Response to Robert Murphy on Whole Life Insurance

On June 15, 2013, I wrote a post about whole life insurance.  Robert Murphy, who is an advocate of the Infinite Banking Concept (IBC), responded to my critique.  In particular, he addressed the notion that buying whole life insurance is mixing two different goals.

In his post, Murphy used an analogy with real estate.  He asks the rhetorical question of whether buying a home is always a bad financial move because it is mixing goals.  Those two goals are investing in real estate and getting a place to live.

I don't necessarily think that purchasing a house is a good analogy to purchasing whole life insurance, but I get his overall point.  Personally, I try to explain to people that a house is a consumer good if you are going to live in it.  If you are going to choose between living in a million dollar house on the beach or a $90,000 condo somewhere else, you would be better off financially if you bought the condo in most cases.  Or you might be better off renting.  Obviously this wouldn't have been true if you bought in the year 2000 and sold it in 2006.  But generally speaking, you are better off paying less for a place to live, at least from a financial perspective, in most cases where there isn't huge appreciation happening.

This isn't to say that you should always look to buy a cheaper place to live in or to rent.  But you should buy something for the right reasons.  If you want a house on the beach and you can afford it, then maybe that is the best use of your money to bring you pleasure.  But it is not necessarily the best financial decision.  Many people stretch themselves to buy a place that has more space or is in a safer location, but it isn't necessarily the best move in terms of money management.

Of course, there are many reasons to buy a house that wouldn't apply to buying a whole life insurance policy.  In buying a house, you don't have to worry about getting kicked out by a landlord.  You can make changes to the house according to your own desires.  You can also get a fixed payment, which would actually be a financial benefit to buying over renting.  Also, in certain times, you might be able to get mortgage payments (plus taxes) that are cheaper than you would pay for rent in a comparable place.

I do think there is one strong comparison between buying a house and buying whole life insurance.  I also think this is one of the few good reasons to buy a whole life policy.  Both are essentially forced savings plans. (I use the term "forced" in a way different from referring to government force.  This does not involve violence, as you are making a decision in which you are essentially forcing yourself to do something to avoid default.)

If you buy a house with a typical mortgage, then a small part of your payment each month is going to paying down the principal balance on your loan.  As time goes on, the amount that goes toward principal gets bigger and bigger.  Eventually, you will pay off your house and not have to worry about a mortgage payment any longer as long as you keep living there.  There are some older people who are terrible savers, yet have their house paid off.  They would probably have a net worth of close to zero if they had never bought a house.

When you buy whole life insurance, you are essentially forcing yourself to save money each month by directing it towards the policy.  It is easy to say that you should buy term insurance and invest the difference, but a lot of people do not have the self-discipline to set aside that extra money.  It can almost be seen as the equivalent of allowing too much withholding tax during the year so that you won't owe any taxes when it comes time to file.  You give the government a loan just to make sure that you are not irresponsible with the money that should be earmarked for paying your taxes.

With all of that said, my biggest concern with whole life insurance is still that many people will get ripped off.  When people mix their goals in buying a house, they generally understand the numbers and they understand what they are doing (although we did see some bad judgement back in the days of the housing bubble).  I'm not sure that I can say the same for a whole life insurance policy.  This isn't a sarcastic comment when I say that you almost need a PhD in economics just to understand everything in it.  It is conflating the goals of life insurance and investing and it makes it quite difficult to understand what kind of a benefit you are getting and how much your rate of return really is going to be.

For this reason, I would generally recommend that people stay away from whole life insurance, unless you are really thorough and you can understand the terms and the numbers without confusion.  So while I won't make a claim that you are a complete idiot if you buy whole life insurance, I would caution most people to stay away from it unless you really understand what you are getting in to.  If there is any confusion on your part, you are probably getting ripped off.

In conclusion, I think most people are better off buying term life insurance.  Perhaps there are some good whole life policies that would be good for certain people.  But I fear that the people who would benefit the most, due to a lack of self-discipline, are also the people who would be least likely to understand the fine details.

Also, as a side note, just because I may have some disagreements with Robert Murphy and others on investment/ money management issues, it doesn't mean that we disagree on libertarianism.  We can both push for a dramatically smaller state (or no state at all) and still have disagreements about money management.  Neither one of us would hold a gun to your head and tell you that you have to buy a certain type of insurance policy.