Life Insurance Primer

What do you think of when you hear the words “life insurance?”

If you are like most people, there is usually a negative reaction. Its reputation is well deserved, as the life insurance industry doesn’t do itself any favors by making a relatively simple concept difficult to understand. Some people like to say that life insurance is a lousy investment. That may be true, but most investments are lousy life insurance. They are designed to do two different things. Life insurance, like all types of insurance, is intended to indemnify a loss.

There are 3 main types of life insurance, divided into two main classifications:

This is, though, a mis-categorization. Universal life insurance policies are far from “permanent.” Their underlying structure of an annual renewable term policy (ART or YRT) paired with a market-based side fund makes them inherently unstable, transferring the risk from the insurance company to the owner of the policy. The following table shows how the classification should look:

Life insurance is an “engineered” product. It will do what it is designed to do. Term insurance and Universal Life insurance are engineered to fail. The only way to keep them going is to inject more money into them. Whole Life insurance, however, is designed to get better, more efficient, and more valuable over time.

TERM INSURANCE

This type of insurance offers only one benefit: the death benefit. There is no cash value.

There are two types of term insurance:

Annual Renewable Term (ART), also known as Yearly Renewable Term (YRT), is a one-year term life insurance policy. Premiums are paid every year on the basis of a one-year contract. As such, the premiums will rise over time as the insured person ages. This type of insurance is also referred to as increasing premium term insurance.

Level term life insurance is where the premium is guaranteed to be the same for a given period of years. The most common terms are 10, 15, 20, and 30 years. After the level term period ends, the policy becomes an annual renewable term (ART or YRT), where the premiums rise every year that it is in force.

UNIVERSAL LIFE INSURANCE
“Weapon of Wealth Destruction”

Imagine that you are contemplating entering into a contract that was guaranteed to get more expensive every year, and the other party could change the terms of the agreement at will, without notice to you, at any time, transferring all of the risk to you. Would you sign that contract? If you have purchased any form of Universal Life Insurance, then that is exactly what has happened.

Universal life insurance was created in the early 1980’s not by the insurance industry, but by Wall Street. The now defunct brokerage firm of E. F. Hutton wanted to “unbundle” the savings element and the life protection element of traditional whole life insurance (something that cannot be done) to take advantage of the runaway market interest rates of the early 1980’s. The result was an annual renewable term policy with a side fund of an interest bearing account, typically a money market fund.

These policies, however, could not stand the test of time. As the rising insurance costs began to outrun the earnings of the side fund, the policies collapsed. As a result, these policies became guaranteed profit centers for the brokerage firm who for years collected the premiums, yet rarely had to pay out a claim (fewer than 1% ever pay out or endow).

Insurance companies took notice of these sure-fire profit centers, and began to offer similar products, with different iterations in an attempt to overcome the inherent shortcomings of the design:

1. Universal Life (UL)
2. Variable Life (VL)
3. Variable Universal Life (VUL)
4. Equity Indexed Universal Life (EIUL)
5. Indexed Universal Life (IUL)
6. Guaranteed Universal Life (GUL)

Regardless of how the industry tries to “put lipstick on a pig,” the problem is still the problem. Universal Life policies are guaranteed to get more expensive each and every year that you own the policy. They are designed to shift the mortality and investment risk to the policy owner with the rate guaranteed during the first year but subject to maximum mortality rates and minimum interest rates in subsequent years.

As you read the contract or even the illustration, take note of the many times “if” is used. The “-ifs-” shift the risk from the insurance company to the policy owner. Even when there are “guarantees,” note that they are contingent on some subtle but dangerous “-ifs-”:

1. “If all premiums are paid.”
2. “If all premiums are paid on time.”
3. “If all loans are paid.”
4. “If all loans are paid on time.”

The results and stability of the contract has its own “-ifs-”:

1. “If mortality experience remains constant.”
2. “If market rates perform as expected.”
3. “If management and operation costs remain the same.”

Also, look at an illustration and find the word LAPSED. It means just what it says. When a person is most likely to need it, they have no insurance!  The salesperson told them that they were building a legacy with a premier financial product only to find out that their money is gone forever.

All forms of Universal Life insurance (UL, VL, VUL, EIUL, IUL, GUL, etc.) are designed to fail, unless more money is injected into them. It is the most disingenuous financial product ever foisted upon the public.

WHOLE LIFE INSURANCE

If a person wanted to develop the perfect financial instrument for all circumstances, and sat down for as much time as it took and used all the factors of goals, time, contributive capacity, potential pitfalls, longevity, and inflation, at the end of the session, no matter how long it took, he or she would have reinvented whole life insurance. Nothing is simpler on the face of financial expositions. There are no caveats about the cash values and the paid-up values. The guarantees are the guarantees. Dividends, although not guaranteed, have outpaced the projections through the years. The Death Benefit starts as an estate creation, and becomes wealth conservation.

Permanent, Straight, Whole

The name is completely descriptive of what it does. It is in force for the whole of life. After the policy is placed in force, it is there forever. It does what it is supposed to do when it is supposed to do it. All that the policy owner has to do is pay the premium in a timely fashion. After the payment of the first premium, all of the policy rights reside with the owner forever. The insurance company only has one right, and that is to accept the timely payment of premiums. The policy owner may make changes and exercise such rights as loans, surrenders, assignments, beneficiaries, and frequency. The insurer only has the right to accept premiums that are paid on time.

The deal is permanent, straight, and for the whole of life.

Life Insurance is a Trust

Life insurance is a Trust. It has a Creator (or Maker) who establishes and controls the Trust, a Trustee who manages the assets of the Trust, and a Beneficiary who will receive the proceeds of the Trust.

Yet whole life insurance is the only Trust where the owner of the trust has access to and use of the assets (cash values) while living.

The Economics of Certainty

With other types of insurance (i.e., health, property & casualty, etc.), you hope to never get the premiums back as the payout may or may not happen, and the proceeds may go to someone else. With WLI, the premiums are accessible as cash value, the payout is assured, and will go to whomever you designate.

The Perfect Foundation for a Cash Flow Management System

Upon further reflection, whole life insurance is money and can do anything and everything that money can do. Additionally, it is an “AND” asset, not an “OR” asset. It is like owning a home that is guaranteed to increase in value with every payment. The payments remain level or complete themselves, and the owner creates equity, with liquidity, use, and control of the cash values along the way. When another opportunity arises (or an emergency pops up), the value of the equity may be accessed without liquidating the asset or interrupting the compounding overall value. It is the ideal “opportunity/emergency” fund; the perfect place to store capital until it is deployed to buy other assets or pay expenses.

Designing a –Maximum Efficient Contract–

While a whole life policy is capital efficient by design, there are ways to maximize efficiency for a Cash Flow Management system. The exact description is a “Dividend-paying, Participating Whole Life Insurance Policy with a Paid-up Additions Rider from a Mutual Company.” DPWLIPUA is the foundation for wealth building.

1. Stock vs. Mutual Company – a mutual company is owned by the policyholders, who participate in the profits of the company through dividends. To remain mutual, all profits must eventually be distributed to the policy holders. In a stock-owned company, the profits go to the investors.
2. Dividends are the profits of the insurance company. Dividends are tax-free, as they are technically a return of premiums in excess of the operating costs of the company.
3. Paid-up Additions Rider – This is what we call the “cash value turbo supercharger.” It is a rider placed on the policy to use the dividends to purchase more “paid-up” insurance (death benefit) at no extra cost to the policy owner. This in turn increases cash value by at least as much as the dividend (and typically more).

This “Maximum Efficient Contract” is designed to maximize cash value and minimize death benefit for ultimate utility for your Cash Flow Management System or “financing system.”