Comparing Life Insurance EP.94

Whether you’re comparing different types of whole life policies, or deciding whether it’s the right time to take a policy loan, it is most profitable to Think in Percent. But a rate of return can be too deceptively simplistic. Discover what percentages are truly important.

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Transcript:

Tom: Welcome to Wealth Talks, where we talk about solutions, money and other things that create wealth in your life. John, we’re here back behind this mic, and we got a great topic to share about this morning.

John: Yes, I am looking forward to it!

Tom: We’ve been getting an awful lot of questions about dividends and comparing policies from one company to another or even a policy written by another agent inside the same company that we would write it with. And the truth of the matter is, how do you really come down to comparing that, because one policy might show total cash values, and total face value of being much higher than the other, even though they are paying the same premium. Let’s talk about the factors that can affect that today.

John: One of them is policy design and that’s one of the things that we look at. But when you’re looking at the end product you’re not necessarily looking at the policy design. You’re starting with the results of that design and that’s where you have to start.

Tom: It is. I think what we have to really, really focus on is, what happens 20 years from now? What happens 30 years from now? Because, even if we are in our 60’s when we’re starting to purchase life insurance, we’ve got another 20-30 years to live according to the actuary tables today. And we better be thinking about what’s going to happen back there because buying life insurance isn’t for the short term, it’s for the long term.

If you want a short-term coverage that’s term insurance, if you want long term coverage and having a financial tool then we’ve got to look at the long-term coverage. Now I’ve been looking at several policies lately and just talked with a prospect last night who in twenty years, we can save between twenty-six and thirty-one thousand dollars depending on how we design the policy, based on the premiums and the coverage that he was getting with another agent.

John: So, we’re looking at guaranteed values here or non-guaranteed or both?

Tom: We’re looking at both guaranteed and non-guaranteed.

John: Okay.

Tom: First of all, we’ll save him twenty-six to thirty-one thousand dollars in premium. Second of all, twenty years from now, we’ll see a guaranteed growth that is 7% higher in a policy we can design and the non-guarantee’s are going to be about 5% higher.

So does it make sense? Now his policy actually showed higher in dividends, how does that happen?

John: Well that goes back to the podcast that we recorded here a few episodes ago with Dan Foley. So you can check that one out Podcast 89 on Dividends Explained, where he goes through how different companies can have different dividend rates, and it doesn’t necessarily mean that the dollar amount of those dividends is anywhere comparable when you’re just looking at the rates. And when you’re looking at the dividends in the different companies too that might buy a different amount of insurance or cause the policy values to change differently on per company basis.

Tom: We’ve always talked about you’ve got to think in percent. Do you really want to give up that 7% guaranteed growth in the policy? It’s not, in my opinion, feasible or fiscally even sound to do that.

John: Right, so when we’re talking about dividends, they’re often based on the correct performance of the company but it’s sort of a shifting sand so to speak. So, we have to start with the guarantees. You were talking about that, that was the 7% increase.

Tom: So, let’s look at the guarantees for a second, because a lot of people think, if I’m earning 4% in the policy and I’m paying 5% on a policy loan, then I’m only losing 1%. And let’s talk about how that really plays out. Because that 4% that a lot of companies “guarantee” isn’t 4% that’s going to show up in your guaranteed cash buyer column.

John: That’s so important. You can read a contract, the life insurance contract. They’ll tell you that the guaranteed values are based on, generally it’s anywhere from a 3.5 to 4% rate. Some contracts list it, some don’t but that rate is behind the actuaries’ calculations for the guaranteed values of any policy that the company writes.

So what they’re using that rate for is to figure out how the premium dollars are going to grow guaranteed in their portfolio. That means the risk is covered by the insurance company. How those dollars are going to grow to be able to pay the death benefit and to make cash values accumulate i.e. guaranteed cash values that accumulate to equal the death benefit age 100 or age 121, whenever that policy endows.

Tom: So, if we look out 30, 25 or even 20 years maybe even 10 years in a contract, and we’re seeing that the cash value is not – the guaranteed cash value hasn’t matched what we’ve paid in premium yet, the guarantees of that company are relatively low or on that contract.

John: It depends on the age and health of the person. For some, especially more elderly people getting into their 60’s, mid 60’s, 70’s if they are not in great health the guarantees might never break even.

Tom: And that’s one of the things that we look at here. Because we’ve got to see if this is worthwhile for this person to purchase this life insurance policy on them or should they purchase it on an insurable interest party.

John: That’s where the legacy of the product comes in too because most likely the person in their 60s is going to die sooner than a child or someone else that they could put the insurance on, so that becomes another factor is the death benefit when they go. The legacy that they leave to their family is going to be more valuable than putting in a policy on someone there that’s younger but is not going to die as soon. So there’s a balance there. There’s not one single answer that’s going to be the case every single time. But yes, that’s one of the things we are looking for, is for the guarantees to exceed the cost of premiums paid, ideally.

Tom: So, when we look at someone in their mid-30s that is purchasing a life insurance policy. What kind of guaranteed, and it’s not even really an internal rate of return. Maybe a better term would be a compound on your growth rate that’s happening in the guaranteed. What kind of percentage can we put on that over the next 20, 30 years?

John: If we have a series of cash flows, that is the premium dollars, and we have a guaranteed cash value number at the end of that time, we can figure out that internal rate or return of the compound annual growth rate up to that point in time. Next year it’s going to be different because we pay another premium and the cash values grow some more. Each year the internal rate of return changes a little bit, but it’s not going to change very much.

Okay. So, it’s going to be along in this range. Generally, on someone in their 30s that could be up to about 2% of guaranteed values.

Tom: So the 4% that everyone talks about that, “Oh, your contracts guaranteed to give you 4%.”

John: That’s the behind the scenes calculation, you never see that actually “see” that money in cash value.

Tom: Because the insurance company is a business.

John: Yes.

Tom: And they have expenses that have to come out of that. They have mortality cost that have to come out of that and so what’s left of that is the guarantees. They start with that 4% because that’s what they’ve known they’ve been able to do for years and years and years.

John: Yes.

Tom: Okay. So, when someone says, “Well, I am paying 5% of my loan and I am renting 5% of my policy it’s a wash.” They need to make sure what they are earning in their policy.

And really, when we say earning that’s even a missed number anyway because what’s really happening, that’s really like the equity that you have in your policy because it’s a representation of the paid-up insurance that has been developed in your policy that you now can either leverage or you could surrender and get the money back that you paid for it.

John: That’s a good point. Because people tend to gravitate towards thinking that everything is an investment financially. Whereas life insurance is not an investment, it’s a financial tool that doesn’t have the same earnings components that you would think of in an investment, it’s more than just that.

So, you can analyze some of the values based on internal rate of return and using some investment terms. But you do have to consider when you take a policy loan, what is that? What is the interest being offset with what you are earning and guarantees? And that’s not the 4% that some people think it is. It’s more like the 2 or it could be up to 4% if the dividends are doing well with the company, but you have to look at those things.

Tom: That being said and everything, we have to be fair and honest here and say that, that growth is not going to be subjected to taxation if we manage the policy right.

John: That’s true! That translates to a much higher growth rate.

Tom: Which translates to a much higher growth rate. Now, let’s look this though. Let’s look at the individual that just wants to use life insurance as an investment. They just want to put money there, store it away and not really do anything with it and that’s fine. I’m not going to tell people what to do. But aren’t they missing out on a huge, huge opportunity because there’s no place else that you can continue to earn even that one or two percent that the policy is guaranteeing.

John: Why are you using your money?

Tom: Why are you using your money?

John: That’s right. It’s a big factor that some people miss. They say, “Well, I could take a loan over here at the bank for 5% interest, why would I do that instead of taking a policy loan. ”And you have to look at the gain that you’re getting in the policy. Not just what you’re paying.

Tom: Yes, an example that I often tell people if I have $50,000 that’s earning 2% which could very well be the cash value in my policy. It could be a CD, it could be anything, okay. But if I surrender that, if I withdraw it and I spend that money, I lose the growth of that 2% and over 10-year period of time, that means I lost almost over $11,000 on $50,000. Now if I went down to the local bank and I borrowed money for $50,000 and I paid the bank back and I had to pay the bank 4%, I would pay them less interest than what I gave up on what I surrendered.

John: That’s true, and the ideal situation, just for those of you who are our listeners. If you don’t follow the reasoning of all of this right now, it’s okay, but the ideal situation is to think both at the same time. If you can get the bank loan at 4% or you could take your savings at 2%, why not take the savings at 2% but pay yourself back like you were paying the bank back at 4%. Doing it that way you will get more than the profit that you would have just got by letting your savings sit at 2% while you pay the bank 4%.

That’s a point that a lot of people miss as they’re talking about you know saving at a lower rate and borrowing at a higher rate of interest. There is the factor of both there, that you see it’s there. So that’s like what we’re doing with the policy, it’s not an exact comparison but it’s a good analogy. Because we’re taking a policy loan. Part of that is being offset by the growth but then we’re paying it back like we were paying back a bank loan at the same rate or a higher rate. That’s what it’s going to do, keep it growing for us.

Tom: And that’s key right there, John. Who determines the rate we pay it back at?

John: We do.

Tom: We do and so what we teach in the Perpetual Wealth Code is the way to pay back a much higher interest rate and keep it comfortable for you. Because like Robert Shiller says, the worst thing that’s happening to America today is people are not saving enough money. And this allows you to save more money; it’s kind of a forced labor of saving but in a way that you don’t feel the discomfort of having that save. So a lot of times I’ll give an example of being able to pay 18% back on a loan that you take from a policy.

Now, doing that you do not lose that guarantee one or two percent growth that the policy has given you. And so, then you benefit from the 18% coming back and when you pay the policy interest loan, whatever’s the difference is yours to keep. And that’s the best way to manage money because that’s called free cash flowing and that’s how so many people have become very wealthy. They just free cash flow with investors’ money or shareholders’ money and we’re just using the insurance companies’ money by leveraging our death benefit to get hold of that.

John: When you think about it most people aren’t using that money at all. They have it locked away in some outside investment, maybe even a qualified plan. We talked about this before, where they’re not using it at all. And so, by putting it into life insurance, we’re getting a baseline guarantee, we’re getting the death benefit which is like a bonus. We don’t get that with anything else that we do, and we get access to be able to use the money. That’s something that is off the playing table for most people, it’s not even an option.

Tom: Well unless our listeners get discouraged about the one to two percent growth, let’s talk for a minute about what money managers make. They’re delighted if they can get one or two percent. Because according to Jack Bogle, they’ll take 80% of the profits over the lifetime of your investment on 2% pay.

John: A case comes to mind, I’m not going to spill the beans on this but there’s going to be an article coming out in the newsletter next month, the physical Living Richly newsletter that Ben was talking – Ben and I were at a meeting, we’re talking to a financial advisor who was boasting to us about how he could charge his clients 2%, and why we should do the same. So, you have to check out the article of the Living Richly issue.

Tom: Well and we have to look at merchant services here too. When I go swipe my American Express card at a terminal in a retail place, the merchant service charges that retailer one to two percent. That’s flat out.

John: Yeah, And so that’s how they can pay you points.

Tom: That’s how they can pay me points back. So we have to start thinking a little bit wiser. I know Jesus told a story about the fact that we have to become the shrewdest people in this world in order to overcome it, and if we continue to be so naive and not understand that little bits of interest here and there working in our favor while we get to leverage that money, that’s doing both. That’s really powerful and that is how the bankers, the financial institutions, the money managers of the world have created wealth for themselves at the public’s expense.

Now we have the opportunity owning a life insurance policy that guarantees us cash value growth at one or two percent to do the same thing, only we are using the insurance company’s money. And Warren Buffett says, the only way to create wealth is to leverage other people’s money.

John: That’s so true. There’s a tip that I’d like to give our listeners right now is to think in percent. You mentioned this in your book, Winning Your Financial Gain. It’s so important when we’re talking about comparing policies, when we’re talking about using the money out of the policies, we need to be able to think in percent. It’s not necessarily an easy thing to do for everybody. So, for to start with, just look in terms of the numbers that are put in and the numbers that come out.

That will be an easy way to start and as you go on that, then start training yourself to think in percent. Because most people think that they understand percentage, they think that they understand what a rate of return is. They have a vague idea, okay well 6% must be better than a 4%. But till you can really think in the percentages, look at the real numbers and train yourself to think in percentages as they relate to the real numbers. And that will help you a lot as you learn to think in percent.

John: And there’s one other thing, when you’re looking at an insurance policy, always get the guaranteed numbers. Add up how many premiums you’ve paid over the first 20 years and see what percentage that is of your guaranteed cash value. And the difference is what your cash value grew by.

John: Yeah. And you’re training yourself to think of percent that way too as you find out, you do get that percentage, very important.

Tom: And that’s the only way really to compare one policy to another to see which one’s performing better. Now it’s going to be different on different individuals because of your health, your age and all those things because those are figured into it. But that’s the way you, the consumer can do a good comparative analysis. Add up your premiums and make it over a long period of time, because whole life is whole life. You don’t want to stop at five years, you don’t want to stop at 10 years because the cost of the insurance is still in that at that point.

Get out there 15, 20, ideally 20, 25 years and see what this is going to end up with. How much money did you put in to get the guaranteed cash value. If you had to put 90% of the cash value there yourself out of your pocket, a policy didn’t work really, really super well for you. So you might want to shop around. If you’ve put in 70% percent of the money that’s in the cash value, well that’s probably more realistic, that’s probably more of what a well-designed policy should look like.

So, don’t be fooled by the fact that people say, well the dividend rate is 4% and your loan rate is 5% so there’s only a 1% difference, that’s inaccurate. Don’t be fooled by the fact that a contract is figured on 4% guarantee. Realize what that means. Re-listen to this podcast, don’t be taken advantage of. Get the policy that’s engineered and designed with the maximum cash value, the minimal amount of premium and the lowest death benefit possible and you’ll be heading on the right track.

John: There we go. Alright, well this has been a great podcast, and we’ll look forward to being back next week with you, here on Wealth Talks. So we talk about solutions, money and other things that create wealth in your life.