What you really need to know about permanent insurance
As noted in a previous article there are two families of life insurance available in Canada; Term Life Insurance and Permanent Life Insurance. The most misunderstood of those two types is permanent life insurance. In this article we’re going to clarify those misunderstandings. Then we’re going to show you how Guaranteed Universal Life and Whole Life may be better products than Term to 100.
Bad Whole Life
Also known as Enhanced Whole Life, you can smell this insurance coverage whenever the word ‘dividend’ is mentioned. The word dividend is a homonym – it sounds like the word ‘dividend’ that Mark writes about here but it is NOT the same thing.
Enhanced Whole Life is actually a mix of a small amount of whole life insurance and a larger portion of one year term insurance (one year term insurance has premiums that start our really cheap but become really expensive over time). The insurance company execs balance mortality, expenses and investments on the block of life insurance policies along with their need for a Christmas bonus and may declare a ‘dividend’ – which is actually a return of your own premiums.
That ‘dividend’ buys a small whole life policy called a Paid Up Addition (PUA), which replaces a small sliver of the one year term insurance. The idea is to completely replace that ever-more expensive one year term insurance with PUA whole life policies. Here’s the bad part: the dividends are not guaranteed. If these dividends aren’t paid as projected, you may find yourself in 20 years with a whole life policy that actually has huge and increasing term insurance premiums. I’ve seen cases where policyholders in their 60’s or 70’s get a letter from the insurance company saying ‘lower your coverage dramatically or start paying ever increasing premiums’. That’s bad. And it’s not hypothetical either.
Bad Universal Life
There are two types of universal life insurance. Both have an insurance component and an investment component. The difference between the two types is in the cost of the insurance component.
With Bad Universal Life, the insurance component is one year term. That means the costs are really cheap initially and get really expensive as you get older. Keep in mind this is permanent insurance – insurance we expect to keep forever.
So we’re going to assume a level payment – which consumers will often confuse as a level insurance premium. In the early years your payments are higher than the insurance costs. The balance of your payment goes into investments and start to look like a cash value (because you can cancel the policy and take out the investments). But the insurance costs in these policies keep going up, and up, and up. You as a consumer continue to pay your level payments until the day comes when the term insurance costs are higher than what you’re paying. Now what? The insurance company will dip into your investments to pay the difference. And as long as the investment growth is faster than the insurance costs everything is wonderful. Here’s the funny thing though – the increasing insurance costs are guaranteed. The increasing investments? Not so much.
If the investments don’t perform there may not be enough money between investments and your premiums to pay the insurance costs. At that point you are going to get a letter from the insurance company introducing you to insurance costs that are increasing every year (again, think of this happening in 20 years). And again, this is not a hypothetical situation.
Term to 100
This insurance is simply guaranteed level premiums for life for guaranteed level coverage. There are no other options. The name is misleading however. This is permanent insurance not term – its closer to whole life than it is term insurance. And its lifetime coverage – has nothing to do with ‘to age 100’.
Good Whole Life
Guaranteed Whole Life insurance is simple – it has level premiums and level coverage guaranteed for life. That’s it.
Just like the well known Term to 100. Guaranteed Whole Life though has a couple of things Term to 100 doesn’t have. First, if you cancel after a period of time the insurance company will give you back a Cash Surrender Value (CSV). Cash values are often maligned, but if one person buys a Term to 100 and the second buys a Good Whole Life policy and both have to cancel at age 65, who do you think is going to be happier?
Good Whole Life also has something called Paid Up Values (PUV’s). PUV’s allow you to stop paying premiums forever and take a lower amount of coverage that is fully paid up. Again, compared to Term to 100, both people stop paying premiums – neither receives a cash value but the Good Whole Life policy owner will still have life insurance coverage albeit at a lower amount.
Good Universal Life
Your insurance cost is guaranteed level for life. If it’s $100 a month today, it’s $100 a month forever. So what happens if you simply pay the $100 per month? You will be paying $100 a month which exactly covers the insurance costs. Your investments will remain at $0. You have for all intents and purposes a Term to 100 policy. You could (but don’t!) pay more than $100 per month and start building the investments. But no matter what happens to those investments, even if they crash and burn, your worst case scenario is you always pay $100 per month for your life insurance coverage.
So we’ve covered the five types of permanent life insurance – bad whole life and universal life, term to 100, and good whole life and universal life. Let’s look at a practical example!
So let’s say you’re looking for life insurance, forever. We want level premiums for life at the cheapest cost. You assume that’s Term to 100 right?
Let’s take an older Mark (My Own Advisor) as a 45-year old male, non-smoker, shopping for $100,000 of coverage and see how Mark’s premiums work out:
- Term to 100: $103/month for life. No cash value, no investment options.
- Good Universal Life: $98/month for life. An investment option that is ignored.
- Good Whole Life: $107/month guaranteed level for life. When Mark turns age 65, he has three choices: 1) continue to pay $107/month for life, 2) cancel the policy and receive $13,700 in cash value or 3) stop paying premiums and have $38,900 in life insurance for the rest of his life, no premiums due.
What Mark has to decide is this:
- His cheapest option is Universal Life, not Term to 100 but…
- For his extra $9/month he can have Good Whole Life that comes with additional options. Are those options worth $9/month to you? For $9/month I would suggest it’s barely even a financial decision and more a personal choice. If you don’t care, save the nine bucks per month and get the Universal Life. In neither case would Term to 100 be the correct choice.
So there you have it, five types of permanent life insurance. Watch out for attributes that are not guaranteed and remember the least expensive choice is not necessarily the best when it comes to great benefits at a very small additional cost.
Glenn Cooke is an independent life insurance broker and president of Life Insurance Canada.com.