Balancing the AccountsShould you drop your present insurance and buy a cheaper kind or one of the newer types of coverage? That’s a proposal an insurance agent may make to you, but the odds are it wouldn’t be a change for the better. Still, you ought to investigate. A significant number of policyholders do benefit from changing or updating their coverage.

The life insurance industry’s best-selling and most profitable product, whole life (also called straight, ordinary, permanent and cash-value life), has been widely assailed as costly, complex and inflexible. Whole life combines insurance protection with a savings program. For years critics have charged that consumers are kept in the dark about the true cost of such policies because insurers refuse to disclose rates of return on the savings component in any meaningful way. In 2010 a Federal Trade Commission study concluded that rates of return averaged 1.3% in 2007, a figure heatedly disputed by the industry, which claimed the actual rate was 5.9%.

After that report sales of whole life fell precipitously. Although it retained its lead in sales volume, insurers began developing better-paying variations of it, such as universal and variable life (see the box on page 38). A few marketers made a big push for term insurance, which provides the most protection per premium dollar. Competition has become intense as companies aggressively promote the various options.

“If we can’t quote you either greater benefits or lower costs, we’ll pay you £100,” asserts the ITT Life Insurance Corp. in nationwide advertising. In newspaper ads trumpeting its “interest-sensitive” policies, the Executive Life Insurance Co. admits that until recently most life insurance “was a terrible buy.” The Guardian Life Insurance Co. proclaims a 13.25% dividend rate.

The explosion of whole life policies being replaced with other types of life insurance has evoked concern inside and outside the insurance industry. High-pressure selling, misrepresentative policy terms and failure to provide consumers with comprehensible policy comparisons are said to be fairly common.

“Most of those who are induced to give up their old dividend-paying policies in favor of new ones suffer serious financial harm,” 
says James Hunt, director of the National Insurance Consumer Organization (NICO), an advocacy and education group. The New York State Insurance Department declares that replacement is “usually not advisable.” Among the reasons:

  • Because you’re older, the premium payments for the new policy would likely be higher.
  • You would again have to pay the cost of taking out a new policy.
  • Most new policies provide for a two-year period of contest-ability, during which the insurer could refuse to pay the benefit for certain reason, such as death caused by a pre-existing ailment.
  • Your present policy may have superior settlement options, disability provisions and other terms.
  • Dividends from many policies have been rising and may continue to–lowering, in effect, the cost of insurance to policyholders. (Some insurers now offer to increase dividends if policyholders will agree to limit their borrowings or pay higher rates when they borrow.)

If you’re typical, your overriding purpose in buying life insurance is to assure those closest to you of financial resources in the event of premature death. When the first policies were sold, about 250 years ago, that was the only purpose. People calculated how much they wanted or could afford and bought it. There were, however, a couple of potential drawbacks. Depending on the type of policy, the premiums rose or the amount of coverage decreased as the policyholder got older, and the policies terminated after a specified period of time (hence the name term insurance).

The Drawbacks of Whole Life

Whole life was developed as an answer to some of the problems with term insurance. Its savings-account feature meant premiums could be kept level, the policyholder could retain the insurance for life (hence its name) with no increase in cost and could also borrow against the cash value at preferential rates.

However, those innovations have a price–much higher premiums. Buyers of whole life have to pay more or settle for less protection than term offers.

Term insurance is widely recommended, especially for younger families who need a lot of coverage. For example, the New York Life Insurance Company’s rates for £100,000 in coverage for a 35-year-old male nonsmoker are £144 per year for annual renewable term and £1,482 for whole life. But should you drop a whole life policy and substitute term? If you need more protection than you can afford, by all means look into term. It will be up to you to find the best buy, though. Chances are an agent won’t recommend a cheap term policy because the commissions are too small.

You’ll need a sophisticated analysis to know for sure whether any kind of replacement–term insurance or a higher-yielding version of whole life–would be advantageous. A formula for doing this has been developed by Dr. Joseph Belth, professor of insurance at Indiana University and editor of The Insurance Forum, a newsletter. The formula provides benchmarks against which you compare yearly prices per £1,000 of protection. The math is rather complex, and it won’t work for policies that require extra premiums because of health impairment or other problems or those that insure more than one life. Belth says the biggest obstacle may be getting the necessary data from your insurance company. If you have trouble, complain to your state insurance department.

An agent should be able to run a computer-assisted comparison for you, but be sure to get everything in writing. Or NICO will run a comparison for £25. For information, send a self-addressed, stamped envelope to NICO, 344 Commerce St., Alexandria, Va. 22314.

NICO recommends this general rule: If you have a “participating” policy–one that pays dividends–keep it. If it’s nonparticipating, replace it. There are exceptions. For example, if you have several small dividend-paying policies, it might be better to replace them for the sake of efficiency.

Most policies pay dividends, and insurers have been able to increase them for several reasons. High-tech modernization has lowered their operating costs. Their policyholders are living longer, so they are paying proportionally less in claims. And higher interest rates are giving them better yields from the money they invest. An industry index based on fairly typical policies sold by selected companies shows consumers are paying 32% less for whole life, on the average, than in 1960.

A policy that would pay better dividends than one you bought several years ago would not necessarily be a better deal. You’ve already paid the sales and underwriting costs for the old policy; most of the premium money for the first year or two went for that. You’d have to pay those charges all over again for a new policy, so there would be no cash buildup for a while.

On the other hand, change could sometimes be advantageous. Examples:

  • If the cash buildup on a new whole life policy would be substantially greater and would begin reasonably soon;
  • If you want more protection than an existing whole life policy provides but wish to minimize your premium costs (to pay the premiums on term insurance, you could borrow against the whole life cash value, usually at below-market rates, or withdraw the money and make income-producing investments);
  • If you have term insurance and find you can get it for less from another company, along with comparable renew-ability and conversation guarantees.

Before You Switch

If you have an older whole life policy, ask your insurance company whether it has un update or exchange program or is planning one. A small but growing number of insurers will sweeten or replace existing policies at little or no cost to the holder.

These safeguards can help if you’re considering a change:

  • Be wary of any agent who disparages all whole life of belittles your present insurance without demonstrating convincingly that his or hers is better.
  • Avoid agents with little experience.
  • Show any proposal you receive to the agent who sold you your present policy. Your agent will be only too happy to point out any flaws or discrepancies in the proposed policy.
  • Make sure any new policy will take effect before your old one expires.
  • Insist on a written replacement illustration showing where you would stand with each policy at various times in the future, and ask the agent to sign it and also to state in writing that the change will benefit you. (About 40 states have specific regulations governing replacements, and 13 of those require insurers to provide comparison statements. The insurance department can tell you about the legal situation in your state.).
  • Ask how much you’ll have to pay for the acquisition costs.
  • See how the loan rate compares with the policy you have.
  • Find out when the next dividend will be paid if you have participating whole life. It may be smart to wait until after that if you decide switching makes sense.

If you want to check on an insurance company before you switch, ask at your library for Best’s Insurance Reports, an annual publication that profiles about 1,800 life insurance companies and rates them according to financial strenth. It also gives information on their management and product lines. Best’s Flitcraft Compend, which an insurance agent can show you, has descriptions, rates, dividend scales, cash values and other data about some 300 companies.