Insurance plans must be able to withstand the pressures of time, while delivering what was promised years earlier. So how do you determine which ones will work both today and tomorrow? Looking back, we see whole life (WL) has performed well through economic ups and downs.

History lesson

All contracts used to be term insurance plans, so clients would get insurance protection for limited periods.

But clients wanted more coverage, so actuaries developed WL plans. Contracts are effective as long as the person’s alive. The policyholder’s premiums go to a fund from which death benefits and expenses are paid. Any excess is credited back to the policyholder in the form of dividends. People can take the dividends as cash, or they can use them to increase their death benefits or reduce their premiums.

WL policies can be participating or non-participating. The values of non-participating contracts are usually determined at issue, and all risks of future performance are borne by the company. If the insurer underestimates future claims, it has to make up the difference. If the insurer has fewer claims than expected, it gets to keep the difference.

In participating policies, any excess profits are refunded to policyholders. Also, par funds tend to be heavily invested in fixed income and, as a result, tend to exhibit low volatility (see “Whole life by the numbers,” below).

Then, investors wanted more transparency and the ability to invest their funds tax-efficiently. So, insurers developed universal life (UL) in the early 1980s. UL allows clients to purchase a plan and pay guaranteed fixed premiums for life. Clients can also deposit excess funds and select their own investments. In that era of high interest rates and supercharged market returns, this seemed a perfect combination—guaranteed life insurance with tax-sheltered growth, and the ability to invest in index funds, mutual funds and guaranteed interest accounts. Performance was no longer linked to the insurer, but to outside investments selected by the policy owner.

In the 1980s and 1990s, UL far outpaced WL. However, that could last only as long as markets remained heated and interest rates remained high. The 2008 crash turned the tide on UL rates. Suddenly, the low volatility of WL plans and their newly respectable rates of return made these products the favourite. Today, WL remains at the forefront of insurance sales, though UL may again become a better choice if interest rates rise and we enter an extended bull market. The current crediting rate for WL is about 6%; as long as investors are satisfied with that return, WL remains viable.

Client example

WL plans worked well for one of our most loyal clients, who recently died at age 100. My father, also an advisor, had encouraged him to buy the plan more than 70 years ago, and the dividends had grown to 150% of the face amount of the insurance. When his children were born in the 1950s, he’d also purchased a $10,000 WL participating plan for each child. As a result of the declared dividends, these policies have also exceeded the initial death benefit. For his insurer, the historical average return of the dividend scale interest rate was 7.6% from 1954 to 2013. And from 1984 to 2013, it was 9.5%, with a standard deviation of 2.1%.

About 25 years ago, I reviewed his son’s insurance plan and we found that he should increase his coverage. He bought a UL plan on both an individual life and joint life basis, cashing in the accumulated value in his WL plan and depositing it into the new UL contract. At that time, the rates for UL were 30% to 50% less than they are today.

Today, we’re reviewing the grandchildren’s situation, and are once again recommending WL participating plans because of low interest rates and market volatility.

Whole life by The numbers

In 2013, a typical dividend interest rate was between 6% and 7%; a 10-year average was 7%; a 30-year 9%; and a 60-year 7%.At one insurer, 97.5% of the surplus in WL participating plans has been distributed annually to policyholders since 1966.
For 2014, one insurer states that approximately 60% of policyholder dividends were derived from investment experience, 30% from mortality gains (fewer people dying than expected), and the balance from other factors, such as expenses, taxes and lapses.Typical standard deviation for WL plans has been 2% or less over the last 25 to 30 years, compared to around 16% for the S&P/TSX Composite over the same period.

Source: London Life, Great-West Life, Sun Life

by Daivd Wm. Brown, CFP, CLU, Ch.F.C., RHU, TEP, a member of the MDRT, and a partner at Al G. Brown and Associates in Toronto