Permanent life insurance, which includes whole life and universal life, is marketed as an investment product that provides a lifelong death benefit as well as cash value that grows tax-deferred inside the policy. Most financial experts, however, believe that permanent life insurance is a poor investment choice for the vast majority of people. In this article, we will look at the main reasons why most people think permanent life insurance is a bad investment that they should avoid.
Expensive Fees and Expenses
The high internal fees and expenses charged by the insurance companies that issue these policies are one of the most significant drawbacks to permanent life insurance as an investment. Permanent life insurance combines insurance and various investment components, all wrapped up in a complicated insurance contract. Life long insurance companies will charge fees and expenses to cover their own costs and profits.
Permanent life insurance charges and costs may include the following:
- Mortality and expense charges: This covers the cost of the insurance company’s death benefit component.
- Administrative costs include record-keeping, accounting, and other back-office expenses.
- Fund management fees: Investment management fees apply if your cash value is invested in subaccounts.
- Rider fees: Any additional riders must pay their own fees.
- Surrender fees: If you cancel the policy, you forfeit some cash value.
Every year, these various charges can amount to a 2-3% or more reduction in your cash value. The compound effect of these expenses takes a huge toll on net investment performance over the decades-long timeframe of these policies.
Fees That are Opaque and Lack Transparency
Because of the layered complexity of permanent life insurance policies, insurance companies are unable to disclose exactly how much and what types of fees are deducted from your cash value. It is nearly impossible to determine the true cost structure and net investment returns unless the policyholder goes through many detailed documents and figures out the actuarial math themselves.
Insurance agents selling permanent insurance also place a much greater emphasis on touting the benefits rather than clearly outlining the drawbacks of these oblique expenses and charges. This information asymmetry makes it difficult for consumers to make informed decisions about these complex products. Investors almost always dislike opaque fee structures.
Extremely Long Time Horizons Required
Because of the high early fees and the way the policies are structured, permanent life insurance truly only works over extremely long multi-decade horizons, as the name implies. The insurance company uses very conservative actuarial table assumptions and only credits very modest interest rates to your cash value in the early years. The companies assume that policyholders will keep the policy for their entire lives, allowing fees and low early returns to be offset later on.
However, persistence rates show that the majority of permanent insurance buyers cancel their policies within the first 10-15 years. Permanent insurance performs extremely poorly as an investment over such short periods due to the high fees and slow accumulation of cash value. Almost no buyers comprehend how long the time horizons must be for reasonable performance. The fact that policies are frequently cancelled prematurely diminishes their investment value.
Doubtful Illustration Assumptions
Insurance agents almost always illustrate permanent insurance policies for prospective buyers using extremely favorable assumptions, such as high illustrated rates of return that can make cash value growth projections appear spectacular. These illustrations, however, are highly dubious projections with little bearing on reality.
The illustrated returns used in models provided by insurance agents on permanent policies frequently assume annual rates of 6-8% or higher. However, actual real-world returns credited to policy cash values have historically been in the 3-5% range based on companies’ conservative actual crediting rates.
These illustrations grossly overstate potential returns by such a wide margin that they border on deception. Most buyers are drawn in by improbable illustrated returns that actual permanent life insurance products have little chance of achieving over time.
Low Real Returns in Relation to Other Investments
Even when more realistic actual historical returns from permanent life insurance policies are considered, net investment performance continues to lag far behind what most other conventional asset classes typically generate over the long term. As an example, according to detailed research compiled by actuary Glenn Daily, average returns from permanent insurance from 1990 to 2015 compared with various stock and bond benchmarks:
- 4.6% return on whole life insurance
- 8.2% for investment-grade corporate bonds
- Municipal bonds exempt from taxation: 5.4%
- Stocks in the S&P 500: 10.2%
While past performance does not guarantee future results. This snapshot provides a reasonably accurate picture of how poor most long-term insurance products are in comparison to alternatives. More often than not, the returns on stocks and bonds will outperform those on permanent insurance. The tax advantages of permanent insurance are also overstated and apply differently to different buyers.
Most buyers are never shown actual real-world rate of return data and benchmarks for permanent life insurance versus other products. If they did, far fewer consumers would find permanent insurance’s return proposition compelling.
Policyholders have little flexibility or control
When a person commits to a permanent life insurance policy, they relinquish all control and flexibility to the insurance company. The insurer dictates the contract and all terms concerning expenses, fees, charges, and cash value returns. The policyholder has no say or recourse other than to cancel the policy entirely, with few options in between.
Investors who build their own portfolios of stocks, bonds, funds. And other assets have complete control over their holdings and investment strategy. Permanent insurance buyers, on the other hand, relinquish all control to the insurance company. These policies also have limited liquidity due to surrender charges if you want to exit.
The lack of policyholder flexibility and control over permanent insurance severely. Detracts from its merits as an asset class for those focused on investing and growing a nest egg.
Permanent life insurance is marketed as an appealing dual-purpose product that provides lifelong death benefit protection. While also serving as a tax-advantaged long-term investment by allowing cash value to grow. However, upon closer inspection, permanent insurance has so many disadvantages as. An investment that it rarely proves worthwhile for the majority of buyers. High fees, a lack of transparency and flexibility. Reliance on unrealistic assumptions, and low real returns leave most buyers dissatisfied and misled years after purchasing permanent life insurance.
Stocks, bonds, mutual funds, and ETFs are far superior investment vehicles with superior returns and control. Furthermore, pure term life insurance frequently makes more sense for solely protecting loved ones. While there is a niche market for some high net worth buyers to use. A specially designed permanent insurance policy in limited circumstances. The vast majority of consumers will fare far better by avoiding permanent life insurance entirely. Those who are sold on its financial merits as an investment will almost. Always be disappointed later on when the agent’s rosy portrayals fail to match up with less impressive realities.