LIFE INSURANCE THE CASH VALUE ILLUSION as an investment Life insurance has been sold almost since its origin, not only as protection for the family but also The industry maintains it is good investment. Knowledgeable economists have labeled it as a very poor investment The unequiv= ocal truth is, however, that it is never an investment either good or bad. until it is no longer life insurance Until such time as a level premium policy is surren dered for its values, it is only a loaded premium contract between the insured and the company stipulating that the company pay the tace value of the policy should death occur. Assume, for instance, Adam One buys a $10,000 00. 20 Year Term policy at $5.00 per thousand for a total premium of $50.00 per year. Adam Two buys a 20 Year Endowment at $50.00 per thousand or $500.00 per year. Both pay premiums for ten years Over the ten years Adam One has paid in premiums a total of $500.00. Over the same length of time Adam Two has pard $5.000.00. Both die. Regardless of whether the insurance company received $500.00 from Adam One or $5.000 00 from Adam Two, both beneficiaries receive $10,000.00 What becomes of the $4,500.00 difference in premium outlay? Is this an investment? The two policies provided an identical death benefit, but Adam Two simply had a policy with a heavily and unnecessarily loaded premium A VAST DIFFERENTIAL Sometimes it becomes expedient to use extremes to prove points. Suppose Adam One buys a $100,000.00 renewable term policy for $424.00 (an actual rate age 35) and Adam Two buys J $100,000.00 single premium Ten Year Endowment for $82.949.00 (an actual rate offered to the public at age 35) Both die the first year There is an $82.525.00 differential the two premiums ($82.949 00 - $424.00 $82.525.00 but both beneficiaries receive $100.000.00 Is the Ten Year Endowment in this case a good investment? חו Admittedly the foregoing are extremes to show what is possible in the insurance world, but let us the whole life. examine a more popular plan, re ordinary lite or straight life (all names for the same plan). It requires lower premiums than most other so-called permanent forms because they are payable for life or until age 100. In a realistic measurement of life insurance cost it becomes necessary to establish the fact that there are actually two costs - not one There is a cost if the insured dies and the face of the policy is paid as a death claim There is usually quite a ditferent cost if the policy is terminated or surrendered for any values which might accrue from excess money paid into the plan As an example a rep resentative premium for a whole lite plan at age 35 is $18 20 per thousand, for a $100,000.00 policy it 1 $100 000 00 por cues are used in these la trations to them thics for the Jyman The fours could be dout est H diveled by s He Adam Three did not have an investment. simply had a life insurance policy with an excessive premium loading $1.820.00 vs an available term rate of $424.00 * Adam Four, after surrendering or cashing in his policy, did have an investment of sorts. It must be stressed, however that it was not an investment, either good or bad. until AFTER HE HAD TERMINATED HIS LIFE INSURANCE POLICY By receiving the $14.800.00 cash value, he re linquished all further rights to any insurance pro tection offered under the terms of the policy WHAT IS CASH VALUE? po At this point a caretul examination of the tential investment or the cash value portion of the policy is in order It is obvious in the foregoing illustration that the company is making a premium charge of $1 820.00 for a risk which it can assume profitably, at age 35 for $424.00 This substantial overcharge is occasioned by the averaging out process between the premium which must be charged at age 35 and the much higher premium, which must be charged at age 99 The difference in premium is collected to pay or partially pay premiums at the advanced ages Legally the companies are required to set forth in the policy the extent of the overcharge. In this case Adam Four could call on the company to return $14,800.00 of his premium overpayments He could also if he chose, accept a new policy in the amount of $35-400.00 with the premiums paid all the way to age 100 As a third alternative he could use his overpaid premiums (cash values to buy extended term insurance or to pre pay premiums on a $100.000.00 poincy the same face values for 15 years and 225 days These options prove conclusively that premiums are paid in advance for the time indicated They Can only be correctly con strued as unearned premiums. THE FALLACY OF PAYING PREMIUMS IN Such situations point out the fallacy of paving premiums in advance Its economically unsound to pay for any merchandise until it is de ivered Adam Four accepted the extended insurance option explained above and was killed in an automobile wreck during the first 225 days of the term, he would have paid for 15 yearsol insurance which he did not need Obvious, he would not need insurance if he were dead It would of course be ever worse it he should accept the $35 400 00 pa d up policy with premiums paid to age 100 Should he die at age 46 he would have prepaid premiums for 4 years un * 1 Year Depo (1 necessarily. Should he pay premiums 54 years in advance? We think not. The chances of his living and needing life insurance to age 100 must be considered remote. In this instance as in the extended term, premiums would have been paid for insurance coverage which was not needed and obviously not delivered. Therefore we must use the more correct and more descriptive terminology and call them unearned premiums. The life insurance industry prefers to call them cash value, or to label them as a savings account, or an investment or a retirement tund. However, by whatever name they are called, they are for the admitted purpose of paying premiums in advance. Review the table of loan and non-forfeiture values in any so-called permanent type plan. The evidence is irrefutable. The unearned premium account will pay premiums for so many years and days in the future. If it is a paid up policy, the premiums are paid to age 100. Let us now conduct a brief feasibility study of a plan we described previously. Adam Four is age 35. His premium on the $100,000.00 ordinary life plan is $1.820.00. He could, however, have purchased a $100,000.00 level term policy for $424.00 Should death occur the first policy year. Adam Four would have paid the company $1,396.00 more than necessary ($1,820.00-$424.00-$1,396.00) to assume the risk. Remember that the company could profitably have assumed the risk for the lesser premium amount, but the difference is earmarked to pay advance premiums. THE SITUATION TEN YEARS LATER Adam Four is now 45 years old. He has paid his premiums faithfully and has at this point deposited with the company $18,200.00. Should he die during the tenth year, the company would pay his benefificiary $100,000.00. For assuming the risk during the tenth policy year the company is compensated or imbursed in three ways: A. The 10th annual premium of $1.820.00. B. The unearned premium account -- $14,800.00 (cash value) which is made up of the previous premium overcharges and interest thereon. C. The interest earned on the "unearned premium' account which, at 4% amounts to $592.00. These three figures added together give the true total single year cost of $17,212.00. C. The interest earned on the unearned pr mium account, which, at 4, is $2.064 ART Thus the company is imbursed through the rent annual premium, the appropriation of fe earned premium and the interest earned on the earned premium, a true total of $55.484.00 Four, however, can purchase a $100.000 (C term policy at age 65 for $4,500 00 If he shouie ca at age 65 with the ordinary life policy in force h. would in effect overpay or overimburse the Pe surance company by 1$36.536 $4,500.00-$52,016.00). $50.984 00 SUMMARY The foregoing series of cost illustrations proves beyond all doubt that: 1. The build-up of an unearned premium accepit Is economically unsound. 2. Unearned premiums are without value when the policy is terminated as a death claim 3. Unearned premiums are without value unt. salvaged by surrender or termination of the policy. |