Life insurance is meant to provide financial compensation to beneficiaries or towards a bequest when a person dies. The most common, and cheapest, form is Term Life Insurance, but as the term increases, it becomes Permanent Life Insurance, that is one that is valid as long as a person is alive. Unfortunately, to complicate things further, many insurance brokers will push the idea of life insurance combined with an investment product. These product could be marketed as “Whole Life”, “Participating Life”, or “Universal Life” insurance. While the details between these products offered by many insurance companies can vary, they are generally plagued with high fees. Read on for details…
Permanent Life Insurance
As discussed in a previous blog post, usually the best kind of life insurance is Term Life, where the insurance period is as long as necessary. This is a very simple product to understand: you pay premiums for a set number of years, and on your death your beneficiaries get a fixed amount.
Permanent Life Insurance is different because there is no term. You pay premiums forever (or sometimes for a set number of years), and when you eventually die your beneficiaries receive the payout. This kind of insurance is useful if a payout is desired to leave an inheritance to beneficiaries or towards a bequest.
Life Insurance Plus Investment
Many insurance companies offer a life insurance product that allows you to pay higher premiums than for term or permanent life insurance, and in exchange the insurance company invests these overpayments. Depending on the flexibility you are offered, these products are sold under different names.
Both “Whole Life” and “Participating Life” insurance refer to the same thing. The excess premiums you pay into the plan get pooled with other participants and invested as the insurance company deems appropriate. Generally, this money is well invested and provides stable returns, but the hidden fees (the equivalent of a Management Expense Ratio, or MER) eat a significant portion of the profits, as would investing in any high fee fund.
The other kind of insurance-investment product is “Universal Life” insurance, where you are given a list of mutual funds offered by the insurance provider, and you can pick where your excess contributions are to be allocated. This is much more transparent than Whole Life, but most insurance companies will only offer high-MER mutual funds to choose from.
Complicated Products are Meant to be Sold
The general guideline is to avoid a product that you do not fully understand. Life insurance with investment options is a product that has so much complexity built in, that it is best avoided entirely. The products are set up to have many layers of fees so that the potential buyer has no way to compare the products against one another.
One specific example presents the choice between a “bonus” guaranteed interest, or the same funds without the “bonus”. At first glance, there is no reason why one wouldn’t want a 1.5% bonus, until one carefully compares the fund lists. A balanced fund from the non-bonus policy had an MER around 2.0%, but the same one in the “bonus” policy list had an MER of 3.6%. The way the MER works, is that it’s a deduction off the entire amount of the portfolio, exactly like interest would be accumulated. The unaware buyer choosing the “bonus” version is actually guaranteeing him/herself a 0.1% loss compared to the non-bonus version of the fund.
The prospectus will not tally up all the fees for you, because then you’d realize how much you were losing, and would walk away. Before you buy, try to get the seller to explain all the layers of fees, and see if they add up.
CJ Capital is not a licensed insurance broker, nor are we affiliated with any financial institution. Contact us if you have a few insurance products in mind and would like an unbiased 3rd-party comparison.