term insurance and pay higher premiums every year or buy 10, 20 or 30-year term. When you buy term insurance for many years, you pay a higher premium the first year than you would if you bought annually renewable term, but the premium is level for the period. So if you buy 10-year term, the premium for the insurance is going to stay the same every year for 10 years. That’s because the company figures out what their risks and costs are each year and simply averages the cost.
When you buy a whole life policy, the insurance company has the same exact mortality and administrative costs, so they charge you the same costs. But it doesn’t stop there. The insurance company actually needs to collect more. A lot more.
Why? Because with whole life, the deal is, you not only pay the cost of insurance, you pay extra. The insurance company takes that extra money and invests it. In theory, the earnings from those investments should earn enough to pay the premiums for you. So, in other words, after a certain number of years pass, the insurance is paying for itself. Isn’t that wonderful?
The only problem is that the insurance companies charge very high commissions for the investment elements when you buy whole life insurance, and it rarely works as they project. They also charge very high expenses. The bottom line is, you could invest that extra money yourself and grow it much quicker than if you bought whole life and let the insurance company do it for you.
That’s why term life insurance is much cheaper than whole life.
Published in The Express Tribune, October 22nd, 2012.
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Kurham,
I don't typically respond to articles because quite frankly no one really reads the responses and quite honestly no one probably will read this article. However, I could not let this article pass with out educating you on some of the things you don't truly understand and may want to research for a portion of your retirement portfolio as well as your readers.
The first point is the insurance companies love individuals like yourself who think buying term and investing the difference is the BIG winner, and that it is the cheapest for the consumer and an easy way to short change the insurance company. What you failed to calculate in your article is the 4,800 other individuals that don't die and that have bought term that never pays out. So in your scenario if the average consumer pays 500 bucks a year for term the insurance company nets over 4 million in profit over that 10 year time period. Keep in mind they are doing the same thing with millions of people. Not only do they sell term to the same group of people each new term they increase the cost for the same amount of insurance taking more money away from the clients lifestyle. Term insurance is useful but it is also a CASH COW.
The second point I want to bring to your attention is this. Why else do you think that whole life insurance is more expensive than term? There have to be other benefits involved or no one would buy it regardless how good an insurance agent is at selling. There are numerous benefits inside a whole life contract that you glossed right over. The two that most truly wealthy people and savvy investors (including your bank), in this country have used it for to enhance their wealth are: Increasing TAX FREE Death Benefit and the ability to collateralize the cash value in the contract. I am going to assume that you understand the TVM and opportunity cost as I make this final point. If you buy term and invest the difference there may be huge risk to money that you need for major capital outlays in your life and when the policy is up you just forfeited all of those premiums that could have been earning interest. Major capital outlays are for most Americans are college education, cars, weddings etc. Whole life may not out perform stocks and other investments but it doesn't need to. A steady and reliable growth that is always there when you need it and you can borrow against it with out interrupting the compounding interest inside the policy is incredibly powerful. I can promise you that an average of 4% and the ability to collateralize the money will beat any buy term and invest the difference in the long run, plus if the insured dies a substantial death benefit is there to protect their loved ones.
Do your research man. You cant honestly believe that after the past 10 years of this dismal economy that buying term and investing the difference is a strategy that most investors are excited about.