Financial Planning: A Midyear Guide 1987 : part five: Building Wealth : Life Insurance as Building Block
When I turned 19 in 1963, my “baby” life insurance policy matured, and my mother made me invest the $500 proceeds in a $10,000 whole life policy. If you let those 2% annual dividends reinvest, she said, the policy will be paid up when you’re only 46, and the premiums are cheaper while you’re young. Besides, if you die, that $10,000 will pay off your mortgage or take care of your kids’ college tuition. Smart lady, my mother.
But then I went away to college, took a bunch of economics courses and decided that whole life insurance policies were bunk, a waste of money, a lousy investment. You could make more by leaving your money in a passbook account. So, despite my mother’s stern disapproval, I cashed in my policy in 1972, and haven’t thought much about life insurance since (except for the group policy my employer pays for). Until lately.
Life insurance was invented for a specific purpose: protection for your survivors, a means to help them pay off your debts after you die. But, even though for most of its history the life insurance business offered only two simple products--term and whole life, the industry often billed a life policy as not just protection but also a good investment, a safe means to build wealth for retirement.
About the time I cashed in my policy, however, the “smart” thinking had pretty much consigned whole life policies to the financial dustbin. They usually offered a fixed death benefit that didn’t grow with inflation; the dividends were very low, and you paid premiums forever (unless you reinvested the dividends, which meant you received no investment income). Term was the wise buy: The premiums were much lower than for whole life; you renewed it annually, and you kept it only as long as you needed it (e.g., until the mortgage was paid off). It didn’t pay dividends, but who cared? It wasn’t meant as an investment, just protection.
And in the 1970s, with double-digit inflation and interest rates, even term insurance seemed less attractive. People often found better protection and much bigger returns by plunking money into high-yield certificates of deposits or money-market funds. About the only thing insurance seemed to have going for it was that death benefits were normally tax-free.
The life insurance industry fought back with an array of new products and variations of old ones meant to make life policies better investments, and in fact, life insurance has become a hot personal investment vehicle in the 1980s. The new products still provide survivor protection, but they also offer a safe and attractive means to build wealth in an era of relatively low interest rates and inflation.
The most talked-about insurance products of the 1980s are:
Variable life. Premiums are fixed, but a portion of them is set aside for investment in stocks and bonds and other vehicles. Above a guaranteed minimum, the size of the death or retirement benefit is pegged to gains or losses in investments.
Universal life. The holder may increase or decrease premium payments and coverage to meet age or income needs. A portion of the premium pays for a guaranteed minimum insurance benefit; the rest is invested in fairly conservative things, such as bonds or mortgages, that build up the policy’s cash value.
Variable universal life, also known as flexible premium variable life. As its name suggests, this combines elements of both variable and universal life. Both premiums and benefits are flexible
depending on investments, which are usually in higher-risk vehicles.
Single premium whole life. This combines insurance with four basic tax benefits: tax-deferred accumulation of cash values, tax-free withdrawals of principal, tax-free loans or withdrawals of
interest and tax-free death benefits. The buyer pays the entire premium up front, and the money is invested at a rate that is guaranteed for at least a year. You can borrow against the principal or interest beginning in the second year.
Annuities. These investment vehicles have been around for years, but have attracted new attention since the 1986 tax reform law eliminated most tax shelters and individual retirement account deductions for a substantial number of wage earners. Contributions to an annuity, either lump-sum or in payments, are not tax-deductible, but investment income is tax-deferred until withdrawal.
In fixed annuities, the insurance companies guarantee a rate of return over a period of time, usually one year. The return on variable annuities depends on investments, making them similar to a mutual fund.
The best way to get a good deal on insurance is to shop around, and a good way to do that is to check “Best Insurance Reports,” a publication put out by A. M. Best Co., which has monitored the industry for years. The Best report rates performance of various insurers and rates their products. It’s available in most libraries.
Industry officials maintain that protection is still the principal reason to buy insurance, but the addition of investment income potential has made options such as variable and universal policies increasingly popular.
“You’re buying the protection offered by a big, sound company, but you’re also getting solid investment expertise as well,” said Kit Fraser, a Santa Barbara insurance agent. “And, in most of the new products, there is a tax benefit in deferral of investment income. That’s important in light of the new tax law.”
According to the Life Insurance Marketing & Research Assn., variable and universal life policies have been growing steadily as a portion of all life insurance sales in recent years. They still represent only a tiny fraction (less than 10%), with term and whole life still the dominant sellers.
Critics contend that many buyers of the new insurance products don’t fully understand the risks they take by gambling that investment income will increase their benefits.
Because the industry has sold its products for years as a relatively risk-free means to protect loved ones, it’s feared that some people don’t realize that death benefits could be greatl reduced if the underlying investments don’t do well.
“There could be quite an uproar when people discover that the insurance they counted on to protect their family is a lot less than expected,” said a professor of insurance at one major university, who asked not to be identified. “What was true 50 years ago is still true: Insurance is for protection, and you shouldn’t play around with it. Make your investments separately.”
The industry pooh-poohs such talk. Sound investments are how the industry manages to make enough money to pay dividends and benefits of traditional policies, officials say, and the new products are merely offering people a chance to increase the benefit if they’re willing to take larger risks.
But, the insurance professor noted, increasing the risk often gives an investor a “short-term” investment mentality, and that is the opposite of how insurance should be viewed.
“Remember that insurance is a long-term idea; you pay now for the protection, expecting the benefits later,” he said. “If you want big profits, buy stocks or bonds or real estate or whatever separately.”
