Whole Life vs Universal Life Insurance For Cash Management

Dr. Robert P. Murphy
September 15, 2023
Whole Life Insurance, Infinite Banking, Cash Management, Financial Planning
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In previous articles (e.g., here), I have made the case for using a properly structured Whole Life insurance policy not only for the death benefit coverage but also as a cash management vehicle. The founder of “Infinite Banking,” Nelson Nash, strongly argued in his writings that only Whole Life would be a suitable foundation for his approach and that attempts to base it on Universal Life products were foolhardy.

On the other hand, there are some financial professionals who believe that UL — and nowadays, they specifically have in mind Indexed Universal Life — provides an even better platform for the “living benefits” of permanent life insurance. (See, for example, this popular video by Doug Andrew.)

In the present post, I’ll explain the basic differences between Whole Life and Universal Life and why WL is superior to UL for cash management purposes.

Plain Vanilla UL

The company that would come to be known as E.F. Hutton introduced Universal Life (UL) in its modern form in 1979, though the concept (including the name “Universal Life”) went back at least to 1971, in a speech by G.R. Dinney to the Canadian Institute of Actuaries.

Ironically, it was also in 1979 that the FTC issued a scathing report on the existing life insurance market, castigating Whole Life policies for their poor returns and opaque operations. In the midst of the high inflation and interest rates of the late 1970s, it seemed much better for consumers to “buy term and invest the difference,” or at the very least to borrow as much as possible against their Whole Life policies and put the money into bonds, leading to a “run on the bank” scenario for the life companies.

The basic structure of a Universal Life policy was an annual renewable term policy, with a “side fund” cash account that would be credited a certain interest return. The term Universal Life was intended to convey the flexibility of the product. Unlike a standard Whole Life policy with its fixed premiums and death benefit, the policyholder of a UL product could adjust the premium payments up or down and turn the dial on the death benefit. (For example, if part of the purpose of the life insurance was to pay off the mortgage in case the breadwinner died, then each year, as mortgage payments were made, the death benefit on a UL policy could be correspondingly reduced.)

The UL policy would be charged for the pure-term insurance expense every period. As the insured aged, the cost would rise, of course (just as one-year term insurance policies become more expensive the older one gets), but on the other hand, if the policyholder “overfunded” the UL in the early years, then the rising cash value would reduce the “value at risk” (meaning the death benefit minus the cash value), and this would cut the other way, tending to reduce the annual mortality expense.

In the big picture, the plain vanilla UL product was supposed to be more transparent for consumers, rather than the “black box” of traditional Whole Life policies.

Variable and Indexed UL

Insurance companies took the premium payments for plain vanilla UL policies and invested them in conservative fixed-income assets, just as they did with the premium payments for traditional Whole Life policies. In the early 1980s, the historically high-interest rates — compared to the low return rates on the bonds purchased years earlier to “back up” older Whole Life policies — made ULs seem much more advantageous than WL.

However, as interest rates came down and insurers had time to roll over their old bond portfolios, the apparent advantage for UL eroded. In 1986, Variable Universal Life (VUL) was introduced in the US market. It operated the same as regular UL, except the client could choose from different subaccounts for the “side fund.” Younger clients who wanted basic death benefit coverage and equity-like returns could, for example, choose subaccounts that invested in the stock market.

Another innovation occurred in 1997 when Transamerica introduced Indexed Univeral Life (IUL). This was like VUL, except the subaccount was tied to an index (such as the S&P500). However, the interesting feature was that IULs offered exposure to the stock market’s upside potential but no downside risk. In other words, IUL apparently gave the same basic death benefit coverage as Whole Life, but in years when the stock market boomed, the IUL side fund would grow much more than the cash value in a WL, yet when the market crashed, the IUL would emerge unscathed.

In case this seems impossible, under the hood, the insurance companies take premium payments for IULs and (after accounting for the expense of the pure mortality risk) invest in call options on the relevant index (such as the S&P500). Thus, if the index rises, the call options likewise rise in market value. However, if the index crashes, the options expire worthless; they don’t go negative. The insurance company is just out the original price of the options.

Why UL Is a Poor Foundation for Cash Management

Now that we’ve explained the basic mechanics of plain vanilla UL and its more exotic variants, we can answer the question: Which vehicle is best for cash management?

I still align with the original guidance from Nelson Nash. The whole point of having a “headquarters” for your cash is that it’s safe and predictable. You want the guarantees that are embedded in a Whole Life contract, where the insurer tells you the fixed premium you need to make, and then the insurer is on the hook for meeting the guaranteed projections in rising cash surrender value.

In contrast, even with standard UL, the client takes on the risk. It’s not as certain what premium will be necessary in, say, twenty years to keep the cash value marching steadily upwards.

If even plain vanilla UL is too risky to be suitable for cash management purposes, then VUL isn’t even close, where the market value of your life insurance policy can drop when stocks crash. IUL is better in that you have downside protection. But even here, you are introducing more volatility into the future value of your life insurance policy. And keep in mind those call options aren’t free; they definitely drag on the internal growth in the years when the chosen index doesn’t perform well.

It’s important to remember that practicing cash management with Whole Life doesn’t tie an investor’s hands. No, the point of building up a large cash surrender value in one or more of these policies, instead of (say) bulking up a 401(k), is that the policyholder has liquid funds to seize investment opportunities. If someone wants to buy call options on the S&P500, they can still do that. But that’s not a good way to store your “cash.”

Nelson Nash had it right: Whole Life insurance is the best financial product for taking control of cash management and reducing reliance on outside bankers.

NOTE: This article was released 24 hours earlier on the IBC Infinite Banking Users Group on Facebook.

Dr. Robert P. Murphy is the Chief Economist at infineo, bridging Whole Life insurance policies and digital blockchain-based issuance together.

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