“The real cost of anything is its value in alternative uses.”
– Thomas Sowell
By Kyle J Christensen, Founder, Principles-Based Planner, Unique Advantage
Unique Advantage Monthly Client Email – January 2025
8-10 minute read
Happy New Year! I love this time of the year. It’s a great time to refocus on the things that matter most, and realign mentality and behaviors with those things that matter most. I love looking forward. I love setting goals and working to achieve them. I believe I was blessed in my life with a natural tendency to look ahead instead of behind in my life. That may be a little insight into why I love being a Principles-Based Financial Planner™.
As it relates to my financial plan, one thing I am constantly looking to do is convert my term life insurance to whole life insurance. There are a myriad of reasons for this, many of which I will cover in this month’s article.
The Personal Financial Snapshot Model helps remind us of the foundational principles that predictably lead to becoming and remaining financially free. It also helps us identify inefficiencies, where money could be used more effectively. As I look at my model (and those of my clients), I want to find ways to accomplish my goals in the most efficient and effective manner possible.
Owning term life insurance is both positive and negative. It’s positive in relation to the principle of Maximum Protection. Term life insurance can provide me with significant amounts of life insurance coverage for a much lower premium than that of whole life insurance. In some cases, and at some periods of time in my life, term life insurance was the only, or the majority of the life insurance coverage I owned. The reason is, I couldn’t afford the premium for whole life insurance. I couldn’t save enough money to “convert” (change) term to whole life. But the priority was and is owning my maximum life insurance. I’m grateful that I have followed my own advice by always having my maximum life insurance coverage, especially now that I am uninsurable (due to my recent heart experience).
The downside of term life insurance is that it’s a “one-use vehicle.” Financial institutions love creating and selling “one-use” vehicles, which are financial products/accounts that are designed for a single purpose (i.e. IRA’s, 529 Plans, HSA’s, etc). One-use vehicles generally are much more restrictive in terms of when or how I can use my money. Of course, there are few such restrictions on the financial institutions that offer these types of products/accounts. They use the money however and whenever they want.
With term life insurance, I pay the premium for it each year, and if I die, it pays a benefit, but if I don’t, it doesn’t pay. There are no other benefits or uses. As I grow older, my premium will increase in my term life insurance policies (and not by just a little). Even if I have “level premium” policies, the premium only stays level for a period of time (the options are ten, fifteen, twenty, or thirty years). Once the level period expires, the premium increases dramatically, essentially forcing me to convert or cancel the policy at that time. Most people simply cancel, which is what the life insurance company hopes I’ll do. When a term life insurance policy is cancelled, no premiums are refunded to the policy owner and no death benefit remains in force. It becomes a total loss of money at that point to the former policy owner and a total gain for the life insurance company (their risk is reduced to zero).
Life insurance companies love to sell term life insurance. In fact, almost all life insurance companies sell term life insurance, and few sell whole life insurance. Why? Because term life insurance almost always results in cancellation in the future. In fact, it almost never results in a death claim (percentage-wise, it’s less than one).
With all of this said, I am not suggesting that term life insurance is bad, or something you shouldn’t ever own. In most cases, term life insurance is what a person should have, possibly along with whole life insurance. Over time, however, term life insurance incurs a cost to the policy owner. As such, it should be converted to whole life. Contrary to what most people believe (even among insurance agents) term life insurance is not efficient. And although whole life insurance requires much more premium, it is also much more efficient.
Let’s say I had $100,000 sitting in Ally Bank’s savings account right now. The current interest rate is 3.8% per year. This means I would earn $3,800 in interest in my savings account over the next twelve months (assuming the interest rate stays at that level, which is likely will not). Let’s say I also have a $3,000,000 term life insurance policy that I am paying $2,500(premium) per year for.
First, let’s look at the inefficiency of the term insurance over time. Over the next 20 years, I will pay $50,000 in premiums over that period of time ($2,500 x 20). If I started the policy today, I would be 68 years old by the end of the period. If I could qualify for life insurance coverage today, it would be very unlikely that I would pass away before age 68. This means that it’s much more likely that I would cancel the policy at or before age 68. And if I cancel the policy at that time, I lose all of the $50,000 that I paid, in addition to losing the $2 million death benefit.
It gets worse. When a person loses a dollar, they don’t just lose the dollar. They also lose what that dollar could have done for them. This is called Opportunity Cost. Thomas Sowell, today’s smartest economist (my opinion and many others’) said, “the real cost of anything is its value in alternative uses.” (Basic Economics, Sowell, p22). In other words, the real cost of anything is whatever else I could have done with that same money. And here’s the kicker, the better you are at investing, the higher your opportunity cost. In other words, a great investor like Warren Buffett has a much higher opportunity cost than a novice investor that just started working for Edward Jones. This is why Warren Buffett’s #1 Rule for Investing is “Don’t lose money.” With that understanding, if I have an Opportunity Cost rate of 8% per year, that $50,000 I lose in term insurance premiums is actually a cost of $114,404.91 ($2,500/yr @ 8% over 20 years).
Ok, hopefully that satisfies the engineers and number-crunchers in the audience (haha). For those who don’t love number-crunching, I apologize.
Now, what if I do something to stop that loss from happening? What if I can avoid losing the $50,000 over the next 20 years? What could do that? Converting the term insurance to whole life insurance. How does that stop the loss? Because whole life insurance is not going to be cancelled by the 20th year. It’s going to remain in force. Additionally, all of the premium I pay in whole life insurance will remain in my control and use (through the cash value), even though the premium will be much greater than it would have been for term insurance over the same twenty-year period. In fact, I will have access and use of more money than I pay in premium over the next twenty years, without having to die first. This is why there is no Opportunity Cost associated with whole life insurance. There is no loss of funds, guaranteed.
Converting the term to whole life insurance saves the term premiums ($50,000) I would have paid and would have lost. And if I save the $50,000 I would have paid and lost, then I also save/recover the Opportunity Cost associated with it. This means that I really save $114,404.91.
When a person converts term insurance to whole life, the rating that the person had on the term insurance is carried over to the new whole life policy. In my case, that’s a BIG DEAL. If I were to apply for a new whole life policy right now, with the heart issues I had last Oct., I would be denied coverage. But because I have a few term life insurance policies in force already, I can convert those to whole life, and I cannot be denied, and my new whole life policy will have the same great rating as my term policies have. Additionally, a few (very few) companies (i.e. Ameritas) will also give back, in the form of a premium credit, your previous twelve months’ premium associated with the term conversion. In other words, if I converted my term policy that cost me $2,500 per year, Ameritas will credit back $2,500, which will be used to reduce my first-year whole life premium. Going back to my Ally Bank account with $100,000 in it (example), if I converted a term policy with a $2,500 annual premium, I am essentially increasing my return on my bank account by another $2,500 (that’s money I would have needed to move from my bank to the new whole life policy, that now can remain). Saving $2,500 is the same as earning $2,500. My return on Ally Bank, in essence, goes from 3.8% to 6.3% (the additional $2,500 is also tax-free because of how it comes to me – in the form of a premium credit instead of taxable interest earned in my bank account).
Converting term life insurance to whole life insurance increases efficiency, stops term premium losses and recovers opportunity costs, and increases the percentage of my income that I am saving. It also puts me in a better position to avoid the problems of self-insuring in the future. I would encourage you to reevaluate each year your life insurance policies and take advantage of any opportunities you have to convert term to whole life.
Note that many life insurance companies don’t offer whole life at all. Additionally, some whole life policies do not perform nearly as well as policies issued by mutual life insurance companies (there are only a handful of mutual life insurance companies: New York Life, Northwestern, Guardian, Ameritas, Mass Mutual, and a few others). So, I would encourage you to convert with a mutual life insurance company (a mutual life insurance company is an insurance company owned by the whole life policy holders, not stock holders). A few mutual life insurance companies will actually allow you to convert from a term policy with a different insurance carrier to their whole life (example: Banner term policy to Ameritas whole life policy). There are parameters that must be met for this, but just know that it’s a possibility.
The choice to convert term to whole life involves each person’s situation and their capability to pay the premium for the new whole life policy. No matter how good something may be, if a person can’t afford to pay for it, it’s not an option. So, having the ability to pay the premium on the new whole life policy is and always will be a major factor to consider. However, most people have a greater capacity than they might think. When I am considering converting term to whole life, I ask myself this question, “Can I systematically save more money than I am currently?” If the answer is yes, then I convert some of my term to whole life. If not, then I keep the term insurance as it is for a little longer.
If you have any questions about this article, please reach out to me or a member of the Unique Advantage team.
I wish all of you a Happy and prosperous New Year! I believe this will be a great year. We have so much to be grateful for. Count your blessings. I look forward to hearing from you this year. Thanks for being the best part of my professional life. I love what I do because of you.
Sincerely,
Kyle J. Christensen
P. S.
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