The math behind why I buy term life insurance and almost never buy whole life insurance

The below calculations are for illustration and discussion purposes only and are not an endorsement of any insurance broker, agent, website, or policy issuer, and nothing here should be taken as any personalised recommendation to buy or not buy any insurance policy.  Please contact us through the form below for an independent second opinion specific to your situation.

I was thrilled to see a new life insurance quote aggregator launch in Hong Kong yesterday called The Insurance Mole.  Full disclosure: I know and have worked with the owner of the insurance broker behind the Insurance Mole for a few years already, and recommend it partly on that basis.  The concept of being able to shop online for lower life insurance premiums has been around in the US for a long time, as I remember with InsWeb back in the first 1995-2000 dotCom bubble, and more recently with Dave Ramsey’s recommended Zander Insurance, where I compare quotes available to US residents.

One definition that may be worth reviewing is the difference between term life and whole insurance:

• In term life insurance, you pay an annual or monthly premium, which may be fixed for a term of 10-20 years or reset annually.  If you die before the policy lapses, your heir receives the face amount, otherwise, the insurer keeps the premiums and pays out nothing.
• In whole life insurance, you pay an annual or monthly premium either for a set number of years (say for 20 years in a “20-pay” policy) or until age 100.  If you die without missing a premium or reach age 100, the face value of the policy pays out.  In other words, the policy is meant to cover you for your “whole life”, and is often sold as a form of insurance where you “don’t throw your money away”.

The first place I disagree with that last sales line for most whole life policies is that I view insurance very much as an expense where I hope to throw that money away, because if I own insurance that pays off, it’s because something bad has happened.  Insurance companies may call these policies by clever marketing names like “Smart Protector” or “Wealth Accumulator”, but it’s important to boil these policies down to what your really getting for the money you pay.

Now, as the title promised, here’s the math behind why I only buy term life insurance and would almost never buy a whole life insurance policy: For round numbers, I took a few quotes for a male non-smoker between the ages of 30 and 40, but I run through several similar calculations regularly.

For the above profile, a $1,000,000 face value 20-year level term life insurance policy might typically cost around $1,000 – $2,000 per year, while a comparable $1,000,000 face value 20-pay whole life policy premium would be around $15,000 – 30,000 per year.  The whole life policy may be guaranteed to eventually pay out (if you fully pay up the premiums over 20 years), but the whole life policy also guarantees you’ll end up paying a lot more in premium.  A long-known and widely-used strategy for outperforming most whole life insurance policies is to “buy term and invest the difference”.  Here’s how it works:

• No matter which of the above two policies you own, if you die within the first 20 years, the insurer pays your heirs $1,000,000, but you would have saved $14,000 – $28,000/year in premiums having bought the term life policy.
• If you don’t die during the 20 year period, you would have saved $280,000 – 560,000 in premiums buying the term life policy instead of the whole life policy.  To come out ahead of the whole life policy, all you need to do is invest this difference so that it grows to more than $1,000,000

When I first moved to Asia, it surprised me how many people here buy whole life and investment linked life insurance policies because they are not sure where else to invest and earn a good rate of return.  Even investing in most boring, low risk, low-return long term investments in the world right now, 30-year US government bonds, anyone with US dollars can get a long-term return of 3% per year guaranteed for 30 years by the US government (updated quotes available on the WSJ), which by the rule of 72 will double your money every 24 years, easily getting that $280,000 – 560,000 in premium savings over $1,000,000 within most savers’ lifetimes, not to mention with the flexibility to take their money out at any time with no lock-ups or “cash value” schedules.  Of course, anyone investing for 30 years should probably consider diversifying into other investments likely to average returns of 4-8% per year or higher in exchange for fewer guarantees.

Insurance companies provide a very important role in society by helping protect us from unforeseen risks, and hopefully this simple math helped clarify why not to use insurance policies as a saving or investment product.