#27 | “I Don’t Believe in Permanent Insurance”

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I went skiing in Utah with a group of guys last year and ended up on a very long lift ride with someone I didn’t know particularly well. We were talking about work and he asked me what I did. His reaction is seared into my memory – “Oh really? I don’t believe in permanent insurance.” He chose his words carefully. He liked term insurance but permanent insurance didn’t sit well with him because it’s complex. To him (and probably many others), complexity is a Trojan horse packed with ways for the carrier to take advantage of the policy. If he can get simple term insurance that covers him just as well as permanent insurance, then why bother?

This mentality is not without justification, but it rests on the flawed assumption that term is different than permanent insurance. That’s simply not the case. Both products rely on the same basic mortality math. The price of one year’s worth of pure mortality coverage is the same regardless of whether it comes in the form of a one year term policy or a permanent UL product. The tricky part is what happens between these two durations. A 10 year term policy artificially flattens the mortality curve, essentially charging more than the price of mortality in the early years and less in the later years. The same thing happens for any policy duration greater than 1 year. But in term, there’s no benefit for paying extra in the early years. People just think of the term cost as the price for coverage because they assumed it’s a stripped-down commodity product (it actually isn’t). In term insurance, the overpayments are simply consumed by the carrier. In permanent insurance, the carrier puts the overpayments in a savings account and grows them tax-free at a competitive interest rate. Sounds great, right?

Not if you’re a consumer. I know this seems a bit counterintuitive, but think about it from the other side. Term insurance is bare-bones coverage at bare-bones cost and looks every inch of it. Permanent insurance offers all of this cash value that people are sure they’re being charged extra to have. In other words, people show up at the dealership looking for a Chevy and every car on the lot looks like a Cadillac. This makes every car salesman who swears that the Cadillac is a Chevy look like a huckster. But the salesman is actually underplaying the story. Quality permanent insurance is a Cadillac for the cost of a Chevy. Sure, you could buy a Chevy for the cost of a Chevy, but wouldn’t you rather have a Cadillac?

Here’s why. Term insurance should give the client the benefit of cash value but it doesn’t. Both permanent insurance and term insurance require excess premium payments in the early years to offset higher mortality in the later years. The difference is that term insurance sucks up the extra payments and permanent insurance allocates it to cash value. In other words, term insurance should offer a benefit but doesn’t and permanent insurance does. Cash value isn’t an extra feature that costs something. It’s the logical result of overpayment in the early years that obviously comes as a result of level premiums. To put it differently, the value of the products is the same, the only difference is what happens to the excess premiums. Term has nothing to show for it and permanent does.

Don’t get me wrong, removing the cash value element does help lower the cost of term, but only at the expense of some policyholders. Having no cash value means that term insurance offers no premium flexibility and no exit strategy. Policy lapses are highly profitable to the insurer. In other words, the folks who keep their policies are subsidized by the folks who don’t (or can’t). With cash value, those people would be able to skip a premium or surrender their policy with some value. Not so in the current structure. The low price of term insurance is partially offset by outsized penalties for certain policyholders. Sound familiar? This looks a lot like Guaranteed UL, which some people call “term for life.” The same concept applies. The average price is low because some policyholders get massive penalties for deviating from the plan.

If you look at permanent insurance this way, it’s hard to say that you believe in term insurance and not in permanent insurance. Theoretically, they operate on the same math. The difference in price should be directly attributable to the fact that term insurance has renewal risk and permanent insurance doesn’t. The price to renew or convert a term policy is uncertain and so term should be cheaper. It covers less of the mortality curve at a fixed price and moves the risk to the renewal price in the future. So choosing term verses permanent should come down to risk appetite. Do you want to lock down your renewal price now (permanent) or let it float in the future (term)? The reality is that only 1% of term policies pay out. The value of a term policy is protecting insurability in a future policy via the conversion right.

But I think this model also illustrates why we’ve got permanent insurance marketing and pricing so backwards. Everyone has been pitched Whole Life by an over-eager salesman who explains the cash value as a magical benefit provided by the strength and investment integrity of the life insurer. In reality, cash value is just the logical consequence of level premiums but you’d never be able to figure that out by looking at Whole Life ledger. Magic seems sexier and companies pander to that perception. As a result, people wanted stripped down insurance term-like permanent insurance, so rather than explaining why cash value makes so much sense, we gave them Guaranteed UL and all of its term-like inflexibility.

We’ve also made sure that the price gulf between term and permanent insurance is as large as possible by paying commissions on both products exactly the same way. Both products pay first year commissions linked to the expected first year premium payment. Term has lower premiums than permanent insurance (because it covers less of the mortality curve) and therefore pays lower commissions. Term bakes the commission into the guaranteed level premium and permanent insurance has policy charges to recover it. As a result, permanent insurance is more expensive over the same duration as term insurance. The problem is compensation, not the inherent nature of term and permanent coverage. Levelizing commissions would go a long way in fixing it.

Final point. Someone who doesn’t know anything about aerodynamics would be highly skeptical of an Airbus A380’s ability to fly. The way we handle this problem in the life insurance industry is to tell them that it does fly, stuff them in the passenger section and then wave from the tarmac. Instead, we would probably be better off explaining how a wing works. Once you get that down, it’s pretty hard to argue that you think a Cessna will fly but an A380 won’t. That’s my argument. The same principles that underlie a term policy also underlie a permanent policy. Once you understand how they work, it’s hard to argue that you believe in term but not in permanent.

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