Consumers Should Study Options Before Buying Whole Life Policy

You’ve been hooked by the emotional ads depicting family members left penniless after your untimely death. You’ve concluded you need to buy life insurance.

But what kind?

If you call an insurance agent, you’re almost certain to get a pitch for a permanent insurance product, also called cash value or whole life.

The likely reason: Agents make money in commissions selling permanent life policies, which carry a surrender value that can be turned into cash when the policy is liquidated.

“Cash value policies are oversold,” said Glenn Daily, a fee-only insurance consultant in New York.

Daily and some other financial advisors and consumer advocates believe term life is often a less costly choice for most people.

Consider the comparison:

A 40-year-old male nonsmoker in good health who buys $250,000 of term coverage could expect to pay about $330 in annual premiums for the first 10 years. The sales commission is about 70% of the first year’s premium.

That same person buying similar coverage in a permanent policy could pay $1,650 in annual premiums for the life of the policy. The commission is 55% in the first year, or $907.50, and anywhere from 3% to 10% over the next few years.

Term life is simple insurance against early death. It is in force only for a specified time, typically between five and 20 years, and only pays a premium if the policyholder dies within that time.

Renewal after the term expires is not always guaranteed. In fact, policyholders who renew may need to submit to a physical exam or other test of insurability.

Permanent life insurance, which has no time restraints, is life insurance with added investment features. The premiums are invested in stocks or bonds, which provide a return to the policyholder.

But James Hunt, an actuary with the Consumer Federation of America, a Washington-based consumer group, says individuals may be better off putting their investment dollars into an employer-sponsored 401(k) retirement plan because contributions there are made before taxes.

“Don’t buy a whole life policy if you’re doing so at the expense of a 401(k) or other tax-exempt investment,” Hunt said.

Another consideration before buying permanent life, Hunt said, is whether you have adequate permanent disability insurance. Even worse than dying early and leaving dependents with no income would be to become permanently unable to work and faced with astronomical medical bills as well as ordinary living expenses.

Between 60% and 70% of employed people don’t receive disability insurance through work, Hunt said.

“If you don’t have any disability coverage, you should think about whether you should buy it before you plunk down money for a whole life policy,” he said.

Yet there are some reasons to pick permanent life as an investment over other products. If the total cash contribution to the policy is below certain federal limits, a policyholder can borrow tax-free against the cash value of the policy, in most cases at cheaper rates than for other types of loans.

Also, the premiums on permanent life insurance can be three to eight times the initial premiums for the same amount of term coverage, but they don’t go up every year like they sometimes do with term life.

Some permanent life insurance products offer policyholders more flexibility on how much they pay in premiums and on what schedule, and how their money is invested.

Universal life, also called adjustable life insurance, allows a policyholder to pay premiums on any schedule in virtually any amount. The amount of coverage also can be changed.

Variable life allows a policyholder to invest the premiums in stocks, bonds, a combination of both or accounts that guarantee principal and interest. The cash value is not guaranteed. Death benefits and cash values vary with the performance of an underlying portfolio of investments.

“Policy-owner control has meant, to me, satisfied clients,” said Ben G. Baldwin Jr., an agent for Equitable Life Insurance Co. in Northbrook, Ill. “I can respond to all those needs.”

But Baldwin offers a big caveat. Permanent life is only for people who want to invest in the financial markets. “If you want life insurance, and you cannot afford or don’t wish to invest, you buy term insurance,” he said.

Buyers of permanent life also should be willing to educate themselves about their investment options, which can be quite complex.

“You shouldn’t invest in anything you don’t understand,” Baldwin said.

Unfortunately, said Daily, as many as one-third of permanent life insurance policies are sold to people who wouldn’t buy them if they were better informed.

“When in doubt, buy term. It’s simple, easy to understand, the sales abuses are less prevalent, and it does not require as much of an outlay with a subsequent loss if you cash out,” Daily said.

Robert Hunter, president of the National Insurance Consumers Organization in Arlington, Va., suggests those thinking about whole life insurance consult a fee-only financial planner who doesn’t earn a commission on the sale.