An annotated guide
to using the
client-approved booklet
Whole Life Insurance Protection
Agent’s Guide to
Permanent or Term Life Insurance:
A Comparison
“The stock market provides superior long-term returns when compared to
other assets.” That single statement, repeated many times, has led many
Americans to believe that the best, and oftentimes only, way to put money
away is in an equity-based vehicle. Unfortunately, that statement is not a fact,
it is an opinion.
This booklet is designed to challenge the assumption that equities will always
outperform over the long term. And, if that assumption is not true, the
argu-ment that we should always buy term and invest the difference is no longer
valid. The booklet proves that advertised returns and experienced returns do
not necessarily have any connection. Using a step-by-step process, it breaks
down the statement that equities provide superior long-term returns and
proves that this is not always the case. Note that at no time are actual dollar
figures discussed. This is not a dollar-for-dollar comparison of one choice to
the other. The point is to challenge assumptions and open an avenue to
discussing the role of permanent life insurance in a client’s portfolio.
The “Buy Term and Invest
the Difference” Question
Form 2832 is for use with your clients and can be ordered through the Forms Catalog on ON-Net.
The S&P 500 index represents approxi-mately 75% of the U.S. market cap and, as such, is a reasonable substitute for the overall stock market. The S&P 500 chart in-cludes dividends reinvested into the index. This is generally considered a more accu-rate rendering of the return of this index than price only.
The 20-year time frame was used as most individuals would agree that this is “long-term.” Had a 15-year time frame been used the average return would be 7.47% and, for a 25-year time frame, 10.90%. Different time periods will yield different results – the purpose is to create discussion and an understanding of real rates of return.
Different 20-year time frames will yield different results. For example, the period 1980-1999 yielded rates of return that were considerably higher than average for the stock market and could be very attractive when compared to a non-equity position. However, it is simply good fortune that al-lows an individual to begin their investment cycle at that point in time. Rather than get-ting bogged down in a dispute over whether one twenty year period is representative v. another, return to the original point, which is that equities do not always provide better rates of return over the long-term.
The 4.34% will remain constant in our examples. It represents the internal rate of return (IRR) the hypothetical client would have received on annual premium pay-ments during this time. As such it already reflects real rates of return, management fees, annual payments, etc.
The first point that needs to be clarified is that average rates of return and real rates of return are not the same. The client needs to understand that the rate of return received on actual dollars can be dif-ferent than the perceived rate of return for an index.
How are downturns magnified? Let’s look at a quick example:
Option 1 Option 2
Year 1 5% -10%
Year 2 5% 20%
Year 3 5% 5%
3-year average return 5% 5%
3 year real return 5% 4.84%
While both Options have a 5% average rate of return, the -10% in option 2 requires greater than a positive 20% return to get to the same point as two consecutive 5% re-turns. Thus the 3 year real return for Option 2 is lower than that for Option 1.
The real rate of return that we determined on the prior page only applies to the first years’ payment. Just as we make annual premium payments to a life insurance policy we need to measure the impact of annual payments to any asset. Think about it, we typically save money in our 401(k) through payroll deduction, money goes into a mutual fund through a monthly bank draft, or perhaps there’s a monthly transfer to a brokerage account. Measuring the return of a single investment over a 20-year period is not the best way to determine a rate of return for a client that is going to choose between two alternatives that involve regular, repeated transfers of cash to an as-set. As we put each transfer together with the others, the true picture of the alternative investment begins to appear.
At this point the roughly 1-2% difference in the two values begins to show the true rela-tionship. However, to achieve that higher rate of return a client would have had to take considerably more risk than they would in a whole life policy. For example they would’ve needed to not only stay in-vested, but actually to have added money during the gut wrenching declines associ-ated with both the dot com crash and the subprime mortgage crisis. By comparison the annual, consistent growth in a life insur-ance policy feels pretty safe.
Does the whole life policy have a man-agement fee? Essentially, yes. There are investment professionals at every insurance company responsible for the money in the general account. However, that cost is al-ready included in any IRR quotation that an insurance company provides. That is not true of index quotes.
Lost Opportunity Cost is an important aspect of fees. Many clients would simply subtract a fee from the gross return in or-der to calculate net return. However, in a rising investment this ignores the impact on the potential gain. Net rate of return needs to consider the fact that any fees reduce the asset by both the fee and the gain that the fee would have received had it not been paid out.
We do not assume surrender of the life insurance policy at this point. If we did, there would be income tax on any gain in the policy which would reduce the IRR quot-ed. Some might point out that this gives an unfair advantage to the life insurance policy. However, it is equally fair to point out that both dividends and short-term capital gains would have been taxed as income (a histori-cally higher rate) and that we are not grant-ing any economic value to the death benefit of the life insurance. The use of long-term capital gains rates is an effort to simplify and be reasonable at the same time.
Taxes are a significant factor in rate of return calculations. Equity quotes do not typically factor in any taxation and therefore can be misleading. Whether your client owns equi-ties in a qualified or non-qualified account,
the ultimate rate of return calculation must take into account taxation.
If buying term and investing the difference is preferable to permanent life insurance over the long-term, then most people would as-sume that returns for the S&P 500 would be higher over a 20-year time frame. Some-times they will be, this time they weren’t. The point of the piece is to help you explain to clients that permanent life insurance may be an effective cash accumulator, protection device, and tax advantaged asset distribu-tion tool.
One further point: As our hypothetical cli-ent moves into retiremcli-ent years, it is very likely that they will be shifting assets from equity vehicles into fixed income vehicles. This means that the deeper we go into out analysis, the more the returns of the assets should trend together. The “invest the dif-ference” client will be putting assets into similar vehicles as the insurance com-pany, with two major differences – no tax advantages and no potential for mortality gains.
The preceding discussion has been sole-ly about rates of return. This is important, as one of the primary reasons individuals do not buy permanent life insurance is the perceived low level of return available on their excess dollars. However, whole life in-surance provides many additional benefits, only some of which are listed below. Take the time to cover all the advantages that can accrue to a whole life policy owner.
Whole life insurance is issued by The Ohio National Life Insurance Company. Guarantees are based on the claims-paying ability of the issuer. Dividends are not guaranteed. Products, prod-uct features, and rider availability vary by state. The issuer is not licensed to condprod-uct business and products are not distributed in Alaska, Hawaii, or New York.
Tracing its corporate origins to 1909, Ohio National markets a variety of insurance and financial products in 47 states (all except Alaska, Hawaii and New York), the District of Columbia and Puerto Rico, with subsidiary operations in Santiago, Chile. We are committed to building long-term relationships with our customers and to providing them with solutions as their needs change over time.
For representative use only. not For use with the general public.
The Ohio National Life Insurance Company Ohio National Life Assurance Corporation One Financial Way
Cincinnati, Ohio 45242 Telephone: 513.794.6100 www.ohionational.com
Form 2833 10-12
