Cash Value Life Insurance Is Useful … for Some

by Aubrey Cohen | posted in Life Insurance
Published on May 6, 2015

 

Stocks burned you in the recession. Now low interest rates are keeping you from making money on safer investments. Could cash value life insurance be a solution?

The short answer is: Maybe. Here’s the long answer.

Cash value life insurance

Most people are more familiar with term life insurance than with cash value, or “permanent,” life insurance. With a term policy, you pay premiums for a set number of years (the term), and if you die during that time, the insurance company pays a defined death benefit to your beneficiaries.

Permanent life insurance costs more than term life insurance because it combines two different functions: insurance and investment. Like a term policy, permanent life insurance pays out a death benefit, and the policy stays in effect as long as you continue paying the premiums. But it also has a cash value component that builds over time, allowing you to borrow against it. Eventually, the policy might become “paid up,” meaning the company will use the cash value to cover the premiums until you die.

There are four varieties of permanent life insurance, all with cash value components built in:

  • Whole life, in which the premiums, death benefit and rate of return on your investment are fixed.
  • Universal life, which has flexibility in premium payments and allows changes to the death benefit amount, within certain limits.
  • Variable life, which allows investment in a variety of funds, bringing the potential for higher returns — and for losses.
  • Variable universal life, which combines the features of universal and variable life.

Because the policies and rates of return in cash value life insurance can be hard to understand, many experts advise sticking with term life insurance and investing the difference elsewhere.

That’s what James Hunt, a retired life insurance actuary and a former insurance commissioner of Vermont, advocates for many people.

“The good advice for young people is to stick to term insurance and to stay away from cash value insurance and do your retirement accounts,” he says. Hunt now runs the Life Insurance Rate of Return Service of the Consumer Federation of America’s Insurance Group. In that capacity, he evaluates the investment returns on cash value policies.

Hunt says everyone should maximize contributions to tax-preferred retirement accounts, such as 401(k) plans and IRAs, before considering cash value life insurance.

Since 1999, cash value life insurance has made up around 75% to 80% of policy sales, in terms of premiums paid, after long holding a larger share of the market, the insurance and financial services industry research group LIMRA reports.

Whole life insurance sales grew for 18 consecutive quarters after the recession, before stalling in the beginning of last year, according to LIMRA. Sales of both whole life and term policies fell by 2% last year, while universal life sales were down 4%, LIMRA reports. Variable universal life was the exception, surging by 10%.

A place for cash value life insurance

Financial planners have long used cash value life insurance as a way for clients’ beneficiaries to pay for or get around estate taxes. There’s less need for that these days, because the federal government has been raising the estate tax threshold in recent years — from $1.5 million in 2004 to $5.43 million this year.

“Among planners, sometimes there’s a perception that permanent coverage isn’t as necessary as it once was, when in fact it’s probably more necessary than ever,” says Brett Berg, vice president of advanced marketing for Prudential Individual Life Insurance.

In a recent article, Berg pointed to people who want to avoid the risk of stocks but also want a greater return on their money than they can get elsewhere. “Many clients can activate their assets by repositioning part of the low-yielding CD or other low-yielding asset to life insurance,” he wrote.

In an interview with NerdWallet, Berg emphasized that the primary purpose of life insurance is to provide a death benefit to one’s family. Investment return, he said, “should be a secondary consideration, but it is a consideration”

Barry Mulholland, an assistant professor in Texas Tech University’s personal financial planning department, takes a similar view. Assuming you have a life insurance need, he says, whole life has “a guaranteed rate of return that may rate up there pretty well with other types of fixed-income assets you can invest in.”

Who should consider cash value life insurance

“My view is it would be appropriate for a relatively small number of people,” says Glenn Daily, a fee-only insurance advisor and prominent commentator on life insurance.

For one thing, you have to be committed to continuing to pay for the policy, because the advantages come many years down the road, while many of the costs pile up in the early years. As Hunt puts it: “You really need to be 100% sure you’re getting in for the long run, because the short run is not going to be good.”

Nearly 14% of whole life policies lapse within the first year, followed by nearly 10% of the remaining policies in the second year and 6% in the third year, before the lapse rate settles down to an annual average of 3.1% percent, according to a study by LIMRA and the Society of Actuaries.

You also need to be able to tolerate complexity, Daily says. “There is simply no way to make an informed purchase decision about cash value life insurance without spending time doing research and without working through a number of choices you have.”

For example, he notes that insurers offer long menus of complicated options and don’t have uniform definitions of key terms like “dividend interest rate” and “gross rate of return.”

Regulators are now developing guidelines for sales “illustrations” for indexed universal life policies, which provide minimum earning guarantees with the potential to make more based on performance of stock indices. Some of these policies “are being sold with extravagant hypothetical earnings rates,” Hunt says.

Mulholland says permanent life insurance clearly can make sense for people who want to pass on money and who have an estate large enough to be subject to the estate tax. On the other hand, he says, young families with a big insurance need but few assets should look at term life insurance.

People who don’t fall into either of those camps need to consider how insurance might fit their particular situations, including their desire to provide money to heirs after death and their need for access to their wealth, rather than having it tied up elsewhere, according to Mulholland.

In his article on cash value insurance, Berg wrote that moving low-performing assets into life insurance generally works best for people who are at least 59½ and family-oriented, have enough money to put into insurance while still supporting themselves in retirement from other sources, have a plan from a financial advisor, and want to provide for others after they die.

“The No. 1 question people need to ask themselves is, ‘Do I or will I need that asset for retirement income purposes?’” Berg says. “if the answer is yes, they may be better off leaving the asset where it is.”

How to shop for cash value life insurance

Hunt offers simple advice: “Stick to cash value policies at TIAA.” TIAA-CREF offers low-load policies, with no sales or surrender charges. While the company specializes in serving people in the academic, research, medical and cultural fields, it’s open to anyone.

Be skeptical about the rates of return that insurers use to illustrate how cash value will grow over time, says Hunt, whose job involves examining those rates. Insurers have been using earnings from the past 30 years, when interest rates were higher, and won’t be able to keep it up unless long-term interest rates on bonds and mortgages rise substantially, he says. “For years, we’ve been warning buyers that what they see is not what they’ll get.”

In a recent survey, Mulholland and colleagues found that 35% of financial advisors considered policy illustrations “less than effective” as a tool to educate and protect consumers.

In addition, consumers should look at a company’s financial strength from a ratings agency such as A.M. Best.

“Some insurance companies, frankly, are riskier than others,” Mulholland says.

Deciding what kind of permanent policy to buy depends on factors such as people’s risk tolerance and time horizons, Berg says.

On this and every other matter related to cash value life insurance, you should seek professional advice from an experienced insurance agent, financial advisor or possibly a lawyer versed in the use of life insurance in estate and business planning, Berg says. “The best advice is to get the good advice.”