What is term life insurance?

@ebrown p,

I agree, but many people do not have the resources to make investment decisions - I would say that what you say would typically yield you more, however, for the average consumer that may not know much about investing, an insurance policy may be easier for them.

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@joefromchicago,

Joe, your example is illustrative.

Quote:

At the end of 50 years, Will has paid $60,000 in premiums, whereas Tim has paid a paltry $36,000 -- a difference of $24,000. Tim, of course, has diligently invested that $24,000, so his heirs get that amount plus any increase. Will's heirs get around $162,834 in death benefits, which is $62,834 more than Tim's heirs get from his policy. In order for Tim's beneficiaries to do better than Will's, Tim has to invest his $24,000 so that it ends up being larger than $62,834. Is that possible?

Yes... it is not only possible. It is quite easy to do with little risk.

In this case since Will (with whole life) pays $100/mo and Tim pays $20/mo, in this example Tim will have $80/mo extra to invest. If you invest $80/month conservatively, you can easily make 5% over the long term with very little risk (financial experts assume 9% for long term investments).

Investing $80/month over 50 years at 5% interest rate means that Tim (with his term life) will end up with $214,382 in the bank (or better yet, in a tax-sheltered IRA).

Even with the numbers you cooked up to make your point, term life is a far better choice than whole life.

Of course, in a real world example (with real numbers) the insurance company is just going to invest your money (after they make the profit they want). It doesn't make sense to think you will get any kind of good deal by adding a middle man to your investment strategy.

1 Reply

@ebrown p,

ebrown p wrote:

In this case since Will (with whole life) pays $100/mo and Tim pays $20/mo, in this example Tim will have $80/mo extra to invest. If you invest $80/month conservatively, you can easily make 5% over the long term with very little risk (financial experts assume 9% for long term investments).

As I said, I made an extremely conservative assumption that Will's death benefit would only increase by 1% per year. If Tim is making 5% or 9% per year on his investment, it is quite likely that Will would see his death benefit increase by a similar percentage, since the insurance company is investing his premiums just like Tim is investing his premium savings. And since Will starts out with $100,000 death benefit while Tim only starts out with $960 in premium savings (in year one), it's pretty easy to see how Will comes out way ahead of Tim if Will's death benefit and Tim's investments increase at the same rate. For instance, if Will's death benefit increases by 5% per year simple interest compounded annually, he will end up with a death benefit of $1,092,133 after fifty years. Under my hypothetical, if Tim gets 5% per year simple interest compounded annually on his investment of his premium savings, he will end up with $152,336. Will, in other words, leaves his beneficiaries with about $840,000 more than Tim leaves his beneficiaries.

ebrown p wrote:

Investing $80/month over 50 years at 5% interest rate means that Tim (with his term life) will end up with $214,382 in the bank (or better yet, in a tax-sheltered IRA).

Well, that wasn't my hypothetical -- remember, Tim's premiums go up every ten years because his term policies expire and he has to renew at increasingly less favorable rates. Still, if we're going with a straight 5% gain every year, Will still ends up far ahead of Tim even in your scenario.

ebrown p wrote:

Even with the numbers you cooked up to make your point, term life is a far better choice than whole life.

Only if Tim's investments vastly outperform the increases in Will's death benefit.

1 Reply

@joefromchicago,

Quote:

Tim if Will's death benefit and Tim's investments increase at the same rate. For instance, if Will's death benefit increases by 5% per year simple interest compounded annually, he will end up with a death benefit of $1,092,133 after fifty years.

Now you are being silly. A five percent annual increase in an investment is what you expect (in fact, over a long term, it is reasonable to expect more). A five percent increase in death benefit is fantasy.

Look at it this way... the life insurance company is out to make a profit. That is the whole point (and the reason why whole life will almost always be a worse deal).

They are going to take the extra money you are spending on whole life and invest it themselves (probably making a 5% or 6% return). Then they are going to take some profit off the top and put the rest into paying off claims and death benefits. At no time are they going to do something that over a large population will lose them money.

If you just take the money and invest it yourself. You will do better without the insurance company taking their profits off of your investments.

1 Reply

@ebrown p,

ebrown p wrote:

Now you are being silly. A five percent annual increase in an investment is what you expect (in fact, over a long term, it is reasonable to expect more). A five percent increase in death benefit is fantasy.

According to your careful research into this subject, no doubt.

ebrown p wrote:

Look at it this way... the life insurance company is out to make a profit. That is the whole point (and the reason why whole life will almost always be a worse deal).

They are going to take the extra money you are spending on whole life and invest it themselves (probably making a 5% or 6% return). Then they are going to take some profit off the top and put the rest into paying off claims and death benefits. At no time are they going to do something that over a large population will lose them money.

Under my hypothetical, even if Will's death benefit only increased 3% per year while Tim's investments increased by 5%, Will would still be far out ahead of Tim after 50 years. But I encourage you to run the numbers yourself instead of just making stuff up as you go along.

ebrown p wrote:

If you just take the money and invest it yourself. You will do better without the insurance company taking their profits off of your investments.

If you believe that insurance companies are out to rip you off, I'm not at all sure why you're such of a fan of term life policies. Don't insurance companies issue those too?

One thing I've neglected to mention: Depending on the type of investment he makes, Tim will have to pay taxes on the capital gains or other income derived from his investments, or else his heirs will have to pay inheritance taxes. In contrast, Will's beneficiaries will not pay any taxes on the life insurance proceeds that they receive upon Will's demise. Just something else to consider.

2 Replies

@joefromchicago,

It isn't a case of insurance companies out to rip you off, but a case of investments of insurance companies needing to earn a return that is twice what an average investor can earn in the market.

For the insurance company to pay a 5% increase in death it would have to earn almost 9% on those payments just to break even. If we assume the insurance company has an overhead of 20% the return on the investment would have to be almost 10%. I don't see why a private investor would only get half the return that an institutional investor would? Yes, 30 years ago, the cost of a broker would have eaten heavily into a small investor, but not in this day and age.

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@joefromchicago,

Joe, I am not making anything up---

Joe wrote:

At the end of 50 years, Will has paid $60,000 in premiums, whereas Tim has paid a paltry $36,000 -- a difference of $24,000. Tim, of course, has diligently invested that $24,000, so his heirs get that amount plus any increase. Will's heirs get around $162,834 in death benefits, which is $62,834 more than Tim's heirs get from his policy. In order for Tim's beneficiaries to do better than Will's, Tim has to invest his $24,000 so that it ends up being larger than $62,834. Is that possible?

It is funny you accuse me of making stuff up... actually I didn't make anything up other than a 5% return on investment (not a very big stretch). I was just useing the numbers that you made up. In your initial example... the death benefits you gave on an $100,000 policy, with increases was $162,384 (see quote above). This was not my number, it was your estimate.

It was only after I pointed out that a conservative investment over a long period time could easily beat that this that you came up with this idea that insurance companies were paying out million dollar death benefits on $100,000 policies.

You are arguing with yourself.

The only claim that I am making, outside of the numbers you provided, is that a conservative investment can earn 5% annually over a long period of time.

I don't think this is unrealistic.

1 Reply

@ebrown p,

ebrown p wrote:

It is funny you accuse me of making stuff up... actually I didn't make anything up other than a 5% return on investment (not a very big stretch). I was just useing the numbers that you made up. In your initial example... the death benefits you gave on an $100,000 policy, with increases was $162,384 (see quote above). This was not my number, it was your estimate.

It was not my estimate, it was a hypothetical. All of those numbers were simply inserted into the hypothetical situation. They only mean something in terms of the hypothetical. If you want to change one of those numbers, that's fine. I'm not sure why you can change the rate of return on Tim's investment but I, for some reason, can't change the rate of increase for Will's death benefit, but you have provided exactly zero evidence to support your position that the increase in the death benefit must always be significantly lower than the return on the investment.

But then I don't care. My point is, and has always been, that whole life and term life are suited for different people. The people who are in the best position to determine which is right for them are the people who are interested in buying life insurance.

ebrown p wrote:

You are arguing with yourself.

Funny, it felt more like a wall.

1 Reply

@joefromchicago,

Quote:

If you want to change one of those numbers, that's fine. I'm not sure why you can change the rate of return on Tim's investment but I, for some reason, can't change the rate of increase for Will's death benefit,

1. I didn't change the number... I postulated a 5% rate of return on a conservative estimate. This is below the standard estimate for long term investments. It was you who changed (significantly I add) your number to a ridiculous figure (after your original numbers didn't do the trick).

2. I did explain why the death rate will always be far lower than the rate of investment. Let me explain it again.

The insurance companies are in the business to make a profit. They will invest the money that you would be investing (if you weren't giving it to them). They are never going to set up a system that will lose them money (over the population of their customers) and so they will never give their customer a deal better than the investment rate (minus the cost to pay the death benefit for their customers).

The reason the whole life is more expensive than term life is that you are paying the insurance company to make your investments for you... rather than making them yourself. This has the additional disadvantages that you are limited in your investment choice and locked into a long term contract.

3. You are claiming (without any evidence) that whole life and term life are both well suited for different people.

My argument is that whole life insurance is for suckers-- it is another way for companies charge customers more money without giving them any real benefit that they can't get for cheaper elsewhere.

Any rational person will go with term life and invest the money they save.

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@parados,

parados wrote:

For the insurance company to pay a 5% increase in death it would have to earn almost 9% on those payments just to break even. If we assume the insurance company has an overhead of 20% the return on the investment would have to be almost 10%.

That's fine. Let's run the numbers for my hypothetical situation:

Will: $100,000 death benefit, 5% simple interest per year compounded annually over fifty years = $1092133.31

Tim: Premium savings invested, 10% return per year compounded annually over fifty years = $1039243.45

In that scenario, Tim actually comes out ahead by $47,110.10 because, in addition to his investments, he also has the $100,000 term policy. But then that doesn't take into account taxes, which would carve a significant chunk out of that amount (Will doesn't have to worry about taxes -- his death benefit isn't taxable income to his beneficiaries). All in all, I'd call that a wash.

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@parados,

I think part of this is the financial savy of the insurance company vs. an individual investor. Insurance companies will have their portfolio managers/research department market analysts, etc. They have the capabilty and knowlege of the market. An average "Joe" does not. So for an average Joe a 5% return with less risk may be what they are looking for.

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it provides coverage at a fixed rate of payments for a limited period of time, the relevant term. After that period expires, coverage at the previous rate of premiums is no longer guaranteed and the client must either forgo coverage or potentially obtain further coverage with different payments or conditions. If the insured dies during the term, the death benefit will be paid to the beneficiary. Term insurance is the least expensive way to purchase a substantial death benefit on a coverage amount per premium dollar basis over a specific period of time.

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Term life insurance is meant for certain amount of time. It is cheaper than the permanent one. But it offers lesser benefits.

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What is term life insurance?

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