Whole Life or Indexed Universal Life Insurance (IUL) - Which is Better?

I used to be an advocate of whole life insurance, having spent over 30 years with one of the top carriers in the industry. Both whole life and any form of universal life insurance - including IUL - have guaranteed elements. Mortality and other expense charges are not guaranteed, but do have maximum charges. Not all caps, floors, and participation rates are guaranteed, but IUL carriers do guarantee that they will not fall below a certain level.

There are two types of whole life - participating and non-participating. If you're looking for guarantees in all respects, non-participating whole is your product. Sold by investor-owned carriers (stock companies), non-participating whole life insurance offers a guaranteed death benefit, guaranteed premium, and guaranteed cash values. However, since the policy needs to remain profitable to the company 50 years or more into the future, these guarantees are usually ultra conservative. Participating whole life insurance is a product usually offered by mutual companies. Premiums in relation to the insurance amount, which is guaranteed, are usually higher than premiums for non-participating whole life. The guaranteed cash values may be similar. But participating polices have a look-back component in the form of dividends (not to be confused with dividends on shares of stock). Whole life dividends amount to premium refunds based on actual experience incurred by the company. Whole life dividends can be taken in cash, used to reduce future premiums, or applied to purchase paid-up additions to the insurance amount.

Many whole life companies heap criticism on indexed universal life insurance (IUL), despite simultaneously offering traditional universal life and variable universal life. The main target of their attacks is focused on IUL, which has taken a large chunk of market share from them over the past 15 years. These companies, for which whole life is their cash cow, would likely be treading water if they introduce IUL, since they are likely to lose as much on one side of the house as they gain on the other. Nevertheless, carrier after carrier has added an IUL product over time.

Whole life companies used to sell their participating whole life products on a “vanishing premium” basis. This concept sets the policyholder up to purchase whole life, with dividends used to buy paid-up additions. Then at some point down the road, subsequent dividends are applied to reduce premiums, and to the extent the dividends do not yet offset the entire premium, paid-up additions are surrendered to make up the difference.

The problem is, the guaranteed elements of whole life are as lousy as the guaranteed elements of any type of universal life. In order to be competitive, whole life companies rely on dividends, which are in effect refunds of premiums for the guaranteed elements that are determined in hindsight not to be needed to support the policy. If you stop and think about it, how is this really different from the “open chassis” concept for any universal life policy? Changes in policy experience will affect either product. You just get a chance to see the breakdown with universal life, while elements are hidden in whole life. Also, whole life pins its competitiveness to dividends, and any such refund will rise or fall based on actual experience in return on investments, mortality, and expenses. Universal life is pay as you go.           

In our low interest environment that has lasted since roughly 2003, all life insurance has suffered by virtue of a steady decline in yields in the General Accounts of carriers. In the case of the whole life companies, dividends have fallen. Many whole life companies have endured lawsuits from policyholders that were not, in fact, able to achieve “vanishing premiums”. Universal life policies too, that assumed 4% or even higher, in their guarantees, have also suffered. But low interest rates aren’t forever. This is a marathon, not a sprint.

So where does that leave us with respect to life insurance as an accumulation vehicle? Whole life or any kind of universal life, so long as they are efficient and designed to reflect market changes, should move in the same general directions. Changes in interest rates, mortality or other expenses affect whole life dividends in much the same way that they affect universal life.

To me, the difference is that IUL offers loans at guaranteed maximum rates that, over time, should be less than the long-term growth rates made possible through efficient index hedging. You can’t get positive arbitrage with whole life – ever.

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