05 Jul 2013

Does Whole Life Insurance Inefficiently Mix Two Goals?

Economics, Infinite Banking Concept, Insurance 12 Comments

[NOTE: The following article originally ran in the June 2013 issue of the Lara-Murphy Report.–RPM]

Does Whole Life Insurance Inefficiently Mix Two Goals?

by Robert P. Murphy

June 2013

In last month’s issue of the Lara-Murphy Report, I explained my own history with Nelson Nash’s Infinite Banking Concept (IBC). IBC allows you to “become your own banker” by funding large purchases through the use of a properly designed dividend-paying whole life insurance policy. I received a lot of good feedback on the article, but also some criticism. In this month’s issue, I want to specifically respond to the critique posted at the blog “Libertarian Investments.”

Summarizing the Critique

The post ran on June 15, 2013, and was titled, “Infinite Banking Concept or Whole Life Insurance.” Let me quote extensively from the post to accurately convey the author’s perspective:

I have never been a fan of whole life insurance.  I have always thought of it as a rip off.  If you need life insurance, then get term life insurance.  You don’t need to mix two things – life insurance and savings/ investments.

I can possibly see benefits to buying whole life insurance for a limited number of people.  Generally, I still think it is a scam though.  There are salesmen who solicit people to buy whole life insurance policies and these salesmen make a living doing this.  This doesn’t automatically make it bad, but I suppose it is due to the nature of the business.

I understand there are salespeople and there is marketing in almost every industry.  A car salesman makes a commission, but it doesn’t mean that you are getting ripped off when you buy a car.  But there are significant differences.  You can go online and get a quote for a term life insurance policy without speaking to anyone.  They will call you up and verify your information.  They may send out a nurse to you to get a physical to make sure you are healthy.  If you are young and healthy, you can get term life insurance that is quite inexpensive.  There really is no need for a salesman…

Whole life insurance is mixing things.  It is mixing life insurance and your savings and investments. For this reason, it makes the numbers rather confusing.  I think the industry likes it this way.  But we all know there is no free lunch (at least those reading this blog who call themselves Austrians).  There is no magical rate of return just because it is a whole life policy.  There are no special interest rates to be earned.  The salesman’s commission has to come from the payments you are making on your policy (so to speak).

I am still not really seeing any advantages to the IBC, other than it being a good plan for those who lack discipline in their financial life.  If anything, IBC would be a disadvantage because of the commissions and fees that you are handing over, when you can simply do much of it on your own and cutting out the middle man (the salesperson).

In conclusion, I might have to read more of Robert Murphy on this subject.  I respect him and I want to make sure there is not something that I am overlooking.  But for right now, I would suggest sticking with a good term policy if you need life insurance.  Take care of your saving and investing separately.  I don’t see a need to combine the two together and confuse them. That is how you get ripped off. [Bold added.]

Thus we see that this critique (the tone of which was far more polite than I lot of the commentary on whole life) falls back on the standard “buy term and invest the difference” recommendation. I specifically addressed that in the last issue, in the context of Dave Ramsey’s critique of whole life, and I’ll end up reiterating some of the key points here in this article.

But the reason I chose to address this specific critique is the writer’s emphasis on the notion that whole life insurance is “mixing” the two different goals of (a) pure life insurance and (b) wealth accumulation. At first this sounds like a very damning point, but as I hope to show, if we moved the context to another arena, it would be an irrelevant bit of trivia.

An Analogy With Real Estate

Most people are familiar with real estate (because we all have to live somewhere), so this is an easy context in which to make my point. Imagine the following hypothetical conversation between two financial advisors:

SALLY: I was talking to a couple last week, who currently live in a small apartment but are now expecting to have a baby. The husband has a stable job, they have a diversified portfolio of financial assets that are on target for their retirement, they hate moving, the husband wants to get a dog, and the wife wants to start a garden. I told them that given all these factors, and especially with the tax deduction on mortgage interest, they should seriously consider buying a house, instead of moving to another apartment.

DAVE: What are you nuts?! Everybody knows home-buying is a scam. For one thing, there are real estate agents who take a nice commission on both ends. But more important, if you buy a house to live in, you are mixing two things: your purchase of shelter services, with real estate investing. There are houses that can be rented; your monthly payment to a landlord is much less than what you’d pay on a conventional mortgage for the same property. If you really want to invest in real estate, then take the money you save on your monthly house payment and go put it in a REIT or something. And last thing: Don’t bother running numbers trying to show me clients who did OK by buying their home, because at any moment Congress could take away the tax deduction and oops, there goes your whole case for why somebody should buy instead of rent. Only suckers own the house in which they live, especially for the poor fools who end up selling their house soon after they buy it. I always tell my clients to rent.

Now let me ask: Does anyone think our hypothetical financial advisor Dave above just “proved” that it’s always a bad financial move to buy a home? Yes, sometimes it’s a bad decision—if someone’s job causes him to constantly travel, or to relocate every other year, then renting probably makes more sense. But we certainly can’t discredit “buying a home” with the observation that it’s mixing the two goals of shelter services and real estate investing.

Notice two that there’s nothing contrived or needlessly complicated about the benefits of buying a home. It’s a straightforward transaction, but if we are to understand its costs and benefits, we need to realize that it’s not just a purchase that provides a flow of shelter services—it can also serve as collateral for loans, it can be bequeathed to heirs, and if the financial picture really changes it can be sold, even before the mortgage is paid off (so long as the owner isn’t underwater). And yes, people need to take the tax code into account when making a major decision such as buying a home, including the deductibility of mortgage interest as well as the (limited) exemption on capital gains for owner-occupied houses. To say this doesn’t concede that “home buying is based on the tax code,” it just reflects common sense.

Let me end this analogy with the final observation: One of the strongest motivations to own one’s house is the peace of mind and security from knowing that, well, you own the place in which you live. If you rent, you had better not get too attached to the place, because you might not be allowed to renew the contract (at least on the same terms) indefinitely. You simply can’t exactly replicate “buying a home” through “rent a comparable property and invest the difference in real estate.” Ultimately, the straightforward transaction of buying a house has certain attributes that are unavailable through other financial strategies.

Back to Life Insurance

The situation is similar when it comes to whole life insurance. It is a straightforward financial instrument: You sign a contract with the insurance company, promising to pay a (level) premium for a specified length of time. In exchange, the insurance company promises to pay a specified amount either when you die, or when you reach a (high) age, such as 121 in recently issued policies. That is the essence of what a whole life insurance policy is; it effectively provides “pure life insurance” for your whole life (since most people are going to die before hitting the maturity date). But in addition, because of its nature, it has other features as well.  You can borrow against it, you can specify an heir to receive the death payment, and if the financial picture changes drastically, you can “surrender” the policy and receive what is effectively the “equity” you had built up inside of it thus far.

Now of course, if someone is going to seriously consider buying a large whole life insurance policy, then he or she needs to consider all of the tax ramifications, because there are plenty of advantages with the current code. So long as a policy has not become a “modified endowment contract” or “MEC” (and reputable insurers and agents will ensure that doesn’t happen), then the policyholder is not taxed on the accumulating cash value, policy loans have no tax implications, and dividends can be withdrawn up to the point of the “cost basis” in the policy without tax. (And of course, whether the policy is a MEC or not, the death benefit payment is itself an income-tax free event for the recipient.) None of this is to suggest that whole life is a creature of the tax code, it just means a person’s lifetime financial plan must consider the tax advantages when evaluating whole life as an option.

For many people, particularly those who use whole life in the context of the broader IBC philosophy, its fundamental virtue is control over one’s money. Usually IBC practitioners talk about “control” in the context of being able to access (through loans, dividends, or partial surrenders) the wealth embodied in a policy at any point, without penalties, unlike traditional tax-qualified investment plans.

However, in our present context, whole life’s superior “control” comes in the form of having guaranteed life insurance coverage. If you just buy a term policy, you may not be able to renew it when it expires. You are in the same situation as the renter, who might get kicked out of “his” house by the landlord, because it wasn’t really “his” house to begin with. With a whole life policy, that particular worry is gone.


In closing, let me be clear that I am not saying that buying a house right now in 2013, especially by going to a commercial bank and taking out a 30-year mortgage, is a great idea. In our other writings, Carlos and I have explained that we think Ben Bernanke’s policies have set the U.S. up for another crash, and that taking out loans from commercial banks is itself a dubious practice that contributes to our inflation problem.

All I have done in this article is show that conventional financial discussions, which routinely dismiss whole life on the grounds that it “mixes two goals,” would likewise end up telling people that they should always rent apartments. We can see how absurd such a categorical statement would be, and we can see all the ways that their hypothetical analysis was not actually apples-to-apples.

If you can understand what I mean with respect to buying a home, then you can at least appreciate my claim that an analogous thing has happened with whole life insurance. When people like Dave Ramsey or the blogger quoted above say they are making a fair comparison by buying a term policy, they are simply wrong. You can’t replicate the flow of benefits from a whole life policy by buying term.

To point this out doesn’t, of course, mean whole life is for everyone. For example, a young couple with very little discretionary income and a bunch of young children will need a large term policy, and depending on the numbers it’s possible they have to wait a few years before even thinking about taking out even a modest whole life policy. I have no problem if the financial gurus simply caution people that whole life isn’t for everyone. Yet they go much further than this, and say that only a fool would buy a whole life policy. Such over-the-top condemnations don’t even begin to make a valid comparison, as I’ve tried to show in this article.

12 Responses to “Does Whole Life Insurance Inefficiently Mix Two Goals?”

  1. Jason says:

    I couldn’t agree more. Whole life is a great vehicle if the situation is uniquely attuned to using it. If the buyer is responsible and did a thorough investigation of what they’re buying into, the advantages would probably outweigh the costs in the long run. Another perspective to take might be from the end result looking back at the beginning. After a person has been in a home for 30 years and they have built equity in their house, have full control over how they wish to use the house (or dispose of it), and considering all the tax advantages they have been able to use throughout the life of the purchase, I doubt many would look back and say it wasn’t wise. The same would be true of a whole life insurance contract. But just because they bought a home didn’t mean they also never contributed to their 401(k) or IRA in addition. It’s perspective, it’s taking into account want the buyer wants, and what the buyer needs, and also what the buyer can keep themselves accountable to.

  2. Tel says:

    But more important, if you buy a house to live in, you are mixing two things: your purchase of shelter services, with real estate investing.

    In that case it is good to be mixing the two, because if you own the house and also live in the house you have both the opportunity and incentive to keep up maintenance and thus maximise both your return and your quality of life. Rental houses are almost universally in worse state of repair.

    That’s pretty much a classic synergy situation, and I can’t see how a similar synergy applies to whole life insurance.

    To say this doesn’t concede that “home buying is based on the tax code,” it just reflects common sense.

    In Australia a lot of it is based on the tax code, but they allowed investment rental properties to tax deduct the mortgage interest (with some significant limitations imposed), while owner/occupiers are exempt from capital gains tax. It is a bit of a stupid system in many ways (all of capital gains tax is stupid) but now we have adjusted to it and changing things would make matters worse.

    Thing is, that system grew up for political reasons with governments attempting to channel investment into owner/occupiers and encouraging families to settle into an area for the long term. Neighbourhoods with predominately owner/occupiers and long term stayers are definitely nicer to live in. People who have something to lose don’t make trouble.

    • ATeamRules says:

      That’s pretty much a classic synergy situation, and I can’t see how a similar synergy applies to whole life insurance.

      With whole life insurance, you get a synergy between the policyholder’s desire for a financially stable insurer and the tax code.

      Basically, you want the insurer to charge enough so it can pay its claims with a high degree of certainty, but you you don’t want the insurer to realize enormous profits at your expense. Whole life insurance solves this by charging a premium that is much higher than the expected value of the death benefits and paying most of that excess back to the policyholder as atual results warrant. This is made much cheaper by giving both the insurer and the policyholder preferential tax treatment. From the point of view of the policyholder, you improve both the value of the tax preferences and the solvency of the insurer if the premiums are large relative to the death benefit, assuming you trust the insurer to actaully pass back the excess premiums.

  3. Keshav Srinivasan says:

    Bob, I have a simple question, which I asked in the previous post as well: what if you have no bequest motive, I.e. no heirs and you don’t care about giving your money to charity after you’ve passed on. Then would whole life insurance still make sense?

    Also, could you explain how dividends work in a whole life policy?

    • Bob Murphy says:


      Good questions, but on this topic I’ve found that I need to give comprehensive answers or else people bite my head off. I would need to think about your first question, but the latter I will definitely be addressing in a (big) future post.

  4. Jackie says:

    Hi, nice blog shared above. People do choose life insurance policies according to their livelihood. Now a days various life insurance policies are available, according to the family income, people choose life insurance policies. Really great thought shared above. Awaiting for more post like this.

  5. Roslyn O. Rosales says:

    Variable universal life insurance pays your beneficiary a death benefit. The amount of the benefit is dependant on the success of your investments. If the investments fail, there is a guaranteed minimum death benefit paid to your beneficiary upon your death. Variable universal gives you more control of the cash value account portion of your policy than any other insurance type. A form of whole life insurance, it has elements of both life insurance and a securities contract. Because the policy owner assumes investment risks, variable universal products are regulated as securities under the Federal Securities Laws and must be sold with a prospectus.

  6. Matt M. (Dude Where's My Freedom) says:

    I’m not so sure about your home analogy. In my area (I don’t really follow real estate, so maybe this is incredibly atypical?) it’s much cheaper to buy than it is to rent, even after factoring in property taxes and insurance. From what I’ve been told by people in real estate, this is essentially a risk premium. The owner of a property is exposed to risk (whether it’s a crash in market values, or the hot water heater breaking, or whatever) that a renter is not, therefore renters have to pay more in order to enjoy the benefits of living in a house without being exposed to any of the risks inherent in property ownership.

    So in this case, there is no “rent and invest the difference” because the difference is negative.

    • Tel says:

      That’s unusual. Hot water systems are reasonably predictable and come with a warranty in any case, I don’t believe they are the cause of the problem.

      I would be guessing there’s a component of sovereign risk built into that, with people being unsure about future taxes, future regulations and other types of uncertainty. In the US, if an incorporated city starts to go broke they tend to take out a whole crater of real estate prices at the same time (just look at Detroit, well OK, Detroit has compound problems, but you get my drift).

  7. Chris says:

    Have you talked to Gary North about this? Now that’s a debate I would like to see!

  8. ATeamRules says:

    I’m an occasional reader of your blog (the Krugman posts are the reason I keep checking back), but I will be commenting on the IBC posts because I have some knowledge and interest in the subject of life insurance. I know that many people in the life insurance industry strongly believe in the value of the whole life insurance and I am interested to read your take on it.

    I take issue with a couple of things in your post:

    However, in our present context, whole life’s superior “control” comes in the form of having guaranteed life insurance coverage. If you just buy a term policy, you may not be able to renew it when it expires. You are in the same situation as the renter, who might get kicked out of “his” house by the landlord, because it wasn’t really “his” house to begin with. With a whole life policy, that particular worry is gone.

    While true, there is still an important difference from home ownership which hurts your analogy. At any age, you will need someplace to live. The same can not be said for life insurance. A family man or woman in his productive years has a strong need for life insurance to care for his loved ones in the event of his death. While there can be needs to insure even after a person retires, the likely amount of insurance desired is almost certainly much smaller for a retiree. The main reason retirees would want to own life insurance are for investment/tax purposes rather than insurance.

    None of this is to suggest that whole life is a creature of the tax code, it just means a person’s lifetime financial plan must consider the tax advantages when evaluating whole life as an option.

    On the contrary, there are plausible tax treatments (i.e. all increases in cash value are treated as taxable investment income to the policyholder, or death benefits in excess of premiums are taxable to the beneficiary) that would almost certainly kill the viability of IBC and the concept of cash value life insurance more generally. I don’t think these tax treatments are particularly likely to come into being, but for a 30-40 year old, the rest of your life gives congress a lot of time to try something stupid to raise a bit of revenue.

  9. Matthew Reade says:

    Discussion of this blog is really good for people to make awareness of insurance & also necessity of insurance. Thanks for writing this kind of blog.

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