When you put yourself and your ideas out on the internet, it's best to have a thick skin, especially if you have chosen to reveal some personal and identifying information as I have. Although on this blog I write about a myriad of subjects, including living below your means, portfolio design, student loan management, retirement planning, insurance of many types, estate planning, asset protection, and mortgages among other subjects, 95% of the “hate email,” “hate comments,” and criticism leveled at this site and at me comes from those who benefit financially from selling cash value life insurance.

I was recently made aware that an insurance agent and blogger (Brandon Roberts at The Insurance Pro Blog) I respect had written three separate pieces referring to my writing. Two were highly critical, one about the first piece I ever wrote on Whole Life Insurance, (admittedly not my best work on the subject, despite the post's popularity) and the other my more recent discussion of an illustration of an indexed universal life policy) while the third pretty much agreed with me that whole life insurance is NOT like a Roth IRA.

Someone is wrong on the internetDisappointingly, all three articles were filled with ad hominem attacks, which I found unusual for this blogger having read many of his other posts. I was challenged by an insurance agent commenting on the blog to “make a serious reply” to Brandon's Monday post (the IUL one.) This post is that reply. However, as I don't permit ad hominem attacks in the comments section of this blog, I'm going to avoid them in this post. They don't fulfill the primary purpose of my blog, or as near as I can tell, of Mr. Robert's either, so I'll give him a pass on his recent writings. Sometimes in blogging we write before we think, or adopt an inappropriate tone due to passion or simply a desire to entertain. I'm going to make a few general points, and then deal with a few of the specific criticisms Mr. Roberts has made of my work.

I'm Not Against Insurance

First, it's important to know that I'm not “anti-insurance” by any means. I carry lots of insurance including professional liability insurance, personal liability insurance, disability insurance, term life insurance, fire insurance, health insurance, homeowner's insurance, auto insurance, and boat insurance. In fact, I spent over $30,000 last year on insurance, or 60% of the average pre-tax household income in this country. All of it was bought from an insurance agent. I'm pretty sure someone earned a commission on all of it and I do not care what it was or what they did with that commission money. I do, however, have a different philosophy about insurance than many life insurance agents have. I believe it is important to insure against financial catastrophes, and self-insure whenever possible. I don't insure my iphone, nor do I insure my life against the possibility of dying in my 80s. Those simply would not be financial catastrophes for me.

I Don't Hate Insurance Agents

Those who have read the About Me page on this site are aware of the events that led to the birth of The White Coat Investor website and my own personal financial enlightenment. Basically, I had terrible interactions with a number of financial professionals, including an insurance agent, a financial advisor, a mortgage broker, and a realtor and eventually decided to start educating myself on these subjects so I could avoid being taken advantage of in the future. One of the best parts of this blog is I have since had the opportunity to meet many of the good guys in the industry (although admittedly, their numbers are far fewer than I would like.) I've been pleased to meet a number of financial advisors who offer good advice at a fair price. I've also been pleased to run into a lot of insurance agents who are knowledgeable and ethical and doing their clients a real service. I suspect Mr. Roberts is one of these as evidenced by his breadth of knowledge on a number of insurance subjects, as well as his stated 0% 5 year surrender rate among his clients who have purchased insurance products (when the insurance industry average for whole life alone is over 30%.)

Unfortunately, as insurance agents themselves are well aware, their industry has some real issues and a lot of bad apples. That's not to say mine does not, as it certainly does, but this blog isn't about medicine, it's about finance. Some of the issues inherent in the insurance industry are:

  1. People can be licensed as insurance agents with minimal if any real financial education
  2. Most of the training agents do receive is from their own company, and primarily consists of sales techniques
  3. Insurance agent compensation is almost entirely commission-based, meaning they face serious conflicts of interest that even the most ethical have difficulty overcoming. Imagine the medical advice you would get from a physician who only got paid as a percentage of the cost of the tests he ordered and the medications he prescribed and you will quickly realize the dilemma that insurance agents are in, through no fault of their own.

I Face a Serious Handicap in any Argument With an Insurance Agent

I am at a real disadvantage any time I discuss insurance with an agent for a number of reasons. First, my full-time profession is emergency medicine. If we were arguing about how to determine if Mrs. Jones's chest pain is caused by a pulmonary embolus, esophageal spasm, or a myocardial infarction while simultaneously taking an ambulance call, working up three narcotic-addicted 30-something females with vague abdominal pain and listening to the psychotic guy down in room #13 fight off 3 nurses, two techs, and a security guard, then I'd probably have a marked advantage in the argument over an insurance agent. That's to be expected.

Second, my blog is far more broad-ranging than that of Mr. Roberts. While I deal with dozens of financial subjects, Mr. Roberts writes about, well, pretty much nothing but cash value life insurance. So he sells it by day, and writes about it by night. Does he know more about it than I do? I sure hope so. I'd be very disappointed if he did not.

Finally, I don't have the ability to run financial projections and illustrations using the software available only to insurance agents. So when I write about a specific policy, I'm completely reliant on either a client or an agent to send me an illustration of that policy. One of the criticisms in one of Mr. Robert's articles is that the policy I wrote about has a 0% floor, not a 3% floor on the crediting rate. While that may very well be true (probably is), I'm a bit handicapped by the fact that I received my illustration from an insurance agent who subsequently spent a great deal of time in the comments sections all over this blog impersonating a physician (i.e. a sock puppet) in an attempt to make cash value life insurance look good. I certainly wouldn't put it past him to monkey with the policy to make it look better than it actually does, misrepresent it to me, or perhaps simply to allow me to persist in an error which makes the policy look a little better than it actually is.

A Bias Against Insurance-Based Investing Products

I'll be the first to admit I am biased against insurance-based investing products. In general, if there is a way to avoid the insurance and have an equivalent (or as is usually the case, better) result, I tend to lean toward the non-insurance route. There are a number of reasons for this.

First, I've been burned by an insurance agent before. The worst part about it was it was an extremely good friend who sold me a completely inappropriate NML whole life insurance policy that had a cumulative negative 33% return despite holding it for 7 years. Fool me once, shame on you. Fool me twice, shame on me.

The Author on the Summit of Eichhorn's Pinnacle, Yosemite National Park

The Author on the Summit of Eichhorn's Pinnacle, Yosemite National Park

Second, every time I apply for insurance I get asked these pesky questions about high-risk activities, like rock climbing. As you might imagine, any investment that requires the purchase of insurance in order to invest in it, is less attractive to someone who is more expensive to insure. Consider a physician who is completely uninsurable due to medical issues. A cash value life insurance product isn't even an option for him, but Vanguard isn't going to have any problem at all letting him buy shares in their mutual funds.

Third, insurance policies are a commissioned product. That means the advice from those who sell them is always complicated by a financial conflict of interest. A competent, ethical agent will, of course, recommend against you purchasing an inappropriate policy, but people are human and they respond to incentives.Insurance agents, like any commissioned salesmen, tend to point out the positives of the product they sell and and minimize or even gloss over the downsides. The best of them are also fervent believers in their product. They really do believe these policies are the best possible thing for their clients. That belief can make them very persuasive.

Fourth, doctors in particular are highly targeted by financial professionals of all types. Insurance agents probably don't quite get that because they've never experienced it. There are mortgage agents, financial advisors, insurance agents, and even realtors who “specialize” in (primarily marketing to) doctors. As a result, we either quickly learn to be very wary, or we end up gradually transferring our relatively high incomes to the financial industry, and never really build any real wealth.

Fifth, an insurance agent views an insurance company as a benevolent entity. Not only do they get paychecks from them every month, but they also see all the good that an insurance company does (like pay death benefits to the families of those who die young.) However, I get to see the opposite side of the coin. I get emails on a weekly basis from physicians who have been sold a policy they don't want, don't understand, and which can never live up to the billing of the agent. Instead of the policy being designed for the maximum benefit to the client, it has been designed to maximize the benefit to the agent. On the other hand, an insurance agent often views traditional investments very skeptically, always being quick to remind clients about the last bear market. They also love to point out the very real issues with the securities industry this blog has pointed out many times (like loaded, high expense ratio mutual funds, market-timing schemes, and the fact that investor returns often lag investment returns by a significant amount due to investor behavior.)

Sixth, the simpler the product, the better it is for the client. Term life insurance is very simple. A Single Premium Immediate Annuity (SPIA) is very simple. An index fund is very simple. It is easy to evaluate and the purchaser knows exactly what he is getting. These products tend to be sold like commodities, and can be bought primarily on price, just like gasoline, beans, and rice. As the products become more complex (like most cash value life insurance policies) most of the benefit of that complexity accrues to those who understand it best- the insurance company with its actuaries, and the insurance agent who sells them day in and day out, rather than the consumer. Keeping things as simple as possible is highly likely to lead to a better deal for the consumer.

Seventh, there is no “free lunch” with any insurance policy. Consider an auto policy. The premiums must cover the actual costs the insurance company will have to pay out as benefits, plus pay all the expenses of running the company (including commissions for the agents), plus provide for any profit the company makes. On average, the client will get out of the policy less value than he puts in. That's just the cost of insurance. But because of that cost, it is usually a good idea to avoid buying any insurance you do not really need.

Eighth, more so than most traditional investments like stocks, bonds, mutual funds, and real estate, permanent life insurance products require a life-long commitment to get the illustrated outcomes. Like the one I was sold, most permanent life insurance products will have a negative return if you only hold them for a relatively short time period (you know, like 5-10 years.) Unfortunately, people's opinions and financial situations tend to change far more frequently than once in their life, resulting in many people being stuck in a life insurance policy they no longer want (even if at some point they did both want and understand the product.)  When you're in that situation with a mutual fund, you sell it and move on. With an insurance policy, you're often faced with a number of less than ideal choices.

I Have No Ulterior Motive

However, despite my bias against investing in insurance, readers should be aware I have no ulterior motive to my general recommendation against it. I don't get paid more if you choose to buy an insurance policy, if you surrender yours, or if you choose not to mix insurance and investing. It's all the same to me. In fact, I could probably make more if I did recommend these products since I could then sell ads to more insurance agents. However, the fact that the vast majority of the proponents of investing in insurance-based products financially benefit from their sales ought to give you pause. That fact doesn't necessarily mean they're wrong, but following the money is rarely a bad idea. If the numbers seemed to demonstrate that most physicians ought to be investing most of their money into indexed universal life policies I would be the first to point that out. Unfortunately, that's not how I interpret the data.

Specific Criticisms

Now, let's move on to some of the specific criticisms Mr. Roberts has leveled at my piece.

Stocks Are Supposed To Have Higher Returns Than Insurance Policies

The (indexed universal life insurance policy) isn’t designed to yield [I think Mr. Roberts means return] as high as directly investing in the stock market largely because it doesn’t have nearly the risk profile that investing directly in stocks does. This doesn’t make one better than the other, it just makes them different.

Okay, I agree with that. The problem I have with this whole concept is that many people don't understand just what they're giving up by taking less risk than perhaps they should. Most people saving for retirement will require a significant rate of growth out of their money in order to reach their goals, especially when they consider inflation. A typical whole life policy bought these days projects a long-term nominal return of 5% and guarantees a return of 2%. Historically, inflation is around 3%. So even if you get the projected return (perhaps a tall order given the falling interest rates we've seen over the last few decades and the fact that most insurance company investments are in nominal bonds) you're only besting inflation by 2%. At 2%, it will require 36 years for your money to double. That simply isn't growing fast enough to meet the financial goals of someone investing for retirement. If you have a 30 year career, and you want your portfolio to replace 60% of your gross working income during retirement, and that portfolio only makes 2% real, you'll need to save 46% of your gross income to reach your goal. I don't know about you, but that's a pretty tall order for anyone, especially a physician who may be paying up to 30% of that gross income in taxes. Lower returns really do have an important effect. Rather than accepting them simply because you're scared of stock market or real estate volatility, perhaps you ought to reexamine which you're more scared of- stock market volatility or not reaching your financial goals. That ought to help you stay the course through the handful of bear markets that you will need to pass through during your investing career.

Hopefully, the indexed universal life policy will have a higher return than a whole life policy (it ought to, as it provides fewer guarantees.) But even if it gives you 7% instead of the 9% you might get in the stock market, if you're putting in $30K a year over 30 years, that 2% difference will eventually compound to a difference of 32%, over $1.5 Million. That's real money ($60K a year in income per the 4% rule.) Accepting the lower returns you will get by investing in life insurance is a serious decision and you should be aware of the consequences of that decision before making it. If you still want the policy after you understand it, knock yourself out.

IUL Losses Don't Look As Bad If You Don't Consider the Surrender Value

There’s a comment about the whole “you can’t lose money” claim that some agents make regarding indexed products that is taken very much out of context. Since the products starts out with a pretty low amount of cash surrender value (not cash value, but cash surrender value, there’s an important difference there) there’s an obvious loss that could be recognized if one were to cash out of the policy.

Similar to the loss one could realize if they bought into practically any S&P 500 indexed fund in early 2008 and then sold. What’s the actual loss in terms of cash value? About 12.73% according to the Midland proposal.

Mr. Robert's argument here is that you really don't lose that much cash value, only 12.73%, in cash value. That's a silly argument, because if the policy is surrendered, you don't get the cash value, you get the cash surrender value. I assure you that is a very real loss (just like selling an index fund in the depths of a bear market is a very real loss.) I had an email the other day from a doctor who bought a VUL (yes agents, I know I'm mixing types of permanent life insurance in this discussion) a year prior and had put $48K into it. Her cash surrender value? $0. Seriously. A 100% loss in an insurance product. When an agent says “you can't lose money with an indexed universal life policy” it's important to understand what he is referring to- that the cash value doesn't go down. You can still walk away with far less than you've put into the policy, just like a mutual fund.

Dr. Dahle then points out that this [a 7.98% return for the IUL] is way behind the ”long-term” internal rate of return of the Vanguard 500 Index Fund, which comes out to 11.05%! … 11.05% is, I assure you, the “since inception” internal rate of return for the Vanguard 500 Index Fund—it says so right on their website. But that time frame spans from the mid 1970’s to present. That’s a tad longer than the 25-year period we were talking about earlier. But what’s 12 years give or take among friends?

Also, that’s the internal rate of return assuming you were all in at year one. Remember that time we wrote that piece that explained how there’s a difference between lump sum investing and systematic investing? So what happens if we take the annualized returns from a 25-year period (1989 to 2013) and calculate the internal rate of return on a $5,500 per year investment in the Vanguard 500 Index Fund? We end up with $317,249.39. That’s an internal rate of return of 5.95%. Wait a minute. That’s less than the indexed universal life insurance policy.

Let's first keep the facts straight, and then we can argue about what they mean. The CAGR (geometric, annualized return) of the S&P 500 (not my favorite index fund, by the way, but the data is readily available) is as follows (all periods ending December 2013):

  • 5 Years 17.99%
  • 10 Years 7.36%
  • 15 Years 4.63%
  • 20 Years 9.22%
  • 25 Years 10.28%
  • 30 Years 11.14%
  • 50 Years 9.98%

Now, I used 25 years in the original post, so let's look at that and check Mr. Robert's numbers. It seems unlikely with a CAGR of 10.28% over 25 years on a lump sum, that DCAing in money every year would give a return of just 5.95%. Indeed, it is wrong, as evidenced below:

Year Contribution S&P 500 Return End of Year Total
1989 $5,500 32% $7,260.00
1990 $5,500 -3.42% $12,323.61
1991 $5,500 30.95% $23,340.01
1992 $5,500 7.60% $31,031.86
1993 $5,500 10.17% $40,247.15
1994 $5,500 1.19% $46,291.54
1995 $5,500 38.02% $71,482.68
1996 $5,500 23.06% $94,734.88
1997 $5,500 33.67% $133,983.97
1998 $5,500 28.73% $179,557.71
1999 $5,500 21.11% $224,123.40
2000 $5,500 -9.11% $208,704.71
2001 $5,500 -11.98% $188,542.98
2002 $5,500 -22.27% $150,829.61
2003 $5,500 28.72% $201,227.47
2004 $5,500 10.82% $229,095.39
2005 $5,500 4.79% $245,832.51
2006 $5,500 15.74% $290,892.24
2007 $5,500 5.46% $312,575.26
2008 $5,500 -37.22% $199,687.65
2009 $5,500 27.11% $260,814.02
2010 $5,500 14.87% $305,914.91
2011 $5,500 2.07% $317,861.20
2012 $5,500 15.88% $374,710.96
2013 $5,500 32.42% $503,475.36

If you look at an overall annualized return, to go from $0 to $503,475.36 while contributing $5500 each year, you can easily see with your favorite financial calculator or Excel “Rate” function that it is 8.95%. For those unfamiliar with it, it looks like this: =RATE(25,-5500,0,503475.36,1) Try it yourself. I'm not sure where Mr. Robert's number came from. I'll assume he made a simple error, like not including dividends or something, rather than ascribing some kind of ulterior motive to him. However, he did point out one error I apparently did make in the original post about this policy when I calculated out a return for the life insurance policy. I assumed that in years when the stock market did poorly, that the cash value would be credited at 3%. Mr. Roberts points out that isn't correct, as the policy would be credited at 0% in those years. If I re-run my numbers using that assumption, the overall annualized return of the cash value in the policy over 25 years would be lower than my previous estimate of slightly more than 8% (impossible to get the exact numbers without access to the insurance company software that includes the costs of insurance.) The actual annualized crediting rate would be 8.28% (rather than the 9.17% my incorrect assumptions led me to.) This would lead to an overall return lower than the 8.6% scale noted in the original article (7.98%). It's impossible for me to calculate it without the insurance company software, but it would  probably be something around around 7.7% or so.

So the “fair comparison” over this 25 year period is 8.95% vs 7.7%. $5,500 a year for 25 years at each of those rates adds up to $504K vs $415K, an 18% shortfall with the insurance policy.

Those are the facts. What they mean to me is that I'd rather invest in the higher returning investment, despite it's higher volatility. Mr. Roberts may arrive at a different conclusion. But you can't argue as he did that this hypothetical insurance policy (which didn't exist in 1989) would give you more money than just investing in the 500 Index Fund (which did exist in that year.) In this instance, I used the pure returns (including dividends) and didn't subtract out Vanguard's very minimal expense ratio for this fund (currently 5 basis points a year for the Admiral shares which have been available since 2000.) That doesn't change the data significantly (especially since thanks to securities lending and solid indexing technique, Vanguard has a very long track record of underperforming the index by much less than the expense ratio), nor should it change the conclusion.

This comparison, of course, assumes that the insurance company DOES NOT change the aspects of the contract that it is allowed to change, such as the cap (remember with this contract the company is allowed to lower the cap as low as 4% a year from the illustrated 14.5% per year) and the costs of insurance. Investing in index funds requires you to “trust the market.” Investing in index linked IUL requires you to not only trust the market (although perhaps to a lesser extent given the minimum 0% crediting rate) but also to trust a single insurance company. If I were going to trust a single insurance company with a significant portion of my nest egg, it would be one whose investments are run by the greatest investor of all time–I'd just buy Berkshire Hathaway stock. Yes, the state guaranty association would likely provide some guarantees in case Midland went out of business, but the guaranteed amount of cash value in most states (usually up to something like $300K total) is far less than the amount that most doctors are encouraged to invest into these types of insurance policies (often $50-100K a year!)

I Only Used The S&P 500 For Convenience

I don't actually invest in an S&P 500 Index Fund. As regular readers know my portfolio consists of a number of asset classes including not only the stocks in the S&P 500, but also many with higher expected returns such as small value stocks, microcaps, and emerging market stocks, indexes not available inside insurance based products. Take a look at returns in those asset classes the last 10 years (10 year period chosen simply for convenience sake, but also because that's about the length of time I've been investing.)

  • 500 Index Fund: 8.37%
  • TSM: 9.04%
  • Extended Market: 11.01%
  • Small Value: 9.83%
  • REITs: 9.25%
  • Emerging Markets: 11.36%

As you can see, most stock asset classes outperformed US large caps in the last 10 years, so a portfolio composed of multiple asset classes would have distanced this insurance-based investing solution by another 1% or so. Even adding a few bond asset classes wouldn't have hurt you much, as TIPS returned 4.61%, intermediate bonds returned 5.61%, and long bonds returned 7.33%.

At any rate, if we're going to look at “the best” IUL, it's also reasonable to compare it to what we'd actually be doing with the rest of our portfolio. In my case, that's a broadly diversified, low-cost, multi-asset class portfolio that has definitely outperformed the 500 Index Fund over my investment horizon.

I Did Include the Mutual Fund Fees in the Previous Post

Mr. Roberts also criticizes that I didn't include the 0.17% ER in the example in my previous post. I did include the ER (although not in the example above.) It also appears he is not familiar with Admiral shares with their lower ER (which anyone with more than $10K in the fund would be using.) Either way, Vanguard's ERs are so low they don't affect the data in a significant way in this example. If you want to subtract out a few basis points from the return, feel free.

Market Performance Affects Market Returns and IUL Performance In The Same Way

The 25-year internal rate of return for the 4% midpoint comes out to 3.41%. But these things don’t work in a vacuum. If the average credited interest rate were cut down 54% than we’d have to also assume that our return on the market was going to decrease by a similar amount….If we took market performance and cut it in half, it too would be in the same territory.

I agree. If market performance is terrible, your returns will be terrible whether you invest in it directly or via an insurance policy. However, even with lower returns, you will still end up with more money by investing directly vs buying the policy. The only situation where that could reverse would be in a decades-long market meltdown, and you're able to take advantage of the insurance company's guaranteed crediting rate. But in that type of scenario, you've got to remember who is supplying the guarantee. If the economy really tanks like that, the insurance company may go out of business. It might also change all terms it possibly can to make the contract more advantageous for the company (lowering participation rates etc.) At any rate, if you really think you're only going to get 4 or 5% nominal out of the stock market over the next 2-5 decades, do yourself a favor and start investing in real estate instead of either stocks or insurance policies. It's very easy to find properties with Cap Rates of 5-6% these days.

The Crediting Rate is Not Your Return

Mr. Roberts also criticizes my statement that the crediting rate is not your return. He ends up off on a tangent explaining the difference between geometric and arithmetic returns, which isn't relevant to the point I was making. The point I was making was that not all of your premium dollars go toward cash value and that the crediting rate is only applied to the portion that goes toward the cash value.

The Commission on This Policy is Only 26%

Mr. Robert's points out that despite that fact that you can only get 25% of the money you put in your first year back upon surrendering, the insurance agent's commission is only 26%. Obviously I'm not privy to the exact amount of his commissions with each product he sells. He brings up the argument discussed above about the difference between cash value and cash surrender value. We'll just have to agree to disagree about which figure is more relevant to the purchaser of the policy, but they're obviously very different early on in the policy life. He also mentions that he can design a policy with immediate liquidity, but at the expense of a lower long term return. I don't doubt that. But the fact remains that he cannot design a policy that does both. There's no magic in investing, even when an insurance company is involved.

A Final Word

This piece is so long that I doubt most of those who started it actually got to the end, but it does represent a “serious reply” to Mr. Robert's criticisms. I again repeat my often-made statement that if an investor, physician or otherwise, truly understands these products that Mr. Robert's blog frequently states even many who sell them do not understand, and still wants one, then go ahead and buy it. It doesn't bother me a bit if you're willing to trade a higher long-term return for lower volatility and some insurance-specific benefits because you see great value there. However, there are a number of important take-away points. First, this product is completely optional. You can be very successful financially without ever owning cash value life insurance. I became a millionaire 7 years out of residency, am well-insured, and possess a rapidly growing portfolio without ever having bought one. Second, you can use an IUL and still reach your financial goals, but it might require you to save more or work longer. Third, remember that the policy discussed is considered a very good policy. There are many that aren't nearly as good and you are likely to experience lower returns with them. Fourth, remember that any discussion of investing in a life insurance policy should take place AFTER you've maxed out all of your tax-advantaged accounts, including 401(k)/profit-sharing plans, 403(b)s, 457s, defined benefit plans, Backdoor Roth IRAs, HSAs etc. In order to get a favorable comparison against straight investing, you need to assume that money is in a taxable account. Finally, if you're an insurance agent, instead of sending me hate mail and posting mean comments, get yourself educated and develop some ethics so you can do the right thing for your clients so I quit getting emails from doctors who have been sold inappropriate policies they don't want or need.