I wouldn’t be a good finance blogger if I didn’t take a minute to point out my love for term life insurance. We love it more than Donald Trump loves his daughter. More like loves her a long time! Just kidding please don’t have the CIA shoot me.
I tend to look at insurance in a pretty simple fashion. It should be in place to protect someone (usually a spouse) in case a major source of income goes away. The insurance settlement should be enough to pay off any debts and make sure the surviving spouse has enough money to live a comfortable life before she goes and shacks up with the mailman or your friend Billy. DAMMIT BILLY COME ON. MY CORPSE IS BARELY COLD. I AM SO GONNA HAUNT YOUR ASS.
Other than that, we can’t really see much use for life insurance. Many even go down my path, choosing to self insure. Insurance agents and other wusses might advocate getting insurance even if you don’t need it today, essentially as way to ensure you’ll have access to insurance in the future. Yes, this is an argument they make with a straight face. It happens “all the time.”
Yeah, suuuure it does. It’s the equivalent of getting a haircut today just in case you can’t get a haircut tomorrow.
The role of whole life insurance
So let’s talk about whole life insurance. I won’t get into too much detail because only insurance guys like reading up on the minutiae of the latest offering from Manulife.
Unlike term life insurance, it never expires — provided you pay the premium. There are two parts consisting of a death benefit and a savings component. The savings component can be invested in various things, including GICs, stocks, etc., usually a product with some sort of insurance feature on it. So the equity portion of the savings component would be in a segregated fund, an investment that charges higher MERs in exchange for assurance you won’t lose all your money.
Whole life insurance sounds like a crummy deal, but there are times when it really makes sense. Estate planning is one such scenario. Since insurance proceeds always pass onto heirs tax free, parents can use whole life insurance products to ensure their kids have enough to pay the tax on any inheritances.
Say mom and dad own a cabin in the woods they’d like to pass onto junior. That cabin would have to be sold to the kid, which means capital gains tax would be owing by the estate. Insurance would allow junior to get the cabin and make sure there’s money left over to pay the taxes. If the parents don’t have enough other assets to pay the tax, the feds can and will seize the cabin.
WHOO KIDS CRA PARTY IN MUSKOKA!!
(Looks around, everyone is reading nerdy tax books)
The problem with whole life
I have no problem with insurance agents selling whole life to people like that. It can play a useful role in estate planning.
What I do have a problem with is insurance salespeople selling the product as a savings account to financial dumbasses.
Such a practice exists today. Oh lordy does it ever. It’s common enough and used poorly enough that it’s time to ban whole life insurance.
I actually talk to people with money problems on a regular basis. It’s part of being a private lender. And more often than not they’re stuck in some whole life insurance product. These aren’t people who need to protect assets from taxation. They’re unsophisticated people who wanted to start saving for the future. So they talked to their local financial guy and now they’re locked into paying $100 or $200 per month into an insurance contract.
These are people who are drowning in debt, folks who are in deep financial doo doo. They shouldn’t be in such products. But they are.
We all know why, of course. Commissions are fantastic for whole life products. An insurance guy is going to push them. He’s got kids to feed and 14 different kinds of his own insurance to pay. Insurance guys are always overinsured. It’s hilariously bad. “Yeah, I have three different kinds of disability insurance. Only a moron has two.” To these guys, there’s no problem that can’t be fixed with more insurance.
The problem with selling whole life insurance to people who don’t really need such a product is it’s hard to argue an insurance guy is really ripping off somebody with such a product. It provides a benefit. It’s just not an ideal benefit. Buddy is getting ahead each month since some of his payment goes towards the cash value. He’d be better off just saving in a regular account, of course, but he’s still getting ahead each month by paying into this thing.
I’m not really serious
Okay, look. I don’t really think we need to ban whole life insurance. It’s a niche product that is a useful estate planning tool.
So how do we stop shady advisors from selling the stuff to unsuitable clients? Especially since a lot of the people responsible work for less than reputable outfits like World Financial Group and Primerica. These people come and go so fast that shaming them is hardly worthwhile. They’re the zombie army of the financial services industry. No matter how many you shoot, they still don’t go away.
And we can’t really expect the regulatory agencies to do anything, since it is easy to argue that such products do have some benefit to the client.
I don’t know what the answer is. Do we ban whole life insurance for people under 40? Do we make sure people actually understand it before entering into it? Or do we just do what I’m doing today and trying to make the target market doubt the product?
I dunno. All I do know is I’m tired of seeing people come into my office and tell me that they “have” to pay $100 per month for a shitty insurance product that is doing them more harm than good.
For most people, buying a house is one of the most exciting times in their lives.
One of the most ingrained parts of our financial culture is home ownership. Not only has it been a decent store of wealth over the last few years, but we have an emotional connection to our houses. Little Timmy took his first steps right over there. And then little Susie pushed him over because she was jealous. Ah, such memories.
Homeowners have all sorts of advantages compared to renters. They have the ability to borrow large sums of money using just real estate as collateral. Once they get some equity in the house, they can then access that equity at a cheap interest rate. Homeowners don’t pay any taxes on gains in the property’s value, either.
There are advantages to being a renter too. Renters are more mobile, which is a plus in 2016. It costs a lot of money to sell residential real estate using traditional means, although that is coming down. And renters get to avoid property taxes, expensive house insurance, and upkeep, all things the average homeowner discounts when calculating gains from their principal residence.
But on the whole, arguing for home ownership will always be better than arguing against it, mostly because of a truth many don’t realize. Renting appeals to someone’s logical side. Home ownership appeals to their emotional side. Eventually, our emotions win out. So we buy a house.
Don’t discount the emotion of owning a house. People get very attached to a place they don’t even own, an attachment that can lead to some really dumb moves. And I’m not just talking about the time I put sriracha sauce and jalapenos on my sub. My mouth is still burning.
The biggest mistake homeowners make is falling in love with a house.
Smart Realtors know this and they exploit it nicely. “Hey, I know you said you only wanted to pay $300,000, but I found you this really nice house for only $320,000. What’s the harm in looking?”
The next thing a buyer knows they’ve completely scrapped their budget. Especially when Realtors say things like “go ahead. Money is cheap.”
Another big mistake new home owners make is when it comes time to shop for a mortgage.
They start out well, browsing the various rate comparison websites for the best rates. Or they might shop around the old fashioned way by picking up the phone and calling banks and brokers.
“Calling people? Oh, the humanity!” — millennials.
But then their well-laid plans start to come unraveled. In their haste to get a mortgage, sometimes new home owners settle for less. Their mortgage broker might not be able to get them a 2.49% mortgage, so they blindly accept 2.69%. The extra 0.2% ends up costing thousands in extra interest over a 25 year loan.
And finally, we come to one of the biggest mistakes of all. Choosing the wrong mortgage life insurance.
Bad mortgage life insurance
As a former mortgage broker, I know the story all too well.
After securing a mortgage for the borrowers, the agent then begins the pitch for mortgage life insurance. They can be protected for just $25 per month, or $30, or whatever. It’s an easy sell because it’s cheap, easy, and the broker has successfully tapped their emotions. Nobody wants to leave a spouse with a huge mortgage debt.
And best of all for the broker, they get a nice commission for selling it. Not as nice as the commission for selling the mortgage, but it’s still a nice bit of cream at the end of a transaction.
But this kind of mortgage life insurance is a real crummy deal for the customer. Premiums stay the same even though the mortgage balance is going down. It’s one insurance company offering the product, so they have no assurance the price offered is competitive (spoiler alert: it’s usually not great). And buying an insurance product from a mortgage broker or banker isn’t generally a good idea. They’re not insurance people.
Probably the worst part about those kinds of mortgage life insurance products is something called post-claim underwriting. Yes, those are fancy words that only make sense to insurance people. What they mean is the insurer waits until you die before seeing whether the stuff put in the application form was true or not.
Here’s how it works in layman’s terms. When you get one of those policies, you answer a few health questions. Once you die, the insurance company starts to verify the validity of these questions. If the insurer finds something they don’t like, this could mean your claim is more denied than that one time I tried to date the popular girl. And her hot friend. And her kinda goofy looking friend.
Instead of buying crummy mortgage life insurance, people should buy term life insurance with a payout large enough to cover their entire mortgage balance.
The difference between the two products is very important. A term life insurance policy will have a consistent payout value for the length of the term, rather than going down with the value of the mortgage.
Since term insurance coverage is agreed to by both parties before you start paying premiums, it’s a solid contract. As long as you continue to pay, you’re covered. There’s no nasty surprises when you’re worm food.
And finally, Canada Mortgage Insurance deals with all sorts of insurers, rather than just one. This translates into much lower prices which can really add up over the life of a mortgage. A decrease of just $20 per month translates into a $6,000 savings over the life of a 25 year mortgage. And remember, that’s not for equivalent insurance. That’s for better insurance.
There are two ways to go about getting mortgage life insurance. The bad way is taking the insurance offered by your bank or broker. The better way is using an insurance broker to get a much better–and usually cheaper–term life insurance product. Even if you have crummy insurance in place today, it’s not too late to switch.