An Introduction to Whole Life Insurance
The most powerful financial tool available today
If you are not familiar with whole life insurance, it may sound strange at first. You have probably heard of a mutual insurance company but might not have really known what they are about. Fun fact: Mutual insurance companies have been around longer than the United States. I will explain in further detail below, but to start, here are a few of the features of a properly designed whole life insurance policy:
- Provides a guaranteed death benefit payout no matter how long you live
- The policy has an associated “cash value” that grows at a respectable, guaranteed rate of interest
- Non-guaranteed dividends are also normally paid to the policy owner
- The policy has a guaranteed loan provision that allows you to borrow against the cash value of your policy, no questions asked
- Even with loans outstanding, the full cash value of your policy continues to earn guaranteed, uninterrupted compounding interest
- Tax-free growth and payouts – The cash value, guaranteed interest, and dividends grow in the policy, tax-free. The death benefit, too, is paid out to the beneficiary of the insurance policy in a lump sum, tax-free
You probably already know what life insurance is. But just in case, here is a very short story about life insurance that is not very entertaining at all.
My dad (the “insured”) made monthly “premium” payments to a life insurance policy. The policy was a contract between an insurance company and the “policy owner” (also my dad). That agreement stated that as long as my dad paid the monthly policy premium, upon his death, the insurance company would payout a lump sum “death benefit” to the “beneficiary” named in the policy (me).
The primary purpose of insurance is to indemnify or “make whole” one party against a loss. In the case of life insurance, a “beneficiary” is “made whole,” financially, against the loss of someone they rely on (like my dad for example).
The idea behind being “made financially whole” is to cover the “human life value” of the deceased. Ideally, the death benefit would equal the total amount of money the deceased would have earned if he had not died, for the duration of the life insurance policy. So, if the breadwinner of a family of four dies, the surviving family members would be left in a financial situation that allows them to maintain their standard of living before the breadwinner died (i.e. “made whole”).
There are two primary types of life insurance: Term Life and Whole Life:
Two Basic Types of Life Insurance
Term Life Insurance
Insures a person for a certain amount of money for a certain period of time or “term.” E.g. $1,000,000, 20 year term life insurance policy.
The policy expires after 20 years. If dad dies before the 20 year term is up, the insurance policy pays a death benefit of $1,000,000. If dad dies after the 20 year term, no death benefit is paid out, as the policy has expired.
Whole Life Insurance
Insures a person for a certain amount of money for their entire (“whole”) life . It is guaranteed to pay out a death benefit, regardless of age, so long as the policy is in force.
It is Whole Life Insurance, specifically, whole life insurance with a “participating” mutual insurance company, that we recommend at StackedLife. We will look at some ways to utilize a specially-designed type of whole life insurance to act as our primary cash asset i.e. savings account. We will get into further detail as to why we are doing this later in this series. It has to do with greater growth, flexibility, and control of your cash/savings.
The Mutual Insurance Company
The mutual insurance concept dates to the late 17th century in England with the establishment of the first mutual fire insurer in 1696. In America the first successful mutual insurance company was founded in 1752 by Benjamin Franklin. It was called the Philadelphia Contributionship for the Insurance of Houses From Loss by Fire, and it remains in business today.
Mutual companies are unique because they were established to serve the insurance needs of policyholders without also having to meet the investment needs of stockholders. The policyholder – often referred to as a “member” – is the sole focus of a mutual insurance company 1.
The policy-owners share actual ownership in the mutual company and, thus, have voting rights. Also, because they are owners, members (policy-owners) are entitled to excess profits in the form or dividends. This, as opposed to a stock company; policy-owners in a stock (insurance) company have no voting rights and dividends are either shared with stockholders or altogether forgone in favor of the stockholders.*
Mutual insurance companies exist to ensure that the benefits promised to policyholders can be paid over the long term. Because they are not traded on stock exchanges, mutual insurance companies can avoid the pressure of reaching short-term profit targets. Members of a mutual insurance company have the right to excess premiums, meaning that if losses and expenses are less than the amount of premiums paid into the company, the members would receive either a dividend payment or a reduction in premiums. In general, the goal of the mutual insurance company is to provide its members insurance coverage at or near cost, since any dividends paid back to members represent excess premium payments 2.
The Salesman in the Room (and a Little History)
In recent history, insurance has been known to invoke a negative image in peoples’ minds due, in no small part, to the sales people historically involved in the industry. Think ‘Ned Ryerson’ from Groundhog Day. Sleazy sales tactics (like showing up at funerals to pitch life insurance) and other “hard-close,” fear-based sales behavior has left a bad taste in the mouths of at least a generation.
We should acknowledge this negative stigma and always be wary of financial product sales that may not be in our best interest. At the same time, however, we should keep things in perspective.
There have been sleazy life insurance salespeople just like there have been sleazy car salespeople and sleazy real estate agents and landlords. Yet – most of us still drive cars and still buy or rent housing. Most of us, in fact, also still buy life insurance. Usually some kind of term life insurance either purchased on our own or offered through our company.
The reality is that, even when acknowledging any “bad actors,” life insurance has, historically, been a bedrock financial tool that has protected the well-being of countless families in their most difficult times.
In 1900, half of all Americans’ savings was held in life insurance and annuities. In 1950, one third of families owned whole life insurance policies 3.
The history goes back even further. Modern life insurance has been around since the 1750s. The first mutual insurer, Society for Equitable Assurances on Lives and Survivorship, was formed in 1762 and the first policy dividend was paid to its mutual members (policy-owners) the same year as the Declaration of Independence, 1776! 4 There are currently existing mutual insurance companies that have been around since the mid-1800s and have paid interest and dividends to policy owners every year for over 150 years, including the Great Depression and Great Recession.
The “Rebirth” of Whole Life Insurance
Whole life insurance is currently seeing a “rebirth” of sorts as people are re-discovering the incredible benefits of storing their cash/savings in a whole life insurance policy. This reemergence is largely due to a growing awareness of the fragility of our debt-based economy and to educational movements like the Infinite Banking Concept (founded by Nelson Nash, the author of the seminal book Becoming Your Own Banker) and the Prosperity Economics Movement.
Now, rather than using fear-based sales tactics, many educated life agents are focusing on the certainty that can be created for families when a family member dies, i.e. the life insurance death benefit. In addition to this, because of the cash flow features unique to whole life insurance, qualified life agents spend even more time educating clients on the “living benefits” that whole life insurance can provide while the client is still alive!
Who Uses Whole Life Insurance?
If the idea of using life insurance as a financial asset still seems strange, it may be helpful to see some examples of people and organizations that have used cash value whole life insurance to grow their personal wealth or improve business operations:
- U.S. Banks have an extraordinarily high number of whole life policies to protect against the loss of key employees
- Family trusts of the ultra-wealthy leverage the power of cash value whole life policies to increase the returns on their investments and to efficiently transfer wealth to future generations
- Entrepreneurs have used the cash value of their personal whole life policies to launch some of the most famous businesses in history 5.
- Walt Disney borrowed $100,000 against the cash value of his whole life policy to help fund Disneyland
- J.C. Penney borrowed against his whole life policy to help meet payroll after the Great Depression stock market crash of 1929
- Ray Kroc dealt with constant cash flow problems in the early years of McDonalds. He used policy loans to help cover salaries of key employees and to finance the initial Ronald McDonald ad campaign
Why Whole Life Insurance?
Ok – so why are we looking at whole life insurance as our method of savings? Why not a savings account? Why not the qualified plan (401k, etc)?
First, let me reiterate: It’s more about the process than it is about whole life insurance. Whole life insurance just happens to be the best tool to implement the process currently (and has been for a long time).
Why Whole Life Insurance:
- Savings – as mentioned, we will use whole life as our primary cash/savings asset
- Budgeting – Because this is an insurance policy with a monthly premium payment due every month, we can start to plan for, and lock in, our monthly allocation to savings
- Growth – whole life insurance earns a much more respectable rate of guaranteed compound interest than a savings account; around 100x higher than your standard Big Bank and 20% higher than a 4-week treasury bill.
- Dividends – A correctly structured whole life policy will also pay a non-guaranteed dividend that can be taken as cash or used to buy more insurance (which increases the cash value). The mutual insurance companies used by StackedLife have paid dividends every single year for over 150 years.
- Flexibility – Through the use of policy contract “riders” called paid-up addition riders, we have flexibility to contribute more or less (subject to limits on both ends) to the policy in any given month, based on life events.
- Control / Ownership – As the policy-owner, you are in complete control of the policy and its cash value.
- At any time, you can take a policy loan to take advantage of opportunities (such as starting a business, or buying a home/property). Your cash is not locked away until some arbitrary “retirement” age (i.e. 59 1/2)
- At any time, you can surrender the policy and receive the full cash value of the policy
- You are also considered a “member” of the mutual company, which is a part-owner. As a part-owner, you have the right to vote for a board of directors. In addition to that, in most states, mutual policyholders also have the right to vote on fundamental corporate transactions involving mergers, demutualizations, and the sale of all or substantially all of the assets of the company. Compare this with your savings, broker, and 401k account. Who has voting rights? Shareholders. Not you.
- Policy Loans – Through the guaranteed policy loan provision, you can borrow against the cash value of your policy, no questions asked. No filling out applications, no qualifying for your loan. There is no set payback schedule to pay the loan back. In fact, you could take out a loan and never pay it back. When you die, the insurance company would simply subtract the loan amount plus interest from the amount of the death benefit and pay that net death benefit to your beneficiary.
- Dual-Use of Your Cash Value – This is where the power of cash value whole life insurance really starts to shine. By responsibly using policy loans, we can start to do two things at once with the “same money.” When you borrow against the cash value of your policy, you have cash with which to make a purchase or to further invest in another opportunity. Meanwhile, the entire cash value of your policy, including the amount you borrowed, is still growing in your policy at the guaranteed rate of interest and dividends are still being paid according to the full cash value of your policy!*
Sound too good to be true? It’s not. This is precisely how the ultra-affluent leverage their cash to increase the returns on their investments.
At this point, a warning must be issued – Using policy loans is not free. It’s not magic money. It’s your savings and the loans work just like any other loan! If policy loans are abused to the point where the insurance premiums can no longer be paid, it could force the policy to be surrendered and you would be right back where you started.
However, even with the above warning, one major advantage to using cash value banking is that you can’t go into debt using policy loans because it is fully collateralized by the money you saved. But you can lose all the money you saved by abusing policy loans. Talk to your advisor and make sure you understand how cash value and policy loans work.
* To avoid any confusion or debate — Different insurance carriers have different ways of handling things like how dividends are paid out when a policy loan is outstanding. For instance, some carriers may pay a higher or lower dividend based on policy loan status. However, if that carrier pays a lower dividend when a policy loan is outstanding, they may have a higher guaranteed interest rate or lower loan interest rate, for example.
The relative differences between how carriers handle dividends and policy loans tend to “come out in the wash.” As such, and regardless of individual carrier procedures, the process and benefits explained in this article is accurate. A qualified life agent/broker can explain how this works with specific carriers and help determine the options that best fit your objectives.
Our mission is to help your family and/or business realize its full financial potential. We help identify areas where money is getting away from you in the form of opportunity cost (taxes, fees, inaccessible cash) and bring that money back under your control.