[As regular readers are aware, I’ve started writing a monthly column for the publication of The American College of Emergency Physicians (ACEP NOW).  Here is my second one.  The topic is a familiar one for long-time readers, whole life insurance. Guess what?  It’s still a lousy investment.]

Question:

My financial adviser thinks I should diversify my portfolio by adding whole-life insurance (WL) as an additional asset class. Do you think this would be a good move?

Answer: WL is difficult to sell. It is expensive and complicated and possesses a terrible reputation. It is rarely recommended except by those who benefit from its sale. Recognizing this, insurance companies offer substantial commissions to those who are able to successfully sell it. The typical commission for WL ranges from 50–110 percent of the first year’s premium. That means if you buy a WL policy with a premium of $30,000 per year, your “adviser” will receive a commission in the neighborhood of $15,000–$33,000. Given that insurance agents have a median income of $47,000 per year, that monstrous commission becomes an incredible conflict of interest.

Commissioned salespeople generally make for poor financial advisers. The worse the financial product, the higher the commission a company must offer in order to get it sold. The higher the commission, the more likely the salesperson is to recommend it to you. Even highly ethical people will struggle with this insanely huge financial conflict of interest. It kind of makes those pens and sandwiches that drug reps used to bring to the ED look pretty silly, no?

If you need financial planning advice, I suggest you pay for it with a straightforward hourly or flat fee. If you need asset-management services, I suggest you pay for it with a flat annual retainer or at least a reasonable fee based on assets under management. Using a commissioned “adviser” may seem like it saves you some money, but there is no price too low for bad financial advice.

It is best to evaluate any financial product on its own merits rather than on the sliminess of its industry.

All that said, it is best to evaluate any financial product on its own merits rather than on the sliminess of its industry. WL does have significant upsides. It provides a lifelong, generally increasing death benefit. The life insurance aspect is paired with a savings account that grows slowly each year with dividends from the insurance company. In many states, the cash value enjoys significant asset protection from creditors. It can be useful in some unique estate- and business-planning transactions. You can also borrow money tax-free, but not interest-free, from the policy to purchase expensive stuff or to spend in retirement. Upon death of the insured, any loans not paid off are assessed against the death benefit and the remainder is paid out to heirs. These unique aspects cause commission-hungry insurance agents to recommend WL as an additional retirement account or even as a unique asset class for your portfolio.

The complex structure and many uses of WL give its proponents an endless number of angles from which to sell it. Unfortunately, for nearly every use of WL, there is a better product to meet that need. If you need to protect your family prior to retirement, term-life insurance works better. If you actually need a permanent death benefit, guaranteed no-lapse universal life works better. If you need your money to grow, investments like stocks and real estate are likely to provide a much higher return. 529s work better than WL to pay for your children’s college, and saving up for your next car works better than purchasing a life-insurance policy to pay for it. If you need guaranteed income in retirement so you don’t run out of money before dying, you’re better off purchasing a single-premium immediate annuity (SPIA). Unlike life insurance, this product actually costs less as you get older and sicker.

Sometimes agents recommend you purchase WL to mix in with the other asset classes of your portfolio. They argue that because the projected long-term returns of WL are similar to those of bonds (especially in our current environment of historically low interest rates), you should include WL as an asset class in your portfolio. Keep in mind you can call anything, including horse manure or Beanie Babies, an asset class. The real question is, “Should I include this asset class in my portfolio?” With WL, the answer is usually no. If I offered you an asset class with the following characteristics, would you want to invest in it?

  1. 50 percent front load the first year
  2. Surrender penalties that last for years
  3. Requires ongoing contributions for decades
  4. Difficult to rebalance with other asset classes
  5. Backed by the guarantees of a single company (and whatever you can get from a state guaranty association)
  6. Requires you to pay interest to use your own money
  7. Guaranteed negative returns for the first decade
  8. Low returns (3–5 percent) even if you hold it for many decades
  9. Must be held for life to provide even that low investment return
  10. Excluded from the investment (or lower returns) for poor health or dangerous hobbies

Once you step back and think about the significant downsides of WL as an asset class, the right decision becomes obvious. Don’t mix investing and insurance. Complexity in financial products always benefits those who sell them more than those who buy them. According to joint reports from the Life Insurance Marketing and Research Association and the Society of Actuaries, 80–90 percent of WL policies are surrendered prior to death. This dire statistic suggests that the vast majority of WL purchase decisions eventually lead to serious regret.

However, surrendering a policy you have held for decades isn’t necessarily a good financial move either. The poor returns of WL are heavily concentrated in the early years, and life insurance of any type does become more expensive as you age and become more ill. Be sure your life-insurance needs, if any, are met with another policy prior to surrendering any insurance policy. Be sure to also calculate your expected return going forward prior to surrendering because the poor returns in the past are now water under the bridge.