Monday, October 26, 2015

Buy Term Insurance, Whole Life Insurance, or Both? What Do Consumers Actually Buy? It Depends. (Part 1)

This is a series of articles summarizing a preeminent recent study examining the intersection of insurance and personal savings.
In “Buy Term and Invest the Difference Revisited," finance professors David F. Babbel from The Wharton School of the University of Pennsylvania and Oliver D. Hahl from Tepper School of Business, Carnegie Mellon University examine in detail term vs. whole life insurance in a paper published in May of this year in theJournal of Financial Service Professionals[1].
Making a decision between buying term, whole life, or a combination of both types of life insurance is difficult. Many advisers have previously presupposed that “buying term and investing the difference” is the right choice. Is it? A thorough analysis and revisit by two leading finance professors, Babbel and Hahl, is revealing:
This study demonstrates that financial analyses which purport to show that the Buy Term and Invest the Difference (BTID) concept dominates the combination of permanent life insurance supplemented with term life are deficient in many ways and incapable of establishing this dominance.
Furthermore, “investing the difference” is somewhat harder than it sounds. They continue:
…the assumed financial discipline necessary to successfully implement the Buy Term and Invest the Difference approach is an unrealistic expectation for many consumers.
There is no one approach that suits everyone, but let’s explore in more detail.
History of Life Insurance in the United States
Life insurance is actually as old as Roman “burial clubs” under Roman General Caius Marius in the first century B.C. In the United Kingdom, it began in London at Lloyd’s Coffee House (future Lloyd’s of London) where members of the shipping industry frequently gathered and planned. In 1759 the Presbyterian Synod of Philadelphia sponsored the first life insurance policies in America for the benefit of their minister’s families.
Interestingly in the United States by 1930, on the eve of the Great Depression,more than 120 million (whole) life insurance policies were in force, the equivalent of one policy for every man, woman, and child in the nation at that time[2].  
During this extraordinary time of economy and searching for financial safekeeping, it may be that each child “was born with a whole life policy in his or her mouth,” however modest.
In addition, because life insurers had been restricted from investing heavily in the securities market since the early 20th century (ca. 1905, after the Armstrong Investigations), they were able to provide a significant source of liquidity during the Great Depression, when such sources were severely limited because of the numerous financial institutional failures[3].
Again, you might say that whole life insurance policies partially replaced savings accounts, in some respects, due to fear of bank failures.
My question is, will this happen again? And when?
Next, PART 2:  Does the Pricing of Term Insurance, Actually Dictate Value, a True Cost Advantage?
[1] David F. Babbel and Oliver D. Hahl, “Buy Term and Invest the Difference Revisited.” Journal of Financial Service Professionals 69, No. 3 (2015), 92-103. (LINK)
[2] Dahl, Corey, “A Brief History of Life Insurance.”, Sept. 9, 2013. (LINK)
[3] Anne Obersteadt, et al., “State of the Life Insurance Industry: Implications of Industry Trends.” National Association of Insurance Commissioners & The Center for Insurance Policy Research, August 2013. (LINK)

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