December 28, 2010

Lapsed Policies Cost Whole LIfe Insurance Holders Big Time

The article Cash Value in life Insurance: Whats it worth to you?  on the site has a good examination of cash value insurance.   One detail they point out is "according to LIMRA International, 12.7 percent of whole life insurance policyholders will lapse their policies in the first year, 8.1 percent will lapse in the second year and another 5.5 percent will lapse in the third year."    12.7 + 8.1 + 5.5 = 26.3%  So that means that 26.3% of cash value insurance policies are canceled within the first 3 years.      I was curious on the LIMRA data so I did a search and found this older document from the 90's that cites similar figures.

The article cites annual return rates based on each year.  The 1st year your loss is 100%.    The 2nd year they cite a loss of 97.4%.   If you hang on to the 3rd year the loss is "only" 19.3%.   They also say the average annual rate of return for the first 5 years is -10.7%. 

If you add those two facts together than about a quarter of people who buy whole life insurance cancel their policies within the first three years and lose a significant amount of their investment.

One in five people who invest in whole life policies lose over 90-100% of their investment due to lapsing within the first two years.

Thats a pretty big deal.   One in five is a lot of people.   Losing 90% or more of your investment is also a very big deal.

Term policy holders also lapse at high rates in the first 5 years.   So this is not something unique to whole life insurance.   But with whole life insurance you have a cash investment involved that has negative return within the first few years.   Lapsing on a term policy only costs you nothing more than the insurance premium which provided you insurance.   Lapsing on a whole life policy can lose up to 100% of your cash investment.

I should point out that lapsing on a policy is something that the holder of the policy does themselves so its within the control of the policy holder.   If you don't lapse the policy then this won't hurt you.   But stuff happens in life so you may end up lapsing due to things outside your control.   If you buy an expensive policy and then face a financial catastrophe in your life the next year then you may not be able to afford the premiums any longer.

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