I’ve written before about How to Dump Your Whole Life Policy. However, I still get emails all the time about whether someone SHOULD dump their whole life policy or not. I find it ironic that I often get challenged by insurance agents showing well-designed policies designed to optimize the investing return, but the ones readers send me always seem optimized to maximize the agent’s commission. I thought it might be useful to work through a case study of a doc with one of these policies. This email is pretty typical.

Q.

I’m really new at financial things…[but]…I’m hoping to get some advice. I have had a Guardian whole life policy since May 2010. I pay $1742 a year (so about $9794 total so far). The cash value is $4576.13.

I’m 34 y/o, don’t have any dependents, don’t mind walking away if that’s sensible. I have paid off all student loans, started maxing out solo 401k and back door ira (as of last year), rent an apt, own my car. I have 1 million term insurance for 20 years (2031). Should I surrender or keep my whole life policy? I read your article about how some people perhaps should keep their policy if they have had it for more than 10 years and am wondering what to do with mine.

Also, if I surrender the policy – do I get some money back? Is that what cash value means? I also hear there are options such as a life settlement options or trading it for an annuity.

A.

I started with explaining how the policy works- i.e. that despite the fact that this doc had paid in $9794, she could now only walk away with $4,576 after 5 1/2 years of holding the policy. Obviously, the return on that is going to be negative. I also explained how if the doc wanted to dump the policy, that an exchange into a low-cost variable annuity, either for a short time period to allow the loss to be claimed or until the value of the VA equaled the basis, might provide some tax advantages.

I also asked some questions making sure I wasn’t missing something, mostly about why the doc bought the policy in the first place. I inquired whether there was a need for a life-long death benefit that wasn’t obvious from the email. No. I inquired whether perhaps there was a desire to “Bank on Yourself.” Nope. Whether the doc wanted another retirement account or was particularly concerned about asset allocation. No, no. When it came right down to it, the doc really didn’t know why the policy was bought. But I knew. The policy wasn’t bought. It was sold. I asked the doc to get an in-force illustration to look at and received it shortly afterward. This is what it showed:

The Illustration

Screen Shot 2016-02-05 at 11.09.19 PM

Screen Shot 2016-02-05 at 11.09.57 PM

Screen Shot 2016-02-05 at 11.10.32 PM

If you’ve never looked at one of these things before, it’s worth a few minutes to understand what you’re looking at. The first section describes the policy and any riders you may be paying for. In this case, the doc is paying $32.50 a year for a waiver of premium rider (i.e. if you are disabled and can’t pay the premium, the insurance company pays it for you), $64 a year for the right to buy another $100K worth of whole life insurance at some point down the road without proving insurability, $100 toward a “paid up addition” (buying even more whole life insurance) and finally another $1.82 for a waiver of premium on that life insurance. All in, an extra couple hundred bucks a year worth of, in my opinion, nearly worthless riders.

Next is a series of tables. Column one is how many years you’ve had the policy. Column two is your age. Columns three and four are your premium. Column five is the guaranteed cash value and column six is your guaranteed death benefit. Next we move onto the projected side. Again the first two columns are the premiums and then you see the projected cash value and the projected death benefit. It is possible your actual numbers could be higher or lower than the projected numbers, but they won’t be lower than the guaranteed numbers. In my experience, which mostly consists of the last 30 year period when interest rates have been gradually falling, the realized returns tend to be between the guaranteed and projected numbers. I’ve never been sent an example of a policy whose actual performance was better than the original projected illustration, but perhaps there is one out there somewhere.

Some Observations and Calculations

The first thing worth looking at is the type of policy. It is indeed a whole life policy. I find it terribly sad that many docs think they have a whole life policy, when in fact they have a variable universal policy or an indexed universal policy. How can you possibly have made a good financial move when you have no idea what you own? You’re not that lucky.

This policy, however, is a Guardian Whole Life 121 Policy. That means you have to make premium payments every year until you die or turn 121. Like with any whole life policy, you could use the dividends to reduce the premium or even use the cash value to pay the premiums, but the illustration assumes that as with most of these policies, the premium is used to purchase “paid up additions,” meaning that the death benefit gradually climbs and if you never surrender the policy or borrow from it, the death benefit will eventually be quite a bit higher than the initial face value.

The second thing I noticed is that the doc thought the premium was $1742. However, with all the riders, including a guaranteed purchase option rider (because of course this doc was going to want MORE of this awesome policy), the total premium was $1941. So in reality, the doc had paid something like $10,913, not $9742. That reduces the return on the first 5 1/2 years of this policy to ~ -25% per year. (If you want to follow along, plug the following equation into Excel)

=RATE(5.6,-1941,0,4576,1) = -25%

Earnest student loan page

Platinum Level Scholarship Sponsor

The third thing I noticed was the loan rate on the policy- 8%. If your best option for borrowing money is 8%, your finances are in such terrible shape that you have no business buying any type of cash value life insurance.

Next I took a look at the death benefit and what kind of return could be seen on the money if the policy was just held until death. This policy was bought at age 28, the doc is now 34. Life expectancy if you reach 34 is 48 years, or to age 82. At age 82, if all premiums are paid, this policy guarantees a death benefit of $267,960 and projects a death benefit of 506,085. Those represent a return on your money of 3.62% or 5.57%.

=RATE(48,-1877,-4576,267960,1) = 3.73%

Next, I noticed that the “break-even” period for this policy is in about year 18 (guaranteed) or year 15 (projected.)

Finally, I took a look at the rate of return on the cash value, that is, what is the internal rate of return on the policy if looked at purely from an investment perspective. The software used for these illustrations can do this, but I think it is ridiculous that it often isn’t put into the illustration, so you have to do it yourself. This particular illustration is a little tricky, in that the premium payments are $1941 for the first 18 years, $1877 for the next 19 years, and $1843 after that. To make things easy, I’ll just use $1877 for the longer term projections, but be aware that OVERSTATES the returns on the policy. Let’s start with just taking a look at the return until the first premium adjustment, at age 45.

Guaranteed

=RATE(12.4,-1941,-4576, 35991,1) = 2.96%

Projected

=RATE(12.4,-1941,-4576, 39615,1) = 4.18%

Remember this is the return GOING FORWARD from today. Not the return from the start of the policy. The return on the first 5 1/2 years was -25% a year. Now mix that with a return of 2.96 to 4.18% per year for the next 13 years and you’ll see the total return for the first 18 years will be a whopping 0.31% to 1.31% per year. Getting excited yet? But wait, there’s more.

Surely it will get better over time, right? Of course it does as that heavy commission paid in the first few years is spread out over more years. If we use the $1877 premium figure, and we run this policy out for 50 years, we see an overall return of

Guaranteed

=RATE(50,-1877,0,162583,1) = 2.01%

Projected

=RATE(50,-1877,0,288724,1) = 3.90%

The best policies I’ve looked at show similar guarantees, around 2%. However, the projected return is usually a little better after 5 decades, sometimes as high as 5%.

Financial Malpractice

Let’s step back for a second and think about what this insurance agent did. This agent took a 28 year old physician and sold her a whole life policy. Think back to when you were 28. What was going with you? Well, you were probably a PGY1 or 2. You had a massively negative net worth as you owed hundreds of thousands in student loans. You probably didn’t even have an emergency fund and certainly weren’t maxing out your retirement accounts. This doc specifically told me she had no dependents (I’m not sure why she needs a million dollar term policy either), she had student loans (back when the policy was sold,) and retirement accounts were not being maxed out until recently. This doc had far better things to do with the money than buy whole life insurance. Let’s think of a few:

  1. Max out a Roth IRA
  2. Pay down 5-8% student loans
  3. Save up a house downpayment
  4. Boost the size of the emergency fund
  5. Go on a well-deserved vacation
  6. Upgrade the beater

But what does this “financial professional” do? He sells a whole life policy. Stand up and take a bow. You should be ashamed of yourself. And all for a couple of thousand dollars in commissions.

What To Do Now

Only some of these figures should matter to the doc now, however. The commissions are all water under the bridge. The way to determine whether or not to keep the policy is to look at it going forward from here. The expected return on this policy over the next 12-13 years is at least 3% and perhaps as high as 5%. You can bump those numbers up a little bit over the longer term. That’s not terrible. Keeping this policy wouldn’t be the worst thing in the world. The returns going forward will be way better than the -25% annualized returns seen in the past.

However, the people who email me always want a recommendation- should I keep it or not? As you can see, I can’t really answer that question for them. If they have no desire for a permanent death benefit, then it comes down to whether they find the return attractive in comparison to other investment vehicles that require them to tie their money up for the rest of their lives. There aren’t very many of those, and almost all are sold by insurance companies, so I tend to just look at the expected returns on what I would invest money in that I didn’t need for 50 years- stocks and real estate. Are those investment vehicles riskier than a whole life policy? Of course. Do they come with a death benefit? No, they don’t. But they do come with expected returns that are typically in the 8-12% range. $2000 a year invested at 3% for 50 years grows to

=FV(3%,50,-2000,0,1) = $232,361.55

$2000 a year invested at 10% for 50 years grows to

=FV(10%,50,-2000,0,1) =  $2,560,598.76

There are no guarantees with investing in stocks or real estate, of course, but it’s easy to see which approach is likely to end up with the most money after five decades. Should this doc dump the policy? It’s up to her. But I would, and then I’d start a website to warn other docs so the same thing doesn’t happen to them. Oh wait, I already did that.

What do you think? Have you been in this situation? What did you do with your policy? What do you think this doc should do? Comment below!