Singapore-based financial blog that aims to educate people on personal finance, investments, retirement and their Central Provident Fund (CPF) matters.

Thursday, 26 July 2018

Is Whole Life Insurance A Scam?

A lot of people have written a lot about the difference between the 2.
So instead of comparing them again, we recommend you read the difference in the link below:
The Case of Term vs Whole Life Insurance

Instead, I will go into the figures.
30-year-old male non-smoker planning for $100,000 in death payouts
Quotes are figures I got from CompareFirst.
Term Life:

Whole Life:

I covered the insurance companies - but you can probably do a simple search on CompareFirst to find the insurance companies.

$1,094 per year in premium difference
In total, you pay $3,570 in premiums for Term, and $46,761 in premiums for Whole, a big $43,191 difference.
Had you took that $1,094 difference in annual premiums and invested it in an index fund that has a long-term returns of 6% annually, that pot of money would have grown into $120,815.65 by the end of the 34 years - and it would be a lot more if you survive longer than the 34 years.

To make it an even fairer argument, you invest that same $1,094 premium difference into an index fund that gives you a long-term average return of 4.75%. That too will grow your money to $92,747.59 by the end of the 34th year - still $25,700 more than what the insurance company gives you. Why the big difference you may ask?

Because most of these returns are derived from the insurance companies investing the money into stocks and bonds that you and I can buy as well, and if stocks and bonds give you an average long-term return of 6%, they have to minus away fees and costs before they give you the returns. So net-net you probably are getting only 4% to 5% returns each year from buying an insurance plan (the returns could be worse).

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Important Point to Note:
When buying life insurance, don't be cheated into the mindset that "if I bought whole life insurance, by the end of the time if I do die, I can get the guaranteed amount + additional investment returns."
More often than not, you will get better investment returns if you bought term-life insurance, pay lower premiums, and invest the premium difference into say an index fund that gives you an average 6% annual returns (which is fairly low returns already).

People often think that "if I bought a $1,100 annual premium whole life insurance, after 40 years, I can get $100,000 (guaranteed) PLUS additional returns from the plan (unguaranteed portion), making my insurance a lot more worthwhile".

The fact is, if you had bought the $100 term-life insurance for 40 years, and invested that extra $1,000 in an index fund that pays you a long-term average of 6%, by the end of 40 years, the insurance plan would have lapsed and you get no money back - yes, $40,000 goes into the insurance company's pocket. But hey, the $1,000 you invested in the market that gives you a 6% return each year would have grown to about $164,000 - more than the $40,000 premiums you have made, and also more than the $67,000 given by the insurance company as 'cash value'.

The Psychology Behind Whole Life Insurance Plans
The reason people buy whole life is that it is hard for people to get over the fact that after paying tens of thousands in insurance premiums over the decades, they are not getting anything back. This is a psychological trick that can end up costing you money in the long-term.
So, think twice before committing to a Whole Life Insurance Plan.

The 2 Advantages of Whole Life Insurance Plans

  1. Your beneficiaries will definitely get a payout because (touch wood) everyone will eventually pass away. Whole Life insurance is forever, hence it is a definite payout
  2. If you do not have the discipline of saving aside that extra $1,000 each year to invest in the stock market through a passive index fund, and let it stay in there for 40 years, then maybe whole life insurance is not be a bad plan for you because it ensures that you will definitely pay that extra $1,000 and it will invest and grow the money on your behalf (just at a lower return).

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  1. Wholelife by itself is not a scam, just a really lousy product for both insurance & long-term savings. "Financial time bomb" is a more accurate term.

    People don't realise that for wholelife, a portion of the premium goes to pay for the insurance anyway. E.g. in the example above, say $105 is deducted from the $1,199 premium. The remaining $1,094 is invested for you in a relatively conservative portfolio of usually 60% bonds, 30% stocks & 10% properties. Hence don't be surprised that even after 30 or 40 years, the internal rate of return for such "participating fund" portfolio is just 3% to 4% --- this has been the actual returns that customers have got in recent years after surrendering their wholelife after servicing them for 25-35 years. Don't forget that the insurance company gets a cut for managing your investment savings --- an actual 5% return from the portfolio can translate to 4% returns to you.

    The worse is that there is built-in heavy penalties for surrendering in the first 20 years. Often you can't "breakeven" until after 20 years of servicing the policy. And on a real basis (inflation adjusted), it can take close to 30 years!

    Wholelife becomes a scam due to the entire ecosystem of management priority, management vested interests, sales focus, biased commissions incentives, poor or unethical knowledge on the part of sales staff, maladvice/miseducation/misdirection of customers by sales staff etc.

    Even using the above $100K sum assured example, straight off there is a deficiency in terms of adequate insurance coverage. Will $100K be enough for a family breadwinner? Even for an average blue-collar worker, he'll need at least $500K with dependents like kids & elderly parents. For the typical graduate worker, it's often $1M coverage needed.

    Can the blue-collar worker afford premiums for $500K wholelife? How about the typical graduate office worker with $1M wholelife? You're looking at $12,000 premiums at least.

    So for wholelife, in order to get adequate coverage, you need to fork out a bomb in premiums which are locked away for many decades, giving you a low rate of return (lower than CPF-SA). And having expensive penalties i.e. lose money, if you surrender in the first 20 years.

    A poor way to use up a significant chunk of your salary.

    1. Exactly! We would not say it is a scam actually, just a badly structured and badly sold insurance product :)

  2. I get the point you're trying to make, but using the term "scam" is ridiculous.

    A few counter-points:

    Firstly, not everyone is inclined towards or has access to investment options. Perhaps in this day and age you could make the argument that every 30 year old male (per your comparison example) should be financially savvy or confident enough to look for such investment vehicles and stick with them over the long term, but in reality this is very far from the truth. Having the gumption and know-how to put money in index funds could be overwhelming for many 30 year old males - what more 20 year old ITE graduates, or 50 year old cleaning ladies?

    Secondly, does your calculus take into account limited-pay whole life plans? These can be paid off within a pre-selected number of years, typically ranging anywhere from 5 to 25 years. The benefit of such plans is that after premiums have been fully paid up, the plan's benefits can last for the rest of the policyholder's life, instead of ending after payment stops as in the case of a term policy. Imagine someone who is particularly long-lived, or a person who has dependants requiring long-term care: in such cases the whole life plan may be an attractive prospect because they will always have fully paid-up (and ever-increasing, due to being vested) coverage no matter what, even if they live to 100+ years old. Contrast this to a similarly long-lived term plan owner who has to self-insure for the next 40+ years after his policy has expired.

    Thirdly, and this is related to point 2: what if your health severely deteriorates after you reach 60? If you'd bought a term plan that stops at 64 (per your example again) you might be in a precarious position because no insurer will be willing to cover you if you decide you want to be insured again after that. Any critical illness that you subsequently develop will then have to be fully treated using funds from your own pocket instead of from insurance. If on the other hand you had bought a whole life plan that lasts until you die, you can always fall back on the payout from the policy instead.

    In summary: whole life plans offer peace of mind that a term plan does not. And for certain segments of the population, this could be well worth the extra premiums.

    1. Hi,

      We do agree with the points you set out - different people under different circumstances do require different policies that caters to their needs.

      We did not exactly say it is a scam - rather we tried to put it out for people to decide if it is a good product or not, and usually it is not.
      There will be cases where whole life is more suited for an individual, but I would argue that for most people, a normal term life would do just good.

      As for critical illness, I guess buying term-life + critical illness + medical is still probably cheaper than buying 1 whole life insurance.