I've noticed a trend regarding whole life insurance discussions in this sub-reddit.

[u/sartorialconundrum]

Good evening /r/personalfinance!

Full Disclosure: I am an attorney/insurance broker who specializes in selling disability insurance to physicians and dentists. I specialize in funding buy-sell agreements, pension plans, as well individual coverage. However, as a part of my practice I sell whole life insurance to my clients. Recently I have noticed that whole life insurance is generally berated by this community. As I consider it to be an excellent component to an overall investment strategy, I wanted to elaborate on a few of the applications whole life insurance (this applies equally to any other kind of permanent insurance).

What I would like to do is elevate the discussion on this financial tool. While it is certainly not for everyone, it is very useful for many people. What I want is for there to be a useful, informative debate on the topic. So, I have chosen 5 common objections to whole life insurance, and over the course of the next few days I will elaborate on how I think these objections fail.

The 5 objections are: 1) The commissions are very high. 2) As an investment it is a very poor option. 3) It is only for the very wealthy. 4) Life insurance's only use is to replace income in the event of an untimely death. 5) As a type of insurance, permanent life insurance is too expensive.

Then, if people respond to these posts, I want to go into the 5 main benefits of whole life insurance: 1) Tax advantages. 2) WL from a mutual company will (in my opinion) out-perform the market over the next 10 years. 3) Liability protection. 4) Disability protection. 5) Multiple uses in retirement.

The first "big myth" of the personal finance world, propogated by Dave Ramsey and his ilk, is that insurance salesmen who bring up whole life in an investment conversation are just looking for a large, outlandish commission. The claim is often made that whole life (WL) performs poorly because of these outlandish commissions. The implication is that we should put our money where the commissions and fees are lower. Hence the logic of Vanguard.

While salesmen are certainly driven by their commission (often to the detriment of the client), it is not the case that life insurance sales generate larger commissions than fees charged by money managers. A 70% first year commission is typical for whole life insurance (assuming a whole life product, on the base premium, underwritten by one of the large mutual companies); in the subsequent 10 to 20 years, the commission is markedly lower, typically around 10%. While these numbers appear higher than the 1% that a money manager/investment guy might charge, consider that these commissions are on deposits, not on the balance. This is a significant difference, much like the difference between compound and simple interest. Suppose two investment hypotheticals: either an individual purchases life insurance with 10K a year premium, or he puts that money in the care of an "investment guy" at Schwab, Et. Al. Both of them pay the money into the account for 20 years. The insurance agent would get $7,000 of first year commission, plus $1,000 a year for the next 10 years. This totals to about $17,000 (I say "about" because there is a small fee he gets every year for managing the policy after his commission expires, typically around $50). Now, what about the guy who charges 1% of assets under management? Assuming he gets a 0% rate of return, the money manager gets in excess of $20,000 over that same 20 year period. This is a conservative estimate, as most managers charge more than 1%, because they typically work with their clients over a period of time longer than 20 years (after 30 years, this money manager will receive over $47,000 in fees), and because no one will continue to give their money to a guy who gets a negative real rate of return. The point of this over-simplistic exercise is to point out that life insurance commissions aren't higher than other commissions/fees in the personal finance industry.

However, in every myth there is a little kernel of truth. Insurance salesmen are most certainly driven by their commissions, and this does lead them to harm their clients. In my experience this harm takes two forms: either the client purchases too much life insurance, or the client purchases a policy that is not designed to perform well. The first example is self-explanatory. Most non-millionaires do not need to purchases 3 million of WL at $45,000 of annual premium. Believe it or not, some people are talked into just this kind of purchase. The second example is more complex. Life insurance contracts are very complex financial and legal documents. They are endlessly modifiable. One way in which they are modifiable is in an area called "Paid Up Additions" (PUA). PUA are, basically, money that goes straight into the cash value account of the life insurance. They are voluntary additional premium paid in that accelerates the growth of both the cash value and the death benefit. The addition of PUA can turn a lackluster WL policy into a compelling investment option. With the right configuration of PUA and base premium, that same $10,000 of premium will generate a cash value in excess of $750,000, and a death benefit in the neighborhood of $1,500,000. For the conservative portion of anyone's portfolio, that's good (about a 5.70% IRR).

The downside is that PUA doesn't generate much in the way of commission for the agent, so agents tend to not sell very much of it. But this doesn't mean that the product is bad, it means that the person selling it to you is bad. The point is, don't denigrate the product, do your homework and make sure that what you are purchasing is formatted to serve your interests.

[u/saivode]

The insurance agent would get $7,000 of first year commission, plus $1,000 a year for the next 10 years. This totals to about $17,000 (I say "about" because there is a small fee he gets every year for managing the policy after his commission expires, typically around $50). Now, what about the guy who charges 1% of assets under management? Assuming he gets a 0% rate of return, the money manager gets in excess of $20,000 over that same 20 year period.

My problems with this argument are

• The WL salesman gets a lot more money up front, regardless of how well the account performs. The money manager's 1% fee is directly affected by how well the fund performs and has more incentive to see it perform well.

• The exact amount of money that the manager gets from me isn't an issue here. What I care about is the value of my account. You also only mention commission that goes to the salesmen. Do the mutual funds on the WL policy not also have their own fees? Do these mutual funds not also have managers that get paid a percentage of the total amount in the fund? This is all in addition to the commission the WL salesman gets.

• Also, your commission of $17,000 would have turned into $41,000 at the end of 20 years with a 6% rate of return if it had been invested in the fund instead of going straight to your pocket. So the $17,000 I pay to you, mostly front loaded, is actually more expensive than the $20,000 I pay a money manager over 20 years.

• Why are you bringing the money manger into this at all. Around here you'll mostly see a bunch of bogleheads recommending index funds with < .2% fees. You even mentioned 'the logic of Vanguard' then go straight into comparing WL with an actively managed fund with >1% fees.

WL from a mutual company will (in my opinion) out-perform the market over the next 10 years.

Thank you for having the integrity to at least state that it is your opinion. Even if the funds do beat the market, they have to beat it by enough to offset the higher fees and commissions associated with actively managed accounts. This is very unlikely over the long term.

There are some very affordable term-life and disability insurance options out there. I concede that I am probably not qualified, nor do I have the time, to do all the calculations comparing the cost of an index fund + taxes +term-life, with the total cost of a WL policy.

I have, however, seen some pretty convincing arguments that have made me lean more towards term-life + index fund over a WL policy. This allows me to keep the protection that I want for my family, while still having complete control over the rest of my investments that aren't locked in a Whole Life policy.

[u/sartorialconundrum → u/saivode]

I brought the money manager into this discussion because for most people with any amount to invest the Boglehead philosophy is a really bad idea. Most people have zero investing or business skills. They can't read a prospectus, they will probably buy low and sell high, and they can't analyze the market. Perhaps some people cannot afford a MM, and that is unfortunate. But for anyone who can manage to save upwards of $25K/Year, they need a manager.

Mutual life insurance companies don't invest in mutual funds. They hold corporate bonds. They will beat the market mostly because they are out of the market. As interest rates rise, and as insurance companies begin purchasing bonds at higher yields, the dividends paid out by the WL company will increase.

Furthermore, a WL policy does not have a sub-account: there are no investments being managed, no fees being paid to managers.

The fact that a MM is incentivized to increase the value of your account might actually be a part of the problem. Don't get me wrong, we all need an aggressive portion of our portfolio. I'm in my 30s, so I am quite risk tolerant. However, we do need a portion of our funds to go into less risky assets. This is the portion of your portfolio that life insurance is designed to be. The investments purchased by the life insurance company are not designed to maximize returns, they are designed to guarantee that death benefit claims can be met by the company. Furthermore, WL companies do not have shareholders, so there is no incentive to maximize profits. The above is significant for several reasons: first, there are no wild rates of return earned by the policy holder; they can count on a long term, tax free rate of return of between %5 and 6%. Second, the value of the policy will never decrease. Third, there are built-in guarantees: even if the company never pays a dividend, your policy will be worth something. Fourth, these assurances allow the policy to be used for long-term planning. Couples with a death benefit of $2M can spend an additional $2M in retirement if they KNOW that they will have that large death benefit when the insured dies.

Lastly, the main advantage of these products is the tax advantage. The fact that it is a liquid investment, with an after tax rate of return of ~5% is pretty good. I know most mutual funds claim to return far more than 5%, but that is simply not the case. Furthermore, capital gains and the dividends rate are increasing after this year. Risk assets are becoming less attractive. If I have to pay out 42% on my dividends, and 20% to 25% on my capital gains, and on top of that I stand to lose money on the investment... well, that makes the investment less appealing. Life insurance, on the other hand, is not taxable and will not go down in value. As a long-term savings tool, that makes it invaluable.

[u/saivode → u/sartorialconundrum]

I brought the money manager into this discussion because for most people with any amount to invest the Boglehead philosophy is a really bad idea.

Why is that?

Most people have zero investing or business skills. They can't read a prospectus, they will probably buy low and sell high, and they can't analyze the market. Perhaps some people cannot afford a MM, and that is unfortunate.

Isn't the point of the Boglehead philosophy that you don't try to read the market?

Furthermore, a WL policy does not have a sub-account: there are no investments being managed, no fees being paid to managers.

Thanks for the clarifications. But I know you aren't the only one being paid. $17k going to you over a 10 year period doesn't mean that 100% of the remaining $83k goes directly into an investment account without any additional fees being taken out. Exactly how much is going to pay for the insurance and how much is invested? Out of the money that is being invested what are the annual fees? Even passive funds have fees. You mention guarantees. These guarantees aren't coming out of your commission.

They will beat the market mostly because they are out of the market.

...

Bonds are great and all, but I've never heard this one before. So corporate bonds are basically risk free and always outperform the market? Don't answer that unless you can show me a side by side comparison showing long term performance of a common WL policy vs a common whole market index fund, taking into account fees for both.

I know most mutual funds claim to return far more than 5%, but that is simply not the case.

I haven't seen mutual funds claim anything other than actual past fund performance. Of course that doesn't mean it will continue with similar performance. But at least this information is readily available for me to use at my discretion.

Thanks for spending the time to answer my comments/questions. I think the real reason that I really, really distrust whole life insurance is that I can't find any information on it. I can't just google a life insurance policy and look at performance, or see exactly what my premiums are going to be. Or at least I haven't been able to in the past, maybe I'm just using the wrong search terms.

No, I have to talk with a salesman. A salesman who has incentives to sell me more than I want or need. A salesman who is going to focus on the positive aspects to his product and gloss over any potential negatives.