I am sometimes accused of being myopic in the term-whole life debate, an accusation that I obviously do not agree with. I can always respect another viewpoint as long as it’s based on fact and not the misinformation bandied about by the likes of Suze Orman and Dave Ramsey.
The mainstream media would have you believe that term and whole life are the same product with different premium structures, and that simply isn’t true. They say that whole life is term with a savings side fund, which is ridiculous. That is simply an analogy, and a pretty poor one at that. The cash value of a whole life policy is legally owned by the insurance company, and is a reserve to pay the future death claim for which they are contractually obligated. If, for whatever reason, the policy owner decides to relieve them of that obligation by surrendering the policy, they will release the reserve (cash value) to the owner, since it is no longer needed.
A life insurance policy is a unilateral contract, meaning that once it’s issued, one party (the policy owner) holds all of the rights. Once the insurance company accepts a person as a risk, they cannot change any terms of the contract. That person could start smoking, drinking to excess, become a pilot or a bomb detonator, and, after the contestability period expires (usually two years), the insurance company couldn’t change or cancel the policy (absent fraud).
I ask people what factor they believe has the greatest influence on the premium, and I hear things like age, health, and policy size, none of which is the correct answer. While all of those factors certainly influence the premium, the factor that has the greatest influence on the premium is the likelihood of the policy maturing in a death claim. The greater the likelihood of a death claim, the higher the premium must be so as to reserve for the future payment of that claim.
Industry statistics show that less than 2% of all death claims are on term policies. Why is that? The reason is that term policies are designed to expire before the insured does. Sure, if death occurs while a term policy is in force, the company will pay the claim. But the policy is designed so that a claim is unlikely. It has to be, because the insurance company isn’t collecting sufficient premium to pay an eventual claim.
That is not to say that term insurance is not useful; it certainly is, given the right set of circumstances. One instance in which term insurance is the appropriate vehicle is when the need is short term in nature. Term insurance is also appropriate when the need is long term but the premium for a whole life policy to cover the entire long term need is unaffordable.
So it is my contention that if the cash is available, whole life is almost always the more efficient way to insure a long term need (age and health obviously come into play). If the cash isn’t available, then fund the need with term. But realize that the term policy is designed to expire before you do.