Much has been written on the Internet about buying a life insurance policy, and most of what's written is about term life insurance.
As the story goes, "just pick the policy with the lowest premium". It sounds intuitive since term insurance is sold as a commodity product. Death benefit, premium. What else is there?
Under the hood, there's a lot.
On nearly every competitively priced term insurance product, profitability is zero or negative. I'm surprised more insurance agents don't know this. Policyholders don't know it, and they end up buying products from insurers who have to get "creative" on the back end so that they can make money on the deal.
After all, how can insurers afford to sell a product they're losing money on?
The answer is, they can't.
You can use your imagination for at least part of the answer on how they pull this off. But, part of the answer is... they treat term insurance as something of a loss-leader and then jack up the cost for insurance once policyholders have been paying premiums for a decade or more and discover they can't live without the coverage.
Here is a quote for a 10-year term policy from a well-known, very competitive, life insurer that specializes in term life insurance. The policy is $1 million for a 43 year-old male, non-smoker, standard risk rating:
The first 10 years are exactly what one might expect. The premium and death benefit is level. Then, something weird happens in year 11, at the insured's age 53. The premium goes... up.
For the first 10 years, the insurance company can afford to break even or lose money. They know enough people will pay the premium increase to make selling the product profitable.
The Internet will tell you that no one in their right minds would pay the increasing premium every year. But, the insurer's financial statements and persistency reports say otherwise. They wouldn't be doing this if it weren't profitable.
People do pay the rising cost of insurance because they often have no other options. They want or need the insurance, but they're no longer insurable, or they don't think they could get another policy at their age for some other reason.
Here is your first lesson in choosing a life insurance company...
Choose companies that offer convertible life insurance products
All other things being equal, a policyholder would much rather keep an existing life insurance policy in force at the same premium than pay a higher premium. If they can't do that, most policyholders would like the option to convert to a permanent policy (either with a lower death benefit to keep the premium level or a new higher premium that's level instead of increasing) if given the opportunity.
Buying a 30-year level term policy, with the option to convert to a permanent policy, allows a policyholder to make that choice and have more control over their future.
Choosing a company where you have no options other than to pay the premium or lapse the policy is an expensive mistake. Some term policies don't even allow you to keep paying the premium.
Some companies sell a 10-pay term product where the policy simply terminates after 10 years. There is no automatic renewal at a higher premium. The policy simply ends and you have to reapply for a new policy.
Again, the Internet will tell you this is fine and that you probably don't need term insurance after it terminates, but let's assume for a moment that not everything goes according to plan and you still need the insurance (after all, the whole point of insurance is that things don't go according to plan, right?).
What do you do?
This is why convertibility is so important. Being able to convert a term policy to a permanent policy like whole life insurance (or even a simple guaranteed UL product) is better than getting nothing in return.
Convertible term products can also be sold on the secondary life settlement market, and this is where things get interesting.
The life settlement market is where investors buy unwanted life insurance policies. An anonymous investor buys your policy, through a broker, and then owns the policy. He makes himself the beneficiary. When you die, the insurer pays him the death benefit (which is why anonymity is important in these transactions).
A policyholder with a term policy that expires with no conversion options has (essentially) a burning match. No one wants burning matches. A convertible policy has market value, and implied equity, which many investors are willing to pay for. Instead of letting the term policy lapse worthless (and losing all those premiums you paid), you could sell it to an investor who may pay you thousands, or hundreds of thousands, of dollars.
If you're buying a convertible term policy, and you are buying from a high-quality company, you are probably buying from a mutual life insurance company.
Choosing a permanent life insurance company
Some companies specialize in permanent life insurance. They have decades, or hopefully centuries, of experience selling these products.
Participating (dividend-paying) whole life insurance is the gold standard in permanent life insurance. It's the lowest risk permanent policy you can buy, it builds guaranteed cash value, has guaranteed death benefits, and is an established product that life insurance companies have centuries of experience pricing and selling. If you have the option to buy a good participating whole life policy, this would be your first choice.
Whole life insurance is usually sold and issued by mutual life insurance companies. Mutual companies are owned by their policyholders, not outside shareholders. The participating nature of the policy means the insurance company shares its profits and favorable mortality experience with its policyholders, not shareholders.
Unfortunately, when it comes to the nitty-gritty details about choosing a mutual insurer to buy from, the advice is pretty thin and typically amounts to, "make sure you choose a well-run mutual life insurance company".
We can surely do better than that.
And so, without further ado, here is how to choose a mutual life insurance company. First, the players worth considering:
Northwestern Mutual (NML)
If you looked up the definition of "mutual life insurer" in the dictionary, there would be a picture of Northwestern Mutual. They are the responsible, rule-following, older brother of the old mutuals. In many ways, they were and are a test case for what a mutual life insurance company can be.
The hallmark of a good mutual life insurer is they spread the costs and benefit across all policyholders and do it in a fair and equitable manner. NML does this in spades.
The company also sports some of the best financial ratings any company could get in any industry, and its balance sheet is clean as a whistle. Roughly $1.7 billion of investable cash flows into the company's general investment account every month. The company is so large that a 0.1% change in the value of their investment portfolio is equal to $275 million——a sum larger than the total size of most companies in the U.S. But, for NML, that sum of money is a rounding error.
Unlike many publicly-traded life insurers, Northwestern Mutual trades almost entirely on its immaculate reputation, and not hypothetical illustrated rates, product gimmicks, or pricing concessions or other marketing B.S. As a result, for better or worse, Northwestern Mutual does not feel any real pressure to be competitive in their product pricing, features, or benefits.
New York Life (NYL)
New York Life is Northwestern Mutual's slightly rebellious younger brother, and the oldest mutual life insurer in the U.S. Its business is essentially divided into two parts. One part is a classic "old school" mutual life insurer that sells lots of participating whole life insurance.
The other side of their business sells tons of non-participating life and annuity products. Like Northwestern Mutual, they have stellar financial ratings. Unlike Northwestern Mutual, they seem to have this idea that they need to be more competitive in their pricing and product features.
Their custom whole life product is one of only two products available on the market (at the time of this writing) that allows a policyholder to have a fully customized whole life product complete with customized payment periods.
While the numbers aren't as big as Northwestern Mutual, they're nothing to sneeze at, either. In 2021, they posted capital and surplus of $30.7 billion, $1.4 billion in insurance sales, $760 billion in assets under management, and $1.1 trillion of life insurance in force.
Speaking of large, MassMutual. The company was the number one seller of whole life insurance in the U.S. in 2017. One of the things that seems to have helped the company immensely is its actuaries and product developers tweaked their flagship products to have a higher illustrated performance than many of its competitors. On paper, this made MassMutual look a lot better than its peers. It also held its dividend payout steady when many of its peers were forced to lower their dividend rate.
MassMutual is one of maybe a handful of companies that publishes a decades-long historical dividend performance chart, including the actual (not hypothetical) historical performance of its flagship whole life products since 1980. That historical performance compares very favorably against its peers.
The company has $235 billion invested assets, $33 billion in total capital and surplus, and paid $1.8 billion in dividends to participating whole life policyholders in 2021.
The Guardian is sort of the odd-man out in the brotherhood of old mutuals. In some ways, it's similar to Northwestern Mutual in that its insurance agents sell the company over the illustration. Because of this, Guardian doesn't seem to feel many of the usual competitive pressures of running a mutual company.
At the same time, the company endlessly tweaks its products, tinkers with features and benefits, and seems to always be revamping one of its products. It feels like the company is always gearing up for battle... but with who?
By the end of 2021, Guardian had $10.7 total adjusted capital and surplus, $90.2 billion in assets under management, and paid $1.1 billion in dividends to its participating whole life policyholders. It's considered a smaller mutual. But, given its dividend payments to policyholders, it also feels like it's punching above its weight.
It offers one of the most flexible paid-up additions riders of any mutual insurance carrier. Most carriers are lacking in this regard. Not Guardian. Policyholders can vary their paid-up additions premiums almost "at will", without any negative consequences on future premium funding.
The company also seems to really listen to its field force, and caters to powerful and very vocal General Agents, which is a sharp contrast to other life insurance companies.
With that said, many of its General Agents seem to be more obsessed with Guardian's unbeatable individual disability insurance products than its participating whole life products.
Speaking of punching above its weight, the baby of the bunch, Penn Mutual, fits this description perfectly.
The company is the second-oldest mutual life insurer in the United States, paying dividends to participating whole life policyholders for 175 consecutive years. By the end of 2021, it had total GAAP Assets of $44.2 billion, with a total of $185 billion assets under the company's control. It paid $123 million in dividends to its participating whole life policyholders, and had $3.2 billion in total capital and surplus. Penn Mutual keeps a significant portion of its investment portfolio (77.9%) in cash, short-term investments, and investment-grade bonds. The remainder of its general account is invested more aggressively to help bump the dividend payments to policyholders.
What really sets Penn Mutual apart from its peers is its size (it's by far the smallest of the old mutuals), its aggressiveness in developing a cloud-based platform (it runs the most technologically advanced underwriting platform in the insurance industry, with an unusually short, but accurate, underwriting process), and its aggressiveness in product design and sales (it has one of the most flexible whole life products on the market, and pushes the product hard through its independent broker channels).
But... maybe one of the more unique things about this little company from Horsham, PA is its commitment to life insurance sales and servicing. Unlike all the other mutual life insurers, Penn Mutual is almost exclusively a life insurance and annuity business. Maybe the only other company that can say that is Northwestern Mutual. But, even they run a sizable long-term care and disability insurance business. Looking at Penn's financial statements, the two largest lines of business are fixed life insurance (whole life and universal life) and fixed annuities. When Penn Mutual says its bread and butter is life insurance, they mean it.
What to look for in a mutual life insurance company
A company that's serious about life insurance
If I ran a hamburger joint that sold one kind of hamburger, but I had 3 different kinds of salads, 5 chicken sandwich options, and was more famous for my milkshakes than my hamburgers, what business am I really in?
I think you know the answer——not a hamburger business.
The same holds true for life insurance companies.
Believe it or not, not all companies are serious about their life insurance business. You can tell a life insurance company loves life insurance because they put it front and center in their business. It's not hiding behind a portfolio of disability insurance, long-term care insurance, retirement planning services, employer benefits packages and so on.
It's such a simple thing to look for, yet often ignored by policyholders. Does the company have a rich life insurance product line, or an anemic one? Does the company focus mostly on individual life insurance, or do they seem to have their hand in a little bit of everything?
Do the general agencies for these companies want to talk your ear off about the company's life insurance products, or are they more interested in selling you disability, long-term care, or some other line of insurance? A company committed to its life insurance business isn't going to abandon it when things get rough. A company that's not serious about its business will arrange things so that the life insurance block can be sold off to another company without too much trouble.
Over the course of 100+ years, there will be a decade or two that's rough. The insurer should be committed to plowing through those rough periods and not abandoning its policyholders for the "next big thing".
Net income is income after dividends have been paid to policyholders. The corporate structure of a mutual insurer or mutual holding company legally requires the insurance company to pay dividends if it is capable of doing so (i.e. if the company has surplus it can afford to pay as a dividend and still meet all its financial guarantees/obligations). What we want to see, then, is how well the insurance company can turn premiums into cash flow (income) and then… how much of that cash flow (income) the insurer is able to turn over to policyholders (the owners of the company) as dividends.
A low net income figure on the company’s balance sheet might mean the insurer is paying out a lot of whatever income it received as dividends. So, low net income is good, but… not too low. The closer that net income figure gets to zero, the more we have to pay attention to what’s happening with the insurer’s investments because… a very low net income can potentially point to a strain on the insurer’s income and thus… its ability to pay a good dividend. If the insurer doesn't have sufficient net income to pay a dividend, it may end up pulling dividends out of surplus, which isn't necessarily bad, unless... surplus starts to decreases year after year.
Bottom line is to track your insurance company’s dividend payment as a ratio or percent of its net income and gross revenue. Most of its income should be paid back to you as a dividend. And, it should be able to maintain a good dividend out of current investment income over long periods of time. If the insurer has to dip into surplus, it should be able to regrow that surplus without too much trouble.
Stable yield on invested assets (not high, not low)
A fluctuating investment return is not a great thing. Ideally, you want a stable investment return over 20+ years. Stable returns mean stable income. Stable income means a stable dividend payment. You see where I’m going with this?
Lots of income-producing assets
Total return on invested assets is the general measure of an insurance company’s ability to turn premium dollars into income-producing assets. The more income the company generates, the higher dividend the company can afford to pay and thus the more money you receive from your life insurance company. Insurers are really, really, good at doing this — better than almost any other investor, but… not all insurers are “great” when compared to their peers.
When income-producing assets aren't enough, it should have ample money set aside in its Interest Maintenance Reserve (IMR). The IMR is money generated from capital gains, which is then amortized over many years or on an "as-needed" basis.
An example of how this was recently used: In 2019, The Penn Mutual Life Insurance Company cashed in some of its bond investments for a $47 million capital gain. This capital gain went into the insurer's Interest Maintenance Reserve (IMR). The reserve can then be used as needed or amortized over many years to boost the company's net income.
The IMR can be funded with both bond and non-bond investments.
For insurers with large unrealized capital gains in equities, the IMR allows insurers to effectively and safely convert equity risks into a steady income that benefits both the company and policyholders. In a low interest rate environment, the IMR can become a hedge against falling interest rates or extreme volatility in interest rates.
In other words, having a large(ish) IMR is a safety net, of sorts.
High liquidity to meet cash loan requests
A highly liquid company is better than a company with a lot of illiquid assets. Generally, the more liquid its assets, the better. An insurer with 70% liquidity is in a more stable position than a company with 50% liquidity.
Low leverage (debt) relative to investment return
Insurers use leverage (debt) to help boost their investment return. Most companies are really good at doing this, but not all of them. How they accomplish this is beyond the discussion of this email but… in general, the ideal scenario is low leverage relative to the investment return. If a company uses a lot of debt but has a low return on its investments, that can signal a problem.
Low-risk insurance products
Whole life insurance is a low risk financial product. For all intents and purposes, it's risk-free, dare I say "bulletproof". The way whole life insurance becomes a serious risk is if life insurers sell a bunch of short-pay whole life insurance with a 4% guarantee, and then interest rates promptly go to 0% and get stapled there for decades.
On the other hand, variable annuities with generous guarantees are nearly always toxic to life insurers.
Insurers that offer generous guarantees inside of variable annuity and life insurance products may be hiding risk to policyholders. These risks are sometimes not realized for years.
On the surface, some of these risky products don't look risky which is what makes them so dangerous. Insurance company management, insurer portfolio managers, product developers, insurance actuaries, and insurance agents who are familiar with how life insurance and annuity products work will know this. Your average investor (including hedge funds and private equity funds) won’t.
For example, life insurers selling generous guaranteed minimum accumulation (or income) benefit riders inside variable annuities place immense pressure on their own general investment account. A casual look at the product lineup doesn't show anything out of place. But, a keen observer will see the liabilities stacking up. And, this risk is systemic, bleeding into other unrelated lines of business.
Another serious risk to life insurers is guaranteed universal life. Guaranteed UL products require immense amounts of capital, and they often put significant pressure on the insurer. This is why you are now seeing many life insurance companies offload their guaranteed UL blocks.
Knowing your life insurer means not just knowing its whole life product. It means also knowing its other lines of business and how risky those products are and whether (or not) they pose any serious risk to whole life policyholders.
A "well-run" mutual life insurer will elect its chief actuary, investment manager, or risk officer as its CEO.
The old mutuals all have CEOs that are either the company's chief actuary, its chief investment officer, or are individuals with years of risk-management experience. This is a large part of what makes these companies so well-run. They aren't simply MBAs or "career CEOs". They are CEOs whose specialty and expertise is in the life insurance business. They understand the risks of the business and of the products the insurance company sells.
The insurance companies that eventually develop financial problems almost always have upper management who don't really and truly understand the financial risks of the insurance products the company sells. This was the case with a recent high-profile merger where the insurer blew a massive hole in its balance sheet (and needed a bail out from a larger financial firm) because management didn't really know what it was doing with its products.
Flexible product chassis
A good product chassis is one that is inherently low risk, very flexible, and accommodating to the policyholder. Lots of life insurance companies sell universal life insurance. That passes the "flexible" test. Universal life insurance policies have the most flexible premium structure of any life insurance policy. But, they are also very risky because the expense loads are variable instead of fixed. Meaning, an insurance company has the contractual right to increase costs over time inside a universal life policy. Agents are quick to point out that insurers wouldn't want to do this. The fact of the matter is, many have increased those costs and continue to do so. If reputation becomes a problem, insurers sell off the subsidiary company with the bad rep, start a new subsidiary, and launch new products.
Traditional whole life insurance is not a flexible product. But, it became more flexible in the 1980s with the introduction of the paid-up additions rider, and various "limited pay" policy designs. It became even more flexible with the introduction of supplemental term insurance riders.
A common solution for flexible "limited pay" products is to sell the policyholder a "10-pay" whole life policy. What if you want to pay for 11 years or 15 or 17 years? You can't.
Most companies don't have products that are essentially "X-pay" (custom pay) products where you can choose how many years you want to pay whole life premiums. Custom-pay products offer, by far, the most flexible chassis available in the life insurance industry.
Many companies do offer a "reduced paid-up" (RPU) option on their whole life products. Sometimes, this option has limitations. The RPU option reduces the death benefit, and eliminates the ability to pay premiums in the future.
Some companies offer a "premium offset" option, which allows a policyholder to temporarily stop premiums, using current dividend payments plus previously accumulated dividends and paid up additions to pay current premiums. Under this option, premiums can potentially be stopped and started many times.
Not all life insurers have a flexible premium paid-up additions (PUA) rider. Most companies don't want policyholders changing their PUA rider payments. Once a policyholder reduces or stops paying on a PUA rider, the company will often disallow future PUA payments, or they will restrict PUA rider payments. A good PUA rider is one that allows unscheduled PUA payments, allowing the policyholder to stop and start PUA premiums as needed.
The most flexible whole life policy designs are ones that include a supplemental term rider, paid-up additions rider, and a flexible premium offset option that can be turned on and off whenever the policyholder wants with a secondary option to convert the policy to a "reduced, paid up" status.
In general, the more flexible the whole life policy, the better.
What about ratings?
Financial ratings are the thing everyone looks at, but are (mostly) a red herring. They can indicate the general financial strength of a life insurance company. But, most insurance companies have great financial ratings so it doesn't tell you much on its own. Plus, ratings tell you about where an insurance company has been, not where it is going. In other words, great financial ratings speak to the life insurer's past accomplishments, and what financial decisions led them up to where they are today. But, it doesn't say anything about how today's financial decisions will affect them 20 years from today.
Financial ratings refer to an insurer’s ability to pay its guarantees on its policies, right now. Ratings aren’t worthless. But, in the context of dividend payments and return on the cash value of whole life policies, they don’t mean much. Almost every life insurer in the U.S. is “overpowered,” meaning it has more than enough money to make good on its promises today. But, some insurers don’t pay a high dividend relative to their peers because they aren’t as good with their investments.
There are a few more metrics a policyholder can look at, but these are the major ones.
Where can you get all this information?
One of the best sources is ALIRT. ALIRT is an independent research firm which analyzes insurance company financial data. They gather information on life insurance companies in the U.S. and then build a financial summary out of the data. They can tell how much an insurer earns, what it has earned over the last 5+ years, and what its future prospects are for generating more income and revenue for policyholders (or shareholders, in the case of publicly-traded life insurers).
Unfortunately, their reports cost many thousands of dollars each, and their subscription service is tens of thousands of dollars per year — not practical for consumers to purchase and even if a consumer wanted to see the information, there’s a good chance they wouldn’t know how to read the financial statements or summary reports.
Fortunately, you can download a company’s financial reports directly from the insurer’s website or by contacting them directly and asking for a copy of their financial statements. Some insurers are better than others when it comes to handing over the info or making it available online.
Unfortunately, combing through a life insurer’s financial statements is more difficult than reading the ALIRT summaries.
Another source for summaries of financial statements is Vital Signs. This may or may not be accessible to consumers. It certainly is accessible to life insurance agents.
On old mutual companies going bankrupt
Could there be a run on the insurance company?
A “run on the bank” is when enough depositors freak out, get scared, and demand their money back all at the same time that it causes the bank to go bankrupt.
So… can this happen to a life insurance company?
Yes, but it's unlikely. In the vast majority of scenarios, a run on the insurance company is not an issue.
For example, last year Penn Mutual had about $2 billion in surplus funds. Its total bond holdings were about $10 billion. That’s a 20% surplus against those bonds.
In order for the insurance company to be in any real trouble, a combination of very unrealistic events would have to happen in a very specific order.
First, interest rates would have to spike by an unheard of amount (even today's sudden rise in interest rates is not that much in the grand scheme of things), which would cause the value of their current bond holdings to drop. And, that spike would have to be significant enough to chew up the insurer’s $2 billion in surplus, meaning the value of those bonds would have to drop by $2 billion (20% or so). That’s a huge drop…
Next, every single policyholder would have to come to the insurance company at the same time, and request a full surrender of their cash value life insurance policy.
If the value of an insurer’s bonds drop significantly, that — in and of itself — is not immediately concerning. As long as the insurer can still make profitable investments and all their policyholders don’t make liquidation requests at the same time, you’re good.
But… even if this series of unfortunate and unrealistic events happened, the insurance company has a protection mechanism (as do all other life insurers) — they can delay surrender and payment of cash values for up to 6 months to prevent a liquidity crisis and to protect other policyholders (and to make sure everyone is paid back in full).
That's why I often say whole life insurance is bulletproof.
Those are not protections you see in fixed income investments, stock investments, or any other type of investments.
To give you some perspective, Northwestern Mutual has about 15% in surplus against their bonds. MassMutual has about 18-19% in surplus against their bond holdings, give or take. New York Life has about 19% or so in surplus.
I would say most of the old mutuals are very well protected against even a catastrophic event. We would have to see the literal end-of-days before you would experience a real problem with a whole life insurance policy. And, even then… it’s questionable as to whether it would be that bad.
So, there you have it. Choose a well-run mutual life insurance company and you should be fine.
Build Financial Security. Learn Everything You Need To Know About Life Insurance
Protect yourself, your loved ones, and build real lifelong financial security. Learn everything you need to know about life insurance by reading The Definitive Life Insurance Buyer's Guide.