Whole-life insurance: what a ripoff

Here’s a snippet from an intriguing WSJ article about the rise of whole-life insurance (behind their paywall, unfortunately):

Lou Kumar, 39, a cardiologist in Arlington, Va., says he probably wouldn’t have given a whole-life policy a second look a few years ago when stocks were rising.

[…]

He acknowledges, however, that many of his friends weren’t convinced, telling him to buy a term policy and invest the rest. He is paying a hefty $4,000 a month in premiums for a $2 million policy from New York Life with a $1 million term-insurance rider. Under the terms of the customized plan, he’s scheduled to stop paying premiums at age 55 for lifetime protection. A 10-year term-life insurance policy for $3 million would cost him just $1,820 a year from the same company.



Whole-life insurance is huge in Singapore; god knows why. It’s pitched as “investment PLUS savings PLUS protection!”, sure, and it plays on people’s fears of not being able to provide for their family.

But whole life insurance is almost always a disgraceful ripoff, compared to buying term and investing the difference. Let’s have a look at the math on Dr. Kumar’s policy…

He’s paying in $4,000/month, of which $150 is life insurance premium (at $1,820 a year, which is roughly right) and $3850 is investment.

At age 39, according to the CDC’s mortality tables for 2004 (if anyone has updated mortality tables please give me a shout), he has 39 years of life ahead of him – so on average he’ll live to 78.

He pays the premiums for 16 years (stopping at his 55th birthday), by which time he’s accumulated about $925,000 if the plan invests in 10yr US Treasuries currently yielding 2.77% (let’s assume that interest rates don’t go up in the next 16 years, which is… well… unlikely). So when he stops, he has 23 years of life ahead of him on average before he dies and the $2m death benefit pays out.

What interest rate do you need to turn $925k into $2m in 23 years? The answer is the 27th root of $2m/$925k, minus 1 – or almost exactly 3.4%.

Right now, we’re experiencing some of the lowest yields in history – but 30yr Treasuries are STILL yielding 3.74%, or 0.35% better than you’d get from this whole-life plan.

If you took the $925k and stuck it in those 3.74%-yielding T-bonds when you retired, you’d make an extra $150,000 on average (less if you die earlier, more if you outlive the average – which, given that the guy is a white-collar worker in an affluent part of the country, is highly likely).

Or what if you stuck the whole lot in equities? Historically, equities have yielded about 8%, counting reinvested dividends. Because everyone’s a pessimist at the moment, let’s assume equities only yield 5% over the next 41 years. And again, let’s assume this guy doesn’t outlive the average American, which is highly improbable.

So he pays $150/month for term life, and invests the remaining $3850/month.

After 16 years, he retires with $1.1 million of stocks under his belt. Already, he’s $175,000 ahead of the whole life plan. At this point, he stops investing, and lets the $1.1 million compound at 5%.

When our doctor shuffles off this mortal coil at the age of 78, he’ll end up with over $3.4 million. By opting for whole-life instead of doing it himself, the guy is giving up $1.4 million in returns; if anything, he’s writing that cheque to the insurance company, because he’s letting them (mis-) manage his money. A cheque for $1.4 million – postdated to the year 2048, but a cheque for $1.4 million nevertheless.

And then there’s the punitive early-withdrawal fees. The massive sales charges. Every fee gouge you can imagine will be in there.

This is why people say “buy term and invest the difference”.

Do it yourself instead. Even if you play completely safe by investing in Treasuries, you’re saving yourself from writing a $150,000 cheque to the insurer. If you put your money in a sensible balanced equity fund, you’re saving yourself from writing a multi-million-dollar cheque to the insurer.

And aren’t insurance companies getting enough of your hard-earned money already?

Edit: updated the mortality tables to the 2004 edition, and fixed a math error that gave Dr. Kumar an excess year-and-a-half of retirement. Doesn’t change the gist of the argument.

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