h3>How does whole life compare as an investment since 2001? A personal case story provides a surprising answer.

 

PART TWO: Could the client have done better if he had used the “Buy Term and Invest the Difference” approach?

A concept that has been around for years has been “Buy term and invest the difference”. This approach was pioneered by Arthur Williams who founded Primerica in 1980 and staked his company to this type of approach. Through the 1980s and 1990s in the largest and longest bull market run that the North American stock markets have ever experienced with an compound annual growth rate of 13.98% per year from 1980-2000, this approach gained immense popularity. In these times, it would perfect sense for someone to favor “Buy Term and Invest the Difference” because for someone holding a whole life policy, it takes at least 10 years to see its cash value eventually amount to something greater than the sum paid in premiums. A whole life insurance policy client would very likely envy the “Buy Term and Invest the Difference” people who were making positive returns in year one and seemingly made more and more money each year as the market just continued to rise and rise.

In a short term snapshot at any point in time trying to compare cash values between the two approaches especially in those early few years of a policy, I suspect that there might not have been a single instance that a “Buy Term and Invest the Difference” approach would have produced a lesser total of cash on hand and hence would appear to be the superior approach. However, if one were to look at a longer term picture, the analysis might be different. Whole life insurance is not for someone on a short term basis as the policy is designed to be held for someone over their whole life and looking at the numbers in later years, it provides a different analysis.

So far, in our analysis, we have compared investing this client’s entire annual premium in either five-year bonds or treasury bills but purchased no life insurance at all. This is valid if simply comparing whole life insurance as a safe, stable savings investment but if our client had needed life insurance, would he have done better if you had bought term insurance and invested the premium savings in some other investment instead of simply purchasing whole life? Term insurance premiums are normally considerably less than whole life premiums for the first 20 to 30 years. Whole life critics contend that the insured can do better by buying term and investing the difference except that we have already seen that if investing the difference in safe, stable savings vehicles, the whole life policy has already outperformed Treasury Bills and Government of Canada 5 year Bonds even before spending any money on term insurance premiums.

Savings vs Investing

As explained previously, had our client actually purchased term insurance, he should not have invested the premium in the stock market or a growth mutual fund if he was to still maintain his desired portfolio balance. He would then no longer be saving his money but rather investing it and exposing himself to the risk of losses and some of them being quite substantial as was the case in 2008 with a (35.63%) loss over just one year. Remember that 30 to 40% of his investment portfolio should be kept in safe stable savings options and 60 to 70% could be in stock market or other investment vehicles. Our client would have been taking undue risks with their savings. I am not saying that a participating whole life policy should be your entire investment plan. It is a great place to start but even better as a place to keep your savings safe while you can make riskier and possibly more lucrative investments elsewhere such as the stock market or private markets like the exempt market.

However for the purposes of this comparison, we shall relax this requirement because we have already seen that our client received superior returns in his cash values provided within his whole life insurance policy. Without even having to pay for term insurance premiums, the cash values of whole life have already provided better rates of return. Also, the main supporters of buy term and invest the difference typically have invested in the market despite taking on greater risks with their money. Over the 20 year period between 1980-2000, taking on those additional risks indeed reaped greater rewards and greater rates of return. However, since 2000, our market has had two major drops: the first around 2001 when the dot-com bubble burst followed in short order by the terrorist attacks of 9/11 and the second major drop in 2008 with the credit crisis and subprime mortgage meltdowns. I will compare participating whole life against a buy term and invest the difference approach allowing an investment in the markets not because I am advocating the approach but rather to see how much better the returns are, if any, for taking on substantially more risk. I want to explore the risk-return investment universe. By taking on greater risks, one should achieve greater returns but that isn’t always the case. When one takes on more risk, they should in theory have a better chance at greater returns but with it carries a greater chance of loss and history has provided us with both.

One must account for the actual cost of term insurance

The cost of term insurance has fallen through the years but in staying with actual numbers, we will compare a Term policy quoted today for a face value of $1,200,000 just like our original whole policy face value and apply today’s rates for the cost of insurance over the 12 year period being compared.

First off, it should be noted that if comparing term insurance against participating whole life insurance, we need to look at what it would cost to maintain that insurance for a lifetime. A major problem with term insurance is that it becomes very expensive if held beyond the initial term period. I suspect that most supporters of “Buy Term and Invest the Difference” never had any intention of maintaining their life insurance for the rest of their lives. After all, less than 2% of term insurance policies ever get claimed upon but for this comparison, let’s assume the intention is to hold life insurance coverage for as long we can.

When selecting a competitive Term 10 insurance policy for a 22-year-old male with a death benefit of $1.2 million, the initial annual premium is $740, significantly less than our $32,521 premium for whole life. The supporters of buy term and invest the difference would then take difference in premiums, in this case $31,781, and put it into some other investment, typically the market. They should be investing in an another safe stable savings vehicles but we have already seen that whole life has outperformed this class of investments as a whole. What most critics of whole life forget to account for is that term rates will increase after each ten year term and that those increases are quite substantial if they try to hold onto in in their later years.

After 10 years the term insurance premiums become $1676, after 20 years the premiums become $2792, after 30 years the premiums become $6824, after 40 years the premiums become $17,840, after 50 years the premiums become $52,820 per year, and after 60 years and until age 85, the premiums are $129,608 per year. So if a client holds a term insurance policy until age 85, they will have paid a total of $1,215,744 of premiums to hold a policy with a $1.2 million death benefit. To this point at age 85, the client will have actually PAID MORE in premiums than they will receive in a death benefit.

Canada Life, Term 10, $1,200,000 Death Benefit, Male, Age 22, Non-Smoker, Good Health

Number of Years Annual Premium Due
1-10 $740
11-20 $1,676
21-30 $2,792
31-40 $6,824
41-50 $17,840
51-60 $52,820
61- Client Age 85 $129,608
Age 86 and Beyond Policy Terminated and Unable to be Renewed
TOTAL PREMIUMS PAID OVER 63 YEARS $1,215,744

Source: Canada Life Assurance Company – 2014

However there is one further drawback to term insurance which is that at age 85, your policy will terminate regardless of anything else. This means by age 86 you will have no further term insurance coverage nor can you buy any further term coverage. This is a real issue if you care about your life insurance and you live long enough. Due to its unique nature, whole life can guarantee its death benefit provided that you make your premium payments consistently regardless of age whereas a standard Term 10 or Term 20 product cannot. Term insurance cannot provide this because your premium costs will go up over time and even if you do choose to continue to pay them all the way through, your policy will terminate with nothing to show for it. Less than 2% of term policies ever pay out. They are great for peace of mind but terrible as an investment as they do not accrue any cash value and 98% of the time, you walk away with nothing. Why not choose a product that as long as you pay your fixed premiums over time, you are guaranteed to see a payout. With whole life, as long as you pay your premiums, you know exactly how much it’s worth today guaranteed and with a participating product, you can go to sleep wondering how much more it will be worth tomorrow. (AUTHOR’S NOTE: I don’t know about you but I sleep a lot better dreaming of growing riches then worrying if I might lose my money tomorrow in the markets. Plus if I sleep better, odds are my health will be better and odds are that I will live longer and if I lived longer, my policy will be worth more in the long run. Even if I should die in my sleep, I know my family is taken care of. After all, this is an insurance product and that’s what it’s all about.)

After all, for people at age 65, their average life expectancy is 85.2 years here in Canada. I suspect that this is not a coincidence. Also, keep in mind that the “average” is 85.2 years which means plenty of people will live longer, potentially much longer. A third of babies born today are expected to reach age 100. People are simply living longer and longer. So after age 85, you cannot have any insurance coverage using “Buy Term and Invest the Difference” short of buying a permanent product like whole life insurance. Comparatively, this whole life policy with its $32,521 annual premium will have cost a total of $2,048,823 of premiums but at least at age 86, this client will still have coverage and part of those premiums paid went towards growing the policy which will be worth substantially more than it does today. Remember that as of today in 2014, our client’s insurance coverage has consequently grown from $1.2 million originally to $4,296,634 which already today at age 35 for the client will provide a payout that is more than double the total premiums required over time. The policy still has 50 more years to grow to see what it will actually be worth at age 85. As the policy grows over time, the death benefit will grow but the total premium outlay will not change.

How has “Buy Term and Invest the Difference” actually fared over the last 12 years?

So let’s just assume that most supporters of “Buy Term and Invest the Difference” are not interested in large amounts of life insurance late in life. Let’s simply compare what our client could have done with a $1.2 million term policy and investing the difference in the market just to see what the returns may have been despite incurring substantially more risk in doing so.

 

Over the last 12 years, if our client had invested the difference of $31,781 each and every year (The last two years of our 12 year period actually only have $30,845 to invest as the term costs increased), the returns would have been very volatile with gains as high as 32.34% in 2009 but losses as deep as -35.63% in 2008. Still, if our client had left his money invested through all the highs and all the lows consistently investing the difference (Something that took a steely discipline as most investors panicked somewhere along the way or were forced to withdraw funds at some point and spent at least some of the recovery time from

TSX Composite Index 2001-2014

Date Market Value Annual Return
1-Jan-01 9321
1-Jan-02 7679 -17.62%
1-Jan-03 6632 -13.63%
1-Jan-04 8241 24.26%
1-Jan-05 9246 12.20%
1-Jan-06 11304 22.26%
1-Jan-07 12924 14.33%
1-Jan-08 13907 7.61%
1-Jan-09 8951 -35.64%
1-Jan-10 11847 32.35%
1-Jan-11 13443 13.47%
1-Jan-12 12097 -10.01%
1-Jan-13 12571 3.92%
1-Jan-14 13548 7.77%

Source: TSX Composite Index Actual Returns

 

2008 on the sidelines waiting to see the market actually recover before putting their own money back into the market. Some investors, such as retirees, might have been forced to withdraw through the low

 

 

       TSX Composite Index 2001-2014

            $31, 781 Annual Deposits

Date Annual Return Investment Balance
1-Jan-02 -13.63% $28,086
1-Jan-03 24.26% $75,312
1-Jan-04 12.20% $120,983
1-Jan-05 22.26% $187,671
1-Jan-06 14.33% $251,749
1-Jan-07 7.61% $305,891
1-Jan-08 -35.64% $217,813
1-Jan-09 32.35% $331,327
1-Jan-10 13.47% $412,865
1-Jan-11 -10.01% $400,791
1-Jan-12 3.92% $450,291
1-Jan-13 7.77% $520,326

Source: TSX Composite Index Actual Returns

points because they had no other choice and needed that money), he would have $520,326 which would appear to far exceed the $440,545 in available cash value in our whole life policy. Except keep in mind that to get our money out of the stock market, we would need to pay our taxes first. Doing so, would still leave $491,905 which still exceeds our $440,545 of available cash value in a whole life policy. So “Buy Term and Invest the Difference” must be the better approach, right? Well, not so fast.

 

 

Keep in mind by investing the difference in the stock market, our client would have taken extra undue risks with his safe money. He would have experienced a roller coaster of ups and downs along the way. The nice thing about a participating whole life policy dividend is that it is smoothed so that you may not get the high highs but you also don’t get exposed to the losses. The insurance company investing the money may have lost money in a given year but as a policyholder, you still get to see your policy grow (This growth comes from a guaranteed portion through your own additional deposit and from a non-guaranteed portion through a policy dividend. The policy dividend is not guaranteed but consider that through the great Depression, the American Civil War , both World Wars, the Dot Com Bubble bursting, the Terrorist Attacks of 9/11, and even the credit crisis of 2008, there has always been a dividend paid at strong companies like Sun Life Financial and Canada Life and has been for over 150 years. Its amount may have fluctuated but policyholders have always received something adding to the value of their policies year over year. There is something to be said for that peace of mind in knowing that your money will be there today and even tomorrow if you need it.

Secondly, if we are simply comparing actual results, we need to compare the complete picture. Sometimes I hear supporters of “Buy Term and Invest the Difference” talk about if they died early, they would be able to collect their insurance and keep the difference that they had invested. This is true but it is not necessarily as lucrative as one may think given that the paid-up additions dividend option is also buying more insurance coverage at the same time that the policy is accruing cash values for the client. In the first year and only the first year, the client would have been better off if they were to meet their unexpected demise. With a whole life policy that has yet to reach its first anniversary, it would pay out the initial death benefit of $1,200,000. With whole life insurance, you can access cash values in your lifetime but when you die, you cannot take them with you. You simply receive the death benefit. So with “Buy Term and Invest the Difference”, the client would collect the same $1,200,000 death benefit from their term insurance plus they get to keep the difference that was invested. In this case, an additional $27,447 as the market experienced a loss in that first year but still, on actual cash in hand, the “Buy Term and Invest the Difference” approach does receive more money overall in total in this first year.

 

            “Buy Term and Invest the Difference” VS Participating Whole Life Insurance – Total Benefit Comparison

Date Annual Return Investment Balance Term Life Insurance TOTAL BENEFIT   Whole Life Cash Value Death Benefit   TOTAL BENEFIT  
1-Jan-02 13.63% $28,086 $1,200,000 $1,228,086 $ 0 $1,200,000 $1,200,000
1-Jan-03 24.26% $75,312 $1,200,000 $1,275,312 $16,483 $1,482,364   $1,482,364
1-Jan-04 12.20% $120,983 $1,200,000 $1,320,983 $35,417 $1,764,549 $1,764,549

 

However, by the second year of the comparison, the whole life insurance policy will pay the client a greater amount on his unexpected early death because the paid up additions had bought an additional $282,364 of death benefit in the first year alone. This would mean that the “Buy Term and Invest the Difference” approach would need to have turned their investment account (At this point two deposits of $31,781 plus returns) into at least $282,364 in two years just to match the final payout. Using our actual results, the client did have a very good second year investing in the market earning 24.26% on his invested money but even with that, his invested difference will only be worth $73,014. With each passing year, this gap in overall payout to our client’s beneficiaries will only widen.

Whereas investing the difference in the stock market has left us with a greater cash value of $491,905 today it also is still only paired with a $1.2 million term insurance policy meanwhile the $440,545 of cash value in our whole life policy is paired with $4.296 million worth of permanent insurance. So now, if our client unexpectedly died tomorrow, the “Buy Term and Invest the Difference” approach would get an overall payout of the $1.2 million insurance policy plus they would keep the difference of $491,905 for a total payout of $1,691,905 but the whole life policyholder would receive a single cheque for $4,296,634.

At this point in time, if the buy term and invest the difference supporter suggests increasing the amount of term coverage to $4,296,634 to offset that difference and still invest the difference, they will be facing a total premium requirement of $4,127,722 to maintain that policy to age 85. Again by age 86, there is nothing to show for those premiums. Meanwhile the participating whole life client who will pay $32,521 in annual premiums per year for 51 years will only require $1,658,571 in total premiums from this point in time to maintain their whole life policy and continue to watch it continue to grow with each passing year. I don’t think that anyone can bypass this staggering difference in death benefits when employing the “Buy Term and Invest the Difference” approach in comparison to participating whole life insurance. So if a client truly believes in the value of life insurance, given what our markets have actually done over the last 12 years, it becomes fairly evident that a participating whole life insurance policy is actually a very strong approach to building wealth. Plus remember that the whole life insurance policy still has another 50 years to continue to grow so the final death benefit will be far higher in the years to come.

Canada Life, Term 10, $4,296,634 Death Benefit, Male, Age 34, Non-Smoker, Good Health

Number of Years Annual Premium Due
1-10 $2,340
11-20 $11,835
21-30 $28,979
31-40 $80,109
41-50 $235,131
51-Client Age 85 $543,759
Age 86 and Beyond Policy Terminated and Unable to be Renewed
TOTAL PREMIUMS PAID OVER 63 YEARS $4,127,722

Source: Canada Life Assurance Company – 2014

 

Conclusion – Part Two 

To review, the cash values in the whole life policy have provided better returns than investing in safe, stable, savings products such as either treasury bills or government bonds. Remember that this is even before the cost of term life insurance if factored in as demonstrated in Part One. By keeping your money invested in safe stable savings vehicles, you cannot beat whole life. Even when we open up the discussion to see how it relates to the entire risk-return universe, whole life holds up pretty well despite having far less risk than the stock market and no chance of loss. If you add in the potential death benefit and value of insurance coverage, it is very hard to compete with risk/reward proposition of whole life insurance. With this policy, in 2008, when the market dropped 35.6% and seemingly investors had no place to hide, this client watched their cash value go to $205,043 (An increase of $53,790) and their death benefit grow to  $3,229,536 (An increase of  $266,300). The whole life policy will also endure until death provided the client continues to make their annual premium payment while a term insurance policy will always terminate at age 85 provided the client survives and continues to pay their escalating premiums. Participating whole life insurance is a truly powerful financial product and fantastic approach to building wealth that can serve many purposes that other products just simply cannot offer.

It is also worth mentioning that the potential of whole life insurance cannot be defined solely by the numbers contained in the policy. Those that have benefitted the most from their whole life insurance policies include some famous names who were able to use the availability of their cash values to be able to seize investment and business opportunities when they came up.  The following examples are detailed in Brian Anderson’s book: “6 Famous Brands Started or Saved by Life Insurance” dated April 26, 2012.

 

First off is the story of Walt Disney. His whole life insurance policy allowed him to start something new by accessing the cash values within his policy.

“Walt became intrigued with creating an amusement park where parents and children could have a good time together. At the time, the only amusement parks in the country were dilapidated places with seedy characters, but Disney dreamed of an immaculately clean, family oriented park with imaginative attractions. After failing in the pursuit of traditional means of financing to build what would become Disneyland, Walt decided to provide his own financing. A large part of this came to be by collaterally borrowing money from his cash value life insurance. Disneyland opened in 1955 and hosted more than 3.5 million visitors in its first year. It became an immediate, resounding success.”

Secondly is the story of Ray Kroc. His whole life insurance policy allowed to continue to build out his business and expand his business model allowing it to grow into the empire that it is today.

“Working as a milkshake machine distributor in 1954, Ray Kroc (1902-1984) took notice of a successful hamburger stand in San Bernardino, Calif., which he called on, intending to sell brothers Dick and Mac McDonald more Multimixers. He learned they were interested in a nationwide franchising agent. Kroc, 52 at the time, decided his future was in hamburgers and partnered with the brothers. He opened his first McDonald’s in Des Plaines, Ill., in 1955 and bought out the McDonald brothers in 1961.Kroc did not take a salary during his first 8 years, and to overcome constant cash-flow problems, Kroc borrowed money from two cash value life insurance policies (and also his bank) to help cover the salaries of key employees. He also used some of the money to create an advertising campaign around emerging mascot Ronald McDonald. Today, McDonald’s serves more than 50 million people each day through more than 30,000 locations in 119 countries.”

 

Thirdly is the story of James Cash (JC) Penney. JC Penney used the cash values in his whole life insurance policy as a life-line and lender of last resort to help his business weather the Great Depression.

“ In 1913, he incorporated the company as the J.C. Penney Company. By 1929, there were 1,400 stores across the country. The stock market crash of 1929 and the ensuing Great Depression devastated the stores and Penney’s personal wealth. The financial setbacks also took a toll on his health — physical and mental — but he was able to borrow against his cash value life insurance policies to help the company meet its payroll and day-to-day expenses. This allowed the company to stay afloat and eventually rebound. Today, the company’s 1,100 stores take in revenues of $18 billion a year.”

 

Finally is the story of Jimmy Pattison. In a letter to another insurance salesperson, Maria Meyer, Mr. Pattison provided this insight regarding his experience of using his whole life policy to help secure a loan to buy his first ever car dealership which set the stage to his eventually becoming the richest person in Canada.

 

“The business world, I discovered, has an interest in Life Insurance. Much of the world’s business is carried on by credit, and bank applications for a line of credit are accompanied by, as a rule, a statement of affairs which requests information as to the amount of life insurance carried.

Then I decided to open my first business which was a General Motors automobile dealership franchise at the corner of 18th & Cambie, I discovered a “Living Benefit” of life insurance, that of borrowing collateral.

When I approached the Royal Bank of Canada for additional capital, the cash values in my life insurance policies were a valuable asset that the Bank manager used in determining whether or not a loan would be granted.

If it wasn’t for the cash values in my life insurance policies the bank may have decided against granting me the necessary capital to begin my first business endeavour.

I am certainly an advocate of life insurance as a vehicle to help a young person take advantage of business opportunities that may present themselves in the future.

It happened to me, and it could happen to others.

I am grateful for the “Living Benefits” of life insurance.”

 

The “living benefits” that Jimmy Pattison is referring to is the cash values within a whole life policy that can be used as collateral for a loan or accessed immediately in an emergency. Especially in today’s world and investing options, nothing starts without access to money to seize opportunities when they arise. All too often, many a financial plan is decimated by needing to get access to cash for an unforeseen emergency. These are stories of a few people whose whole life insurance policies allowed them to jump at life changing opportunities that opened up so many more doors. Access to liquidity at the right time can be more valuable than any investment returns because without the funds to participate, all of the above stories could be about missed opportunities but instead there are about legacies that were built up through the assistance of their whole life insurance policy. Maintaining a solid safe, secure base to any investment plan is integral to any financial plan but to also have access to the liquidity to seize opportunities when they arise in invaluable. There is no better place to start building wealth than through a participating whole life insurance policy.

Risks Involved with Whole Life Insurance

When trying to determine taxes in years to come, there is no guarantee that today’s tax policy will be the same tomorrow so always keep that in mind. Today, whole life insurance is a very tax-advantaged way to invest and has been for over 150 years but the past is no predictor of future tax policy. As with any investment of any kind, changes to the tax code present a level of risk. No one knows what investments or areas of the tax code may get changed in the future.

The single greatest risk the whole life insurance is quite simply cash flow risk. If you cannot make your premium payments consistently, the performance of the policy could be severely hampered or worse the entire policy could lapse. Yet, as long as we pay our annual premiums, we can count on that death benefit being paid out at some point in time. While very few people can ever guarantee the ability to always be able to make a premium payment, someone can make it a priority much like a mortgage payment, and find a way to pay it off each and every time.

Much like a mortgage, if we take on too great a payment and cannot pay it off regularly, we can lead ourselves to great financial strain and again much like a mortgage, if we cannot alleviate the financial strain eventually the bank or insurance company will foreclose and take our insurance policies much like the bank would foreclose on a house if one cannot make mortgage payments. This worst-case scenario risk must be balanced with reality. If we made our policy payments a priority like our mortgage payments and applied the same discipline, we should be fine in the long run. Even including 2008, foreclosure rates in Canada have never been above 1%. The number of mortgages in arrears (ie Behind on their payments three or more months but a stage before any bank will foreclose) has never peaked higher than 0.65% of outstanding mortgages since 1990 (source: Canadian Bankers Associate, “Number of Residential Mortgages in Arrears”). Said another way, when looking at the number of mortgages that have been in arrears since January 1990, at least 99.35% of all Canadian mortgages have been healthy and paid regularly and mostly on time (Some clients may have missed a payment or even two but not more otherwise they would qualify as part of the arrears statistic. That is not to say that each and every Canadian had lots of money available to pay the mortgages but instead that each and every Canadian had the discipline to maintain their mortgage payments. This same type of discipline is critical to keeping a whole life insurance policy healthy and on track. By doing so, over time the policy will pay back substantial returns to the policyholder either through available cash values or an eventual death benefit.

If someone could ensure their payments remain a priority so that one receives the death benefit amount either in old age or at their eventual death, should that death benefit amount not factor into an investment calculation especially since it governs where your cash values will go? When people evaluate life insurance policies as investments, they almost do so exclusively by looking at cash values. If I quit on my policy, it is true that the cash value is the only number that matters but if I plan to follow it through to completion in either death or old age, isn’t it true that the death benefit becomes a much more meaningful number? Just remember that any numbers shown in a projection or illustration are not guaranteed. The only numbers that you can count on as guaranteed are those that you see on your annual statement. Then you know at least where your death benefit will be if you continue to make your payments and where your cash values stand as of that present day. With a participating whole life insurance policy, you can go to sleep wondering how much more it will be worth tomorrow. I don’t know about you but I sleep a lot better dreaming of growing riches than worrying if I might lose my money tomorrow in the markets. Plus if I sleep better, odds are my health will be better and odds are that I will live longer and if I lived longer, my policy will be worth more in the long run. For my money, there is no better way to grow your wealth, no better place to keep your savings, and no better base to build upon for the rest of your investment plan.

 

Douglas Guest – 2014