What is Whole Life Insurance?
By John D. Perrings
A powerful, centuries-old financial asset
If you are not familiar with whole life insurance, it may sound strange at first. You have probably heard of a "mutual insurance company" but might not really know what they are about.
Fun fact: Mutual insurance companies have been around longer than the United States.
I will explain in further detail below, but to start, here are a few of the features of a properly designed whole life insurance policy:
(Pictured right: The PENN MUTUAL LIFE INSURANCE COMPANY, est. 1847)
- Provides a guaranteed death benefit payout no matter how long you live
- The policy has an associated “cash value” that grows every year, with no down years, guaranteed
- Non-guaranteed dividends are also normally paid to the policy owner
- The policy has a guaranteed "policy loan" provision that allows you to borrow against the cash value of your policy, no questions asked
- Even with loans outstanding, the full cash value of your policy continues to earn guaranteed, uninterrupted compounding growth
- Tax-deferred growth – The cash value, guaranteed interest, and dividends grow in the policy, tax-deferred.
- Tax-free access - The cash value can be accessed, via policy loans, tax-free
- Tax-free benefits - the death benefit is paid out to the beneficiary, income tax free
- "Living benefits" include the many strategies that use whole life insurance to eliminate debt, permanently reduce taxes, and increase spendable income
You probably already know what life insurance is. But just in case, here is a very short story about life insurance that is not very entertaining at all.
My dad (the “insured”) made monthly “premium” payments to a life insurance policy. The policy was a contract between an insurance company and the “policy owner” (also my dad). That agreement stated that as long as my dad paid the monthly policy premium, upon his death, the insurance company would payout a lump sum “death benefit” to the “beneficiary” named in the policy (me).
The primary purpose of insurance is to indemnify or “make whole” one party against a loss. In the case of life insurance, a “beneficiary” is “made whole,” financially, against the loss of someone they rely on (like my dad for example).
The idea behind being “made financially whole” is to cover the “human life value” of the deceased. Ideally, the death benefit would equal the total amount of money the deceased would have earned if he had not died, for the duration of the life insurance policy. So, if the breadwinner of a family of four dies, the surviving family members would be left in a financial situation that allows them to maintain their standard of living before the breadwinner died (i.e. “made whole”).
There are two primary types of life insurance: Term Life and Whole Life:
Two basic types of life insurance
Term Life Insurance
Insures a person for a certain amount of money for a certain period of time or “term.” E.g. $1,000,000, 20 year term life insurance policy.
The policy expires after 20 years. If dad dies before the 20 year term is up, the insurance policy pays a death benefit of $1,000,000. If dad dies after the 20 year term, no death benefit is paid out, as the policy has expired.
Whole Life Insurance
Insures a person for a certain amount of money for their entire (“whole”) life . It is guaranteed to pay out a death benefit, regardless of age, so long as the policy is in force.
It is Whole Life Insurance, specifically, whole life insurance with a “participating” (dividend-paying) mutual insurance company, that we recommend at StackedLife. We will look at some ways to utilize a specially-designed type of whole life insurance to act as our primary cash asset i.e. savings account. We will get into further detail as to why we are doing this later in this series. It has to do with greater growth, flexibility, and control of your cash/savings.
The mutual insurance company
The mutual insurance concept dates to the late 17th century in England with the establishment of the first mutual fire insurer in 1696. In America the first successful mutual insurance company was founded in 1752 by Benjamin Franklin. It was called the Philadelphia Contributionship for the Insurance of Houses From Loss by Fire, and it remains in business today.
(Pictured right: The Amicable Society for a Perpetual Assurance Office)
Mutual companies are unique because they were established to serve the insurance needs of policyholders without also having to meet the investment needs of stockholders. The policyholder – often referred to as a “member” – is the sole focus of a mutual insurance company (1).
The policy-owners share actual ownership in the mutual company and, thus, have voting rights. Also, because they are owners, members (policy-owners) are entitled to excess profits in the form or dividends. This, as opposed to a stock company; policy-owners in a stock (insurance) company have no voting rights and dividends are either shared with stockholders or altogether forgone in favor of the stockholders.*
Mutual insurance companies exist to ensure that the benefits promised to policyholders can be paid over the long term. Because they are not traded on stock exchanges, mutual insurance companies can avoid the pressure of reaching short-term profit targets. Members of a mutual insurance company have the right to excess premiums, meaning that if losses and expenses are less than the amount of premiums paid into the company, the members would receive either a dividend payment or a reduction in premiums. In general, the goal of the mutual insurance company is to provide its members insurance coverage at or near cost, since any dividends paid back to members represent excess premium payments (2).
The salesman in the room (and a little history)
In recent history, insurance has been known to invoke a negative image in peoples’ minds due, in no small part, to the sales people historically involved in the industry. Think ‘Ned Ryerson’ from Groundhog Day. Sleazy sales tactics (like showing up at funerals to pitch life insurance) and other “hard-close,” fear-based sales behavior has left a bad taste in the mouths of at least a generation.
We should acknowledge this negative stigma and always be wary of financial product sales that may not be in our best interest. At the same time, however, we should keep things in perspective.
There have been sleazy life insurance salespeople just like there have been sleazy car salespeople and sleazy real estate agents and landlords. Yet – most of us still drive cars and still buy or rent housing. Most of us, in fact, also still buy life insurance. Usually some kind of term life insurance either purchased on our own or offered through our company.
The reality is that, even when acknowledging any “bad actors,” life insurance has, historically, been a bedrock financial tool that has protected the well-being of countless families in their most difficult times.
In 1900, half of all Americans’ savings was held in life insurance and annuities. In 1950, one third of families owned whole life insurance policies.
The history goes back even further. Modern life insurance has been around since the 1750s. The first mutual insurer, Society for Equitable Assurances on Lives and Survivorship, was formed in 1762 and the first policy dividend was paid to its mutual members (policy-owners) the same year as the Declaration of Independence, 1776! (4)
There are currently existing mutual insurance companies that have been around since the mid-1800s and have paid interest and dividends to policy owners every year for over 150 years, including the Great Depression and Great Recession.
The "rebirth" of whole life insurance
Whole life insurance is currently seeing a “rebirth” of sorts as people are re-discovering the incredible benefits of whole life insurance as a cash asset. This reemergence is largely due to a growing awareness of the fragility of our debt-based economy and to educational movements like the The Infinite Banking Concept®, created by R. Nelson Nash, and introduced in his seminal book, Becoming Your Own Banker
Now, rather than using fear-based sales tactics, many educated life agents are focusing on the certainty that can be created for families when a family member dies, i.e. the life insurance death benefit. In addition to this, because of the cash flow features unique to whole life insurance, qualified life agents spend even more time educating clients on the “living benefits” that whole life insurance can provide while the client is still alive!
Who uses whole life insurance?
If the idea of using life insurance as a financial asset still seems strange, it may be helpful to see some examples of people and organizations that have used cash value whole life insurance to grow their personal wealth or improve business operations:
(pictured right: Wells Fargo balance sheet 2019)
- The largest holders of whole life insurance, by far, are the banks themselves. U.S. Banks hold hundreds of billions of dollars of whole life insurance, that make up as much as 25% of their "tier 1 capital."
- Family trusts of the ultra-wealthy leverage the power of cash value whole life policies to increase the returns on their investments and to efficiently transfer wealth to future generations
- Entrepreneurs have used the cash value of their personal whole life policies to launch some of the most famous businesses in history.
- Walt Disney borrowed $100,000 against the cash value of his whole life policy to help fund Disneyland
- J.C. Penney borrowed against his whole life policy to help meet payroll after the Great Depression stock market crash of 1929
- Ray Kroc dealt with constant cash flow problems in the early years of McDonalds. He used policy loans to help cover salaries of key employees and to finance the initial Ronald McDonald ad campaign
Why whole life?
Money must reside somewhere.
Whole life insurance is an excellent place to store cash and then perform other economic activities such as financing large purchases or buying other income generating assets.
Where do you store your cash?
If you maintain a healthy emergency & opportunity fund, where is that cash sitting? In a bank, earning 0.1%? What if that could, instead, be sitting in life insurance, earning 3-5% while also providing death benefit and disability protection?
Ownership and control
Did you know that when you pull up to the bank drive-thru and deposit money via that vacuum tube, the second your money is sucked into the bank's building you become an unsecured creditor of the bank? You are, legally, no longer the owner of that money.
Reduced lost opportunity cost and increased returns
Since we finance everything we buy, wouldn't it make sense to have a process that allows our financial lives to capture the debt service on those transactions?
Imagine the incredible efficiency we would create, over a long period of time (our entire lives), if we became the "lender" for every significant transaction in our lives...
And this doesn't require a financial "overhaul." Simply by adding a layer of cash value whole life insurance, and learning how to use it, it is possible to eliminate debt, permanently reduce tax, and increase your spendable income now, later in retirement, and for your next generation.