In my previous post I've written about the true cost of terms plans, which evoked a discussion and gleamed some important points. This particular post is to address 'the other side' of the spectrum - the whole life plans - and hopefully balance the bias.
Using the previous case study of the 26 year old male, I shall expound on it and determine what is the true cost of the whole life plan to him. Now, in terms of the cost, there are actually two types:
1) The 'actual' cost of the policy (i.e. how much he has to PAY for it).
2) The 'opportunity' cost of the policy (i.e. the value of the next best alternative forgone as the result of making a decision. In this case it is usually assumed to be better investment returns).
Now, if the insured were to purchase a limited-payment whole life policy rather than a term plan, his 'actual' cost would be $2,394.15, which is the annual premium.
On the other hand, if the insured were to purchase a term policy, his 'actual' cost would be $312.70, which is the annual premium.
So essentially there is a yearly difference of: $2,394.15 - $312.70 = $2081.45
In other words, the insured would have an excess of $2081.45 per year if he had opted for the term instead of the whole life.
Once we ascertain the excess, this is where the second aspect of cost comes in - the opportunity cost. Here it simply means what better use could he have for the $2081.45 - like for instance investing. If the insured uses this amount of money to invest for 30 years (put in $2081.45 for a limited-payment of 20 years and let the the amount accumulate till 30th year) at a range of hypothetical rates of returns, he will get back the corresponding amounts:
Annual rate of returns - Amount at the end of 30 years:
0.00% - $41,629
3.25% - $78,997
4.00% - $91,748
5.00% - $112,109
5.25% - $117,888
6.00% - $137,120
7.00% - $167,857
8.00% - $205,640
So that's quite a lot of returns from 'buy-term-invest-the-rest' huh? Whole Life can't match this. No way. Right, so let's see where the whole life stands.
Surrender Value of Whole Life - Amount at the end of 30 years:
0.00% - $55,300 (i.e. just the guaranteed amount)
3.25% - $76,540 (i.e. guaranteed of $55,300 + non-guaranteed of $21,240)
5.25% - $91,987 (i.e. guaranteed of $55,300 + non-guaranteed of $36,687)
If he were to surrender the limited-premium whole life at the 30th year, he will get back $76,540 (assuming an investment returns of 3.25%). So the 'buy-term-invest-the-rest' wins by a margin of...$2,457. After all the consistent work. For 30 years. The efforts are worth $2,457. No wonder they say that making money is tough. Phew.
Hey but if he were to have an annual returns of 5.25%, then the 'buy-term-invest-the-rest' will exceed the whole life by $25,901! Not too bad huh? So the only way to make his efforts worth it is to ensure that his investment returns is greater than 3.25%. Maybe 5.25%. Or even 8%. The best is 20% like Buffett. But whether Mr Insured can attain that - well that's a different story. If Mr Insured isn't that great at investing, and he gets 0% returns...well he might be better off with a whole life because he'll get $13,671 more.
So the true cost of whole life is not just the premium he have to pay, but also the possible opportunity cost of losing out on investments (we are talking about positive returns here ok...no he wouldn't lose his capital). Alright. Now go. Take the money and invest. He just have to make sure that he earns enough returns for his needs and efforts (easy, surely he can do much better than 5.25%). Oh by the way, he's got to ensure that he have at least $100,000 after 30 years - which is the sum assured he forgo to do the investment.
Using the previous case study of the 26 year old male, I shall expound on it and determine what is the true cost of the whole life plan to him. Now, in terms of the cost, there are actually two types:
1) The 'actual' cost of the policy (i.e. how much he has to PAY for it).
2) The 'opportunity' cost of the policy (i.e. the value of the next best alternative forgone as the result of making a decision. In this case it is usually assumed to be better investment returns).
Now, if the insured were to purchase a limited-payment whole life policy rather than a term plan, his 'actual' cost would be $2,394.15, which is the annual premium.
On the other hand, if the insured were to purchase a term policy, his 'actual' cost would be $312.70, which is the annual premium.
So essentially there is a yearly difference of: $2,394.15 - $312.70 = $2081.45
In other words, the insured would have an excess of $2081.45 per year if he had opted for the term instead of the whole life.
Once we ascertain the excess, this is where the second aspect of cost comes in - the opportunity cost. Here it simply means what better use could he have for the $2081.45 - like for instance investing. If the insured uses this amount of money to invest for 30 years (put in $2081.45 for a limited-payment of 20 years and let the the amount accumulate till 30th year) at a range of hypothetical rates of returns, he will get back the corresponding amounts:
Annual rate of returns - Amount at the end of 30 years:
0.00% - $41,629
3.25% - $78,997
4.00% - $91,748
5.00% - $112,109
5.25% - $117,888
6.00% - $137,120
7.00% - $167,857
8.00% - $205,640
So that's quite a lot of returns from 'buy-term-invest-the-rest' huh? Whole Life can't match this. No way. Right, so let's see where the whole life stands.
Surrender Value of Whole Life - Amount at the end of 30 years:
0.00% - $55,300 (i.e. just the guaranteed amount)
3.25% - $76,540 (i.e. guaranteed of $55,300 + non-guaranteed of $21,240)
5.25% - $91,987 (i.e. guaranteed of $55,300 + non-guaranteed of $36,687)
If he were to surrender the limited-premium whole life at the 30th year, he will get back $76,540 (assuming an investment returns of 3.25%). So the 'buy-term-invest-the-rest' wins by a margin of...$2,457. After all the consistent work. For 30 years. The efforts are worth $2,457. No wonder they say that making money is tough. Phew.
Hey but if he were to have an annual returns of 5.25%, then the 'buy-term-invest-the-rest' will exceed the whole life by $25,901! Not too bad huh? So the only way to make his efforts worth it is to ensure that his investment returns is greater than 3.25%. Maybe 5.25%. Or even 8%. The best is 20% like Buffett. But whether Mr Insured can attain that - well that's a different story. If Mr Insured isn't that great at investing, and he gets 0% returns...well he might be better off with a whole life because he'll get $13,671 more.
So the true cost of whole life is not just the premium he have to pay, but also the possible opportunity cost of losing out on investments (we are talking about positive returns here ok...no he wouldn't lose his capital). Alright. Now go. Take the money and invest. He just have to make sure that he earns enough returns for his needs and efforts (easy, surely he can do much better than 5.25%). Oh by the way, he's got to ensure that he have at least $100,000 after 30 years - which is the sum assured he forgo to do the investment.
6 comments:
From the looks of it, you are more of an insurance agent than a financial planner.
Please go and browsse wilfredling if you want to know what a financial planner do.
Your last paragraph on sum assured of $100,000 is it from this assumption below:-
5.25% - $91,987 (guaranteed $55,300 + non-guaranteed $36,687)
If so, we have to compare apple for apple.
For WL, The person would only have GUARANTEED $55,300.
So, for the person on BTIIT, even if he made 0% reutrn, he would be getting $41,629 at the end of the 30yrs (excluding any dividends he recieved over the 30yrs which could be re-invested).
To beat your guaranteed return value of $55,300, the person only needs to get a 3.25% return on BTITT plan to get $78,997.
YOU ARE AN INSURANCE AGENT INdeed. Agents like to twist and manipulate words to confuse naive customers. Can you please search your conscience and ask yourself, are you being fair to customers who put their trust on you to offer them the best advice?
Btw, it speaks volume of your integrity and character when you can twist words like that.
Hi both anonymous,
Firstly, there is no need to make personal attack. To be fair, what right does a nameless, faceless person named anonymous have to talk about another person's blog posting. At least this author make his/her point be known. If he makes a mistake, point it out and be done with it. No need for venomous words.
Secondly, why do you only look at the guaranteed portion of the whole life and not at the non-guaranteed returns? If you only wish to look at the guaranteed part only, then for BTITR, the guaranteed part is $0, unless you put it in banks with their miserable rates.
True, for WL, a person will be guaranteed only $55,400. To compare like with like with another BTITR person with 3.25% returns (and getting $78,997), the whole life returns will be $76,540 (55,300 guaranteed and 21,240 non guaranteed at 3.25%). If an individual investor with BTITR philosophy can get 3.25% returns, why can't a par fund get 3.25% returns too? I think what this author is trying to convey is that the returns of whole life is not much worse compared to the returns of your own investment.
It's very possible to get -3.25% returns when investing your own. But at least for the whole life, you get a guaranteed part. Still, this whole idea of using whole life as an INVESTMENT instrument feels wrong.
I think the main adv of holding a whole life is simply not to cash it out. If you treat whole life as an instrument to park your money, then may I ask...who is going to insure you once your policy is surrendered?
Hi Anon (Short form for anonymous) July 3,
Thank you for your feedback. I am glad that you are a follower of wilfredling and I am relieved to know that you are aware and agreeable of what we financial planners do. I am a financial advisor like wilfred, and I share his perspectives. The difference is that he is my senior in the business, and when I reach his level maybe you can also help to recommend me on others' blogs as well. Thank you in advance. :)
Hi Anon July 5,
Thank you for your feedback. I agree with you that we have to compare apple for apple so here we goes:
For the Whole Life:
A)Returns: 0%, Guaranteed: $55,300
B)Returns: 3.25%, Guaranteed: $78,997
For the BTITR:
A)Returns: 0%, Guaranteed: $41,629
B)Returns: 3.25%, Guaranteed: $76,540
So to compare apple with apple we compare A with A and B with B. That is exactly what I did and I did not twist my words. However, you insisted to compare A (Returns: 0%, Guaranteed: $55,300) with B (Returns: 3.25%, Guaranteed: $76,540), so you are not comparing the same thing. The important assumption that I infer from you is that you assume that BTITR can make returns at 3.25% while insurers cannot make ANY returns at 0%. I beg to differ. The market is impartial - the bull run benefits individual investors as well as the insurers, and the bear run can affect both as well. If you can hit 3.25%, it would be unfair to insist that the insurer cannot.
By the way I do not know how you judge me to be an insurance agent, and I have no way to prove otherwise to you unless you can meet me. I am very happy to know that you are concerned about my integrity and character, and I will do my best to fulfil your expectations. I take care of my clients, and in case you don't know I put my signature on every page that my client signs. If anything should go wrong, they can complain to FIDReC and hold me accountable . However if they should listen to you, and if anything goes wrong, then who can they seek redress from? Call the police or CASE and say that YOU - Anon July 5 - misled them? You mis-represented the fact? Please be responsible for your remarks when you know that people cannot hold you responsible when you are protected by your anonymity. Thank you for your consideration and kindness.
Hi la papilion,
Thank you so much for your feedback. You have pointed out some valuable insights that enriched this discussion. :)
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