I was recently making some comments on a financial blog, and was not all that surprised to find what I already knew- most people have a small scale idea of how whole life insurance really works. Traditionally whole life insurance has been seen as a cost, which, when crafted in the traditional way, is. It emphasizes high death benefit, while trying to maintain low costs. This type of policy structure creates low policy cash values, and can be rather expensive. This idea has become wide spread. Most people run from anything that has even the appearance of whole life, and understandably so.
The idea I would like to present here is that not everything is how it seems. I’m not sure who coined the phrase, “you can’t judge a book by its cover,” but I relate this intelligent phrase to the topic at hand. Whole life insurance may have more to it than you think.
There are a lot of individuals, especially those that take an interest in finance, that will tell you about the horrible product that is whole life insurance, and I understand their perspective. They contend that if there were anything good to it, “why have I not heard about it before?” The answer is rather simple.
The agent’s perspective:
When an agent writes a policy, their pay structure is based on what is called the “base premium.” The base premium is what determines the face value of the policy, along with a number of different criteria- age, gender, health- to name a few. The agent’s commission is based solely on this dollar amount, so naturally an agent would be interested in selling the most amount of base premium possible. Now put this into perspective. In the United States in 2008 there were 434,800 licensed life insurance agents (bls.gov). What do you think the majority are promoting? I’d be willing to bet they promote whatever lines their pockets with the most cash.
Now there is another perspective on whole life insurance that I would like to introduce. One that, for reason stated above, traditionally goes unnoticed… unfortunately. It contrasts the traditional structure of whole life like black contrasts white. It creates a totally different machine, and a very efficient one I might add. I will refer to this type of policy as a “Banking Policy.”
When a banking policy is structured, the base premium (based upon which the agent is paid) is decreased to its absolute minimum, and the cash value is maximized. By maximizing the cash value, the policy inherits a large amount of benefits, benefits that I will explain shortly. To better emphasize this point, I will use an example of a 35 year old male in good health. I am pulling these numbers directly from an illustration by a highly rated insurance company.
Base Premium = $10,000
Cash Value = $0
Face Amount = $808,943
Agent Commission = % of $10,000
As you can see the agent makes a substantial amount of money, and the policy holder pays strictly for death benefit. Now let’s look at how a policy is structured when it’s structured for high cash values: same contribution ($10,000).
Base Premium = $3,401
Cash Value = $6,599
Face Amount = $319,199
Agent Commission = % of $3,401
This is a complete reversal to the traditional structure. Analyze for a moment which one you think an agent will be interested in selling you, the former or the latter? Most agents promote the former; it is more beneficial to them. So if you are wondering why you have only heard of a traditional policy, this is why.
The Banking Policy:
The banking policy is structured much differently, as you can see, than the traditional whole life insurance policy. Most people are unfamiliar, or unaware, of this type of structure. Its purpose is not to emphasize death benefit, but to create a tax favored, liquid pool of money, that can be utilized as a personal bank. It is structured using what is called ‘maximum accumulation.’ To better understand maximum accumulation, we need a little background. In 1988, the government instigated a new law. This law disallowed large single deposits into an insurance policy without it becoming a modified endowment contract, inherently losing its tax advantages and becoming similar to a government qualified plan.
Maximum accumulation is a structure that maximizes the policies to create the highest amount of cash values, and the least amount of base premium, without the policy being categorized as a MEC (Modified Endowment Contract) under government law. This is the basis of how a banking policy is structured, high cash values and low costs while maintaining important tax advantages. It maximizes all the possible advantages that can be found in an insurance policy.
So how does this policy look in the next 5, 10, 20 years?
There are a couple things to note about the performance of a policy. The first is that in the year one a portion of the contribution goes to the cost of insurance, as well as in year two. Year three, however, is a different. Year three’s contribution is fully accessible the moment you place it in the policy. This is now a fully functioning bank. It takes an additional two years to recoup the original cost of insurance, but by that time- year 5- you are about breakeven. The total amount of money you have put in is now available in cash value. This includes the cost of insurance. At this point it is no longer necessary to make contributions, the growth in the policy will sustain and grow the policy on its own.
After year 5 this policy becomes a more and more efficient machine. It becomes similar to an airplane. The longer it is in flight the more gas it burns. The more gas it burns, the lighter the aircraft becomes, and the better gas mileage it gets. The longer you’ve had the policy, the faster it grows.
For a more visual representation of what these values can grow to, please visit and watch this video: Whole life insurance banking policy.
Now that we have established the difference between a traditional whole life policy and a banking policy, I want to make a quick point. The banking concept is very conceptual, and is not a form of investing. It is process by which wealth is created. The whole life insurance policy may provide good returns, but that is simply the tip of the iceberg. It represents the smallest portion of the value of the banking concept. Allow me to explain.
According to Miamiherald.com, the average American has a 401k balance of $66,900.
According to creditcards.com, the average credit card holder has a credit card balance of $15,788 at an average APR of 14.48%. This creates a minimum payment of about $315.76.
According to msn.com, the average car loan balance is $24,864, with an average monthly payment of $479.
So the average American is saving for the long term, which is commendable, but this long term savings is inaccessible, creating a predicament. This average American is going to have a need for capital at some point. He will need to buy a car, pay a medical bill, go on a vacation, and the list goes on. So where does he go for capital? The money inside the 401k is untouchable without serious tax consequences, so that’s not the best option. If he has the cash to pay for it, we then must assume that he could have contributed more to his 401k, not maximizing his retirement fund. He will also miss out on what that money could have earned had he not paid cash for his purchase. What the average American tends to do, however, is look for an outside source for that capital. We see this by the average balance on credit cards and car loans. Let’s look at a balance sheet for this average American.
401k Value 66,900
CC Debt (15,788)
Car Loan (24,864)
From a balance sheet perspective, we are in the positive… that’s good, right? Let’s break it down a little more, let’s look at the annual profit/loss statement. We will assume a 10% return on the 401k.
Profit / Loss
Credit Cards (3,789)
Car Loan (5,748)
By finding the difference in interest paid and interest earned, we find that the average American here is paying $2,637 more in interest than he earns in his investments. Wouldn’t he be better just paying cash for his purchases and not contributing as much to his 401k? What if you were paying yourself that interest and not someone else? You’d have some pretty strong year end growth, and you would have a eliminated a lot of risk in the process. So the problem here is the place where his money is being stored. Apart from multiple other reasons why his 401k is not benefiting him, it doesn’t allow him access to his money. So what if he utilized a different fund. A liquid fund that allowed him to grow his money tax free, a fund that allowed him to access the money at any moment he wanted, that guaranteed him a 4% growth on his money, and that had been around for over 200 years without fail?
Would it not be better for him to be able to access that capital, maximize his investments, and redirect the finance cost and/or opportunity cost back to his own fund? He would plug the holes where he is losing money, and he would have high, predictable returns on his investment dollars. I could write another 5 pages on risk here, and why there is no reason he should be taking any, but within this process he will also be eliminating that. This is the purpose of the banking policy. It allows you to maximize investment dollars, gives you access to capital you are going to constantly need, and it helps you capture money that you normally lose either unnecessarily, or unknowingly