I came across an internet blog post titled “5 Things Life Insurance Companies Don’t Want You to Know.” With a title like that, you can be sure it is of limited educational value.
The first “secret” is that permanent life insurance is not a good investment. That’s a secret? It’s not a good investment because it’s not an investment. It’s insurance. Does anyone look at their car insurance, homeowner’s insurance or health insurance as an investment? So why would you look at life insurance as an investment?
People who don’t understand whole life insurance describe it as term insurance with a savings component. That is not at all an accurate description of the product. As stated in these messages ad infinitum, the cash value of a life insurance policy is a reserve to pay the death claim.
The reason why whole life has a cash value and term insurance doesn’t has nothing to do with whole life being an investment. It has to do with the likelihood of the company having to pay a claim. Statistics show that less than 2% of all life insurance claims are paid on term policies. That’s because, on average, policies that result in death claims have been in force for over 30 years. The bottom line is most people outlive their term insurance.
Let’s look at the “investment” argument another way. Term insurance can be considered a lousy investment because it rarely pays a claim. It provides psychic value (peace of mind knowing your loved ones are protected should you meet an early demise), but rarely will it provide any monetary value.
Whole life, on the other hand, will pay a death claim provided you don’t sell, surrender or lapse it. True, it probably won’t be for 30, 40 or even 50 years, but the internal rate of return on the death benefit of a whole life policy issued by a major mutual life insurance will usually exceed 5%. And life insurance proceeds paid by reason of death are income tax free.
In conclusion, don’t fall for any of the hype found on the internet, about any topic. If life insurance companies really had out-sized profit margins, you could be sure that Jeff Bezos would swoop in and rectify the situation.