I had an experience last week that helped solidify my stance in the permanent versus term insurance debate. One of my friends was getting a new life insurance policy. She already knew I am a “buy term and invest the rest” kind of guy. But she is the type of person that studies every angle of a situation to ensure she makes the best decision that she can.
So she got quotes for both term and permanent policies. And of course, the permanent policy illustrations claimed she would make much more money if she invested in their permanent insurance rather than buying a term policy. I suggested that we dissect the illustration together to see if we could find the true benefit of these permanent policies. We quickly found that the illustration wasn’t quite as helpful or accurate as it should be. Here’s why.
The illustrations were convoluted
The first thing that stood out to me was that the multiple illustrations totaled over 100 pages. Despite their length, the illustrations never clearly explained the benefits and drawbacks of the different policies my friend should consider.
One of the policies was a Flexible Premium Universal Life policy. The illustration showed a variety of scenarios of account growth with guaranteed values, non-guaranteed values, as well as several different formulas for how interest was charged to the account. In the end, neither of us understood what we the numbers actually showed us, even though we are both lawyers and analyze numbers on a daily basis.
The illustrations hid the fees
One thing notably absent from the 100+ page description of the accounts was a simple discussion on the fees associated with each policy. Way at the back of the Universal Life illustration, we found a break out of all of the charges – premium charge, cost of insurance charge, policy issue charge, and other charges.
The scariest of these charges was the policy issue charge which was almost 19% of the yearly premium. I repeat…19%!!! In the first ten years, my friend would pay 27% of her premium in fees. Yet somehow the illustration still gave a 9.7% return on investment on the premiums.
I don’t’ see how that math works out, but the warning in the illustration let me know the numbers probably weren’t that useful: “This illustration assumes that the currently illustrated non-guaranteed elements will continue unchanged for all years shown. This is not likely to occur and actual results may be more or less favorable than those shown. “
The illustrations don’t compare apples to apples
The illustration we paid particular attention to broke down the opportunity costs of investing in a term policy versus a permanent one. The illustration showed most of the investment policies beating the “buy and invest the rest” approach by over $500,000.
Again, rationally speaking, I don’t see, given the high costs, how that could be true. But I also dug deeper into the illustration’s assumptions and found that the comparison was from between a tax-deferred savings vehicle and a taxable account.
In other words, the illustration assumes my friend doesn’t have access to a 401k or IRA, or that she’s completely maxing them out and has no other places to put her cash. If the comparison were between two tax-advantaged accounts, we could analyze the costs of each vehicle without having to take taxes into account. My guess is that the expensive permanent policies would lose that battle, which is why it wasn’t shown.
In the end, my friend decided to go with the term policy. The high fees, complexities, and overall unease of the illustrations didn’t sit well with either of us. The simple strategy of buying term insurance and investing in the retirement tools at your disposal still appears to be the best bet.