#334 | Whole Life Through the Lens of a UL Believer

For the past 3 weeks, I’ve been doing a weekly webinar for AIN* that Jeff Reed, AIN’s maestro of content, entitled “Whole Life Through the Lens of a UL Believer.” The title is a nod to the path of my career. Until I started working at MetLife in 2013, I’d really only dealt with Universal Life products. I didn’t know much about Whole Life. As surprising as this might sound, that was true of my time at MetLife as well. In retrospect, I can say that I understood what Whole Life did and how to use it, but I didn’t fully understand how it actually works. And in my experience, I think that’s how most agents – even those who sell Whole Life – feel about the product.

What forced me to wrestle with the actual mechanics of Whole Life was a series of articles on the product that I started writing in the fall of 2018. For the first time in my career, I hit writer’s block. Why? Because I was confronted with the uncomfortable realization that I didn’t understand Whole Life well enough to write about it. My mental model clearly had gaps and misalignments. The only remedy was to stop the series and (no pun intended) get serious about understanding Whole Life.

The key, in the end, was to look at Whole Life through the lens of Universal Life. Whole Life started to make a lot more sense. The goal of the AIN series was to take folks along for the same ride, if you will, towards a better understanding of how Whole Life works and where it fits from the vantage point of folks like me who are used to dealing with Universal Life. This article will hit on a few of the high-level points and conclusions from the series, including a few that surprised even me as I built the content, and make the case for Whole Life in today’s environment.

The Whole Life Market

When folks talk about Whole Life, they’re generally referring to a particular variant of Whole Life – large-face participating policies sold by mutual and mutual holding companies. And for good reason. That part of the market, what I’ll call “traditional” Whole Life, makes up 71% of the annualized premium in the overall Whole Life market. The Big 4 mutual companies – Northwestern, Mass Mutual, New York Life and Guardian – account for a whopping 86% of total traditional Whole Life sales. Penn Mutual is a distant fifth, followed by Lafayette Life and OneAmerica.

However, if you look at the Whole Life market through the lens of policies sold, the story completely changes. Participating Whole Life makes up just 22% of total policies sold. The remaining 78% is what I’ll call “small face” Whole Life, which is typically non-participating Whole Life generally sold as “final expense” insurance. These policies average just $850 in premium. Whereas traditional Whole Life is oriented around surplus earnings that fuel dividends, these small face Whole Life policies have razor-thin margins and the focus is guaranteed values. It’s a world apart from where the readers of this newsletter generally operate. As a result, when I talk in this article about Whole Life, I’m referring only to the “traditional” participating Whole Life variant.

Whole Life through the Lens of Universal Life

Fundamentally, Whole Life and Universal Life are both sub-categories of the broader category of permanent life insurance. All permanent life insurance policies follow the same structure:

The difference between Universal Life and Whole Life is the packaging. Universal Life exposes policy charges and interest credits so that the policyholder can pay flexible premiums to maintain coverage for as little as one month or as long as their lifetime. The catch, though, is that the charges and interest credits can change at the life insurer’s discretion subject to guaranteed limits.

Whole Life calculates a fixed premium to maintain coverage for life based on the guaranteed rates such that the cash value ultimately equals the death benefit at maturity. The policy charges and credits are not discretely broken out because both premiums and cash values are guaranteed, but they’re still the basis for the product values. Each year, the total difference between the guaranteed mortality, expense and interest rates and the current mortality, expense and interest rates is credited to policy values in the form of a dividend.

Simply put – Universal Life can fall, Whole Life can rise. With Universal Life, the flexible premium is calibrated to current rates that can deteriorate all the way to the guarantees. With Whole Life, the fixed premium is calibrated to guaranteed rates and the dividend provides benefits that reflect current rates. Whole Life leaves nothing to chance. Too often, flexible premium Universal Life is sold as fixed premium Whole Life. It ain’t. And it shouldn’t be sold that way, unless the product has a secondary guarantee.

However, I think it’s also worth noting that just because Whole Life has a fixed premium, that doesn’t mean it isn’t flexible. The difference is that the flexibility in Whole Life comes as a natural byproduct of cash value accumulation. Cash value can be used to pay premiums, for example, through either withdrawals or policy loans. The policy death benefit can be reduced to a paid-up amount, which eliminates future premiums altogether. Dividends can be used to pay premiums or even taken in cash. Mature Whole Life policies are, I would argue, very nearly as flexible if not more flexible than their Universal Life counterparts.

The Benefits of Participation

It is very tempting to read the description above and think that a Whole Life and a Universal Life policy with identical charges and identical funding will produce identical performance. If the crediting rates for the two policies are also identical, then that’s a reasonable conclusion. But in the real world, that isn’t what happens.

Universal Life is based solely on a crediting rate derived from the life insurer’s general account yields. Whole Life derives its crediting rate from the general account, but it also participates in the broader profits produced by the mutual life insurance company. A Universal Life policyholder is just a policyholder. A Whole Life policyholder is literally a shareholder. They have equity exposure in the mutual company. Profits produced by the mutual company must make their way into the dividend or into surplus, which itself exists for the benefit of policyholders.

This a profound difference that should not be underestimated. Over time, we would expect a blended portfolio of fixed income and equities to outperform a portfolio of pure fixed income. The same logic applies to participating Whole Life. Over time, we would expect participating Whole Life – with its equity shares in the mutual company – to outperform an otherwise equivalent non-participating Universal Life policy as long as the life insurer is profitable. That’s the power of participating Whole Life.

How 7702 Has Changed Whole Life

Until last year, Universal Life had something of a trick up its sleeve for accumulation sales – the Guideline Premium Test (GPT). Universal Life can operate under either GPT, which has a narrow statutory cash value corridor and calculated (but generous) premium limits, or the Cash Value Accumulation Test (CVAT), which has a wider cash value corridor and no premium limits. In terms of pure accumulation, GPT produces better long-term performance because of the narrower corridor. As a result, a Universal Life policy optimized for accumulation under GPT could illustrate better performance than an otherwise identical Whole Life policy under CVAT simply because the Universal Life didn’t need to carry as much death benefit.

However, all of that changed with the drop in the 7702 rate to 2%. Now, the CVAT corridor can be much tighter than it used to be, which narrows the gap between GPT and CVAT. At the same time, GPT premium limits relative to maximum non-MEC premium limits have fallen, which means that GPT policies need more initial death benefit per dollar of premium than CVAT policies.

In the long run, Universal Life under GPT still has a bit of an edge on Whole Life under CVAT, but the margin is much, much thinner. As a result, Whole Life products using a 2% guaranteed minimum rate are more compelling accumulation tools than ever before relative to Universal Life. Little wonder why companies are moving their 10 Pay chassis to 2%, starting with Mass Mutual and Guardian, but now followed by New York Life and presumably Northwestern Mutual at some point as well.

The Choice of Guaranteed Rates

But Whole Life isn’t just an accumulation product, as it’s often perceived by folks on the independent side of the business. Whole Life can also be a compelling protection solution, as I’ll talk about in just a minute. For most products, life insurers are trying to balance accumulation efficiency with protection (and, by extension, the richness of the guaranteed cash values). The changes to Section 7702 that allow life insurers to use guaranteed rates anywhere from 3.75% to 2% has given vastly more flexibility for life insurers to calibrate products more towards protection/guarantees (3.75%) or more towards accumulation (2%).

Some companies have taken a product-by-product approach. MassMutual, for example, uses a 3.75% rate for its protection-oriented Pay to 100 product and a 2% rate for its pure-accumulation 10 Pay product. New York Life, by contrast, uses a 3% rate for all products, which means its CWL 10 Pay Whole Life is more protection and guarantee oriented than MassMutual. Security Mutual Life of New York uses 3.75% for all of its products, which creates ultra-cheap products in today’s environment, but the illustrated performance lags more accumulation-oriented offerings.

Not surprisingly, life insurers are beginning to use the flexibility in rate to calibrate their products to specific niches. Guardian uses 3% for its accumulation-oriented Pay to 99 and Pay to 95 products, but uses 3.75% for its protection-focused Pay to 121 product. Northwestern Mutual has both 3% and 2% Pay to 100 products, with the former being focused on all-base protection and the latter focused on accumulation and term-blended sales**. New York Life, for example, is rolling out a 10 Pay product at a 2% rate that will directly compete against Guardian and MassMutual’s 2%, accumulation-focused offerings.

If the old 4% 7702 rate Whole Life market was 2-dimensional, the new 2% 7702 rate Whole Life market is 3-dimensional. There’s a lot more going on. There are more axes of competition. There’s more turf to plant flags. And that’s exactly what life insurers are doing.

Whole Life for Protection

I mentioned above that there are many successful life insurers and agents selling Whole Life for protection. That notion might seem laughable to the UL-oriented folks reading this article. It certainly used to be laughable for me, as well. Why would anyone buy Whole Life for protection when they can get a Guaranteed UL policy for a 3^rd of the price? Clients don’t care about cash value. Clients don’t care about growth. They just want low-cost, efficient life insurance protection that they can use for estate and business planning, right?

To trot out the well-worn trope, price is only an issue in the absence of value. Protection-oriented Whole Life sales are built around value, not price, for the simple reason that making Whole Life cheap generally doesn’t work very well. The easiest way to make Whole Life cheap is to blend huge amounts of Term into the coverage. One benefit of blending term is that it lowers the headline price***. The problem, though, is that it introduces a lot of sensitivity to dividends. It turns a safe product into a risky one. And if you’re going use term blends that way, then you might as well just sell Universal Life.

Instead, Whole Life is best positioned for protection as a value play. Over time, Whole Life death benefits grow because dividends buy Paid-Up Additions that directly increase the death benefit. The same effect can appear to happen in an overfunded Universal Life policy, but it’s different. With Universal Life, death benefit increases based on cash value growth can be taken away later with adverse performance. Not so with Whole Life. Once a paid-up addition is earned, it stays there forever. Current dividends produce guaranteed benefits in Whole Life.

As a result, Whole Life can credibly be positioned against Guaranteed UL in terms of long-term performance. Eventually, there will is a crossover between the IRR of the level death benefit, low-cost Guaranteed UL policy and the more expensive Whole Life policy with the increasing death benefit. Take a look at the chart below on a 45 year old Preferred Male. The Guaranteed UL is the most competitive price currently on the market.

The crossover point between the Whole Life and Guaranteed UL is before attained age 90. That’s important because the life expectancy for a 45 year old preferred male is around age 90, meaning that on a weighted mortality basis, the Whole Life policy will deliver more benefits than the Guaranteed UL based on current performance. In a rising rate environment, that will be even more true. The inflation-adjusted value of the Guaranteed UL will fall, but increasing dividends will only further grow the Whole Life death benefit. The longer the client lives and the higher rates go, the better Whole Life looks by comparison.

But the best play, in my mind, is a blend between the two. The table below is the same as the one above but with a new IRR line representing a 50/50 Whole Life and Guaranteed UL portfolio. Assuming the GUL has zero cash, the cash value in the Whole Life policy is greater than the cumulative premiums paid for both policies by age 70. A blended portfolio offers the stability of guarantees with a performance and cash value hedge at a much lower sticker price. It’s extremely compelling. Take a look.

Guaranteed VUL is the thorn in the side of this story because it can offer cash value liquidity and upside with reasonably priced guarantees. However, as I’ve written before, Guaranteed VUL is something of an either/or solution and it needs (generally) 7%+ gross returns for the cash value to actually begin to push up the death benefit. By contrast, dividends appear in the form of guaranteed higher death benefits from day one in Whole Life. It’s a both/and solution. The best idea of all worlds, then, is to blend Whole Life with Guaranteed VUL.

Whole Life for Accumulation

It’s not hard to make the case that Whole Life is an excellent accumulation product, particularly in the wake of the changes to Section 7702. But for this webinar series, I made a more specific point – that the gap in illustrated performance between Whole Life and Indexed UL has shrunk to such a small differential that, in my view, it’s hard to justify selling Indexed UL over Whole Life. Take a look at the illustrated cash value IRRs for a middle-of-the-pack Indexed UL versus an accumulation-focused Whole Life product from a blue-chip mutual company:

Age 90 Cash Value IRR – No Income – Male, 45, Preferred, $1M DB, maximum funding for 10 years – CVAT

The only way that the Indexed UL product handedly out-illustrates the Whole Life product is by using an engineered index with a substantial fixed interest bonus. As I’ve written numerous times before, this tactic is nothing more than exploitation of an AG 49-A loophole that will likely be closed within the next 6 months. The more comparable rate to Whole Life, instead, is the AG 49-A max rate for the S&P 500 account. For that account, the Indexed UL product beats Whole Life by a paltry 0.22%.

Consider what that 22bps means. The Whole Life illustrated values are based on the life insurer’s actual paid dividend interest rate. The Indexed UL illustrated values, by contrast, are dependent on a whole host of assumptions – long-term future equity returns are equal to past long-term equity returns, the shape of future equity returns is the same as the shape of past equity returns and the cap never changes. Even then, the max AG 49-A rate represents an average outcome, meaning that the chance of underperformance is 50% even all of the previous assumptions come true.

To put it bluntly, that 22bps is very, very speculative and risky – even if the life insurer doesn’t change the rates in the product. If someone gave you the choice between a 4.49% guaranteed rate or a 4.71% rate with a 50% chance of underperformance, which would you choose? Now imagine that 50% chance of underperformance is predicated on a 12.5% S&P 500 total average return assumption for the next 50 years. It’s hard for me to imagine that anyone would choose the 4.71% when the comparison is framed this way. Indexed UL is about the potential for greater upside, not the certainty of it.

If the client wants the potential to significantly outperform Whole Life, then Variable UL is a better choice. There’s a strong argument to be made for clients allocating their equity assets into Variable UL and their fixed income assets into Whole Life. The blended result will deliver robust downside protection with significant upside potential, especially when considering the wide range of crediting strategies (and fund choices) that are starting to pop up in Variable UL.

Premium Financing

Between pure accumulation and pure protection stands premium financing, which needs enough accumulation to satisfy collateral requirements and enough protection to make the juice worth the squeeze. The vast majority of premium financing deals that I see use Indexed UL, but there’s quite a bit of premium financed Whole Life as well. The two are often compared on the basis of illustrated performance and, on that score, Indexed UL takes the cake and seems to “work” better for premium financing than Whole Life.

The problem is that premium financing deals generally don’t go south because of long-term performance that didn’t materialize for the simple reason that most deals haven’t been around long enough to actually get long-term performance. Instead, premium financing deals go pop because of short-term performance that causes collateral strain. Managing collateral, in my view, is probably the chief predictor of success in the first few years of a premium financing deal.

On that score, Indexed UL and Whole Life are markedly different. Whole Life cash values grow in a stable, consistent and somewhat predictable way. That means collateral strain is relatively known. Indexed UL cash values, by contrast, grow in fits and starts because equity performance is all over the map, particularly if the policy hasn’t used dollar cost averaging (and many don’t). As a result, Indexed UL collateral strain is unknown because index performance is unknown.

The effect is that collateral strain for Indexed UL could be almost anything. Perhaps a better way to put it is that collateral in Indexed UL will be almost anything. The chart below shows the collateral strain in each year of a standard premium financing deal using Indexed UL with accrued interest. The yellow dots are the collateral requirements shown on the nice, smooth, predictable premium financing spreadsheet used to sell the deal. The blue dots of various shades are collateral requirements in different S&P 500 return scenarios.

The numbers just below the x-axis show the percentage of deals that still require collateral. For example, year 12 shows no collateral in premium financing proposal, but 44% of stochastic S&P 500 return scenarios still require collateral. After 20 years, 17% still require collateral. The results are stunning. Imagine being 20 years into a “free” insurance deal and still being underwater and having to post collateral. Now imagine being one of those top right hand blue dots where after 13 years, for example, you were supposed to be riding off into the sunset and instead you’re posting 35% of your premium as collateral.

What do you do in that scenario? Well, The Wall Street Journal already answered that question this week. And if you want to avoid that scenario while still using premium financing, then sell Indexed UL at very conservative illustrated rates or, better yet, just use Whole Life.

*Advantage Insurance Network (AIN) is an organization that sits above independent BGAs and aggregates production to increase payouts in exchange for a membership fee. There are numerous organizations like AIN, but one thing that somewhat sets AIN apart is their focus on delivering product-related content to their member BGAs. This webinar series was part of that effort.

**This isn’t as much of a paradox as you might think. The whole idea behind blending Term is that, eventually, the dividends from the base chassis will buy off the Term coverage. So if you were going to choose which product to blend, you’d want to blend the one with the base chassis that has the highest dividend potential, which is the case for a 2% Pay to 100 product.

***Term blends can also be used for maximum funded designs and my comments about the risks of term blends don’t really apply in those scenarios. There, Term is simply being used to reduce commissions and increase accumulation efficiency.

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