I'm quite sure there's a collective gasp from our audience when they hear us say that life insurance is not the answer to everything. Yep, we said it and we're gonna stand by it today.
Life insurance is a fantastic tool and one that we both think is super swell for a myriad of reasons.
When we were new agents we were told to spout off all sorts of features that whole life insurance (in particular) possessed.
- Guaranteed 4% plus dividends
- Guaranteed death benefit
- Self-completing plan
Those things sound good but…what does any of that really mean?
Life insurance can be one of two things–death benefit focused or cash value focused, however, it can't accomplish both goals very well…at least on a short-term basis. When you try to make it perform both functions, it can dilute the results on both sides of the ledger.
Long-term, it can perform quite well in regards to cash value and death benefit (see this article on how well blended whole life performs both in terms of death benefit and cash surrender value long-term) but it can't do both in the best way possible from the very beginning. And it certainly isn't going to guarantee that either will work very well.
There's a cost involved for a guarantee. Of course there are hard dollar costs but even more is the opportunity cost.
Guarantees are expensive.
If I'm giving you a guarantee on a contract, then I'm guaranteeing you that something better is not going to happen. Think about it this way…if you go to the bank and buy a 5 year CD that guarantees you 1.2% you have just purchased a guarantee that you can't do any better than 1.2% for the next five years.
That's not always a bad thing, merely the way it works. There are times when that's a fair trade.
Our point is that many times people rely too heavily on having a “guarantee” that is of little use to them.
But Whole Life Insurance Gives Me a 4% Guarantee
The 4% guarantee (on a whole life insurance policy) is on the reserve building of the policy. Just because the reserve building is occurring at 4% a year, does not mean that your cash surrender value is growing by 4% per year.
It's not quite that simple when you are looking at whole life insurance. Your cash surrender value is effected by that and that is a good thing but you won't see 4% as your minimum credited interest on your whole life insurance in every case.
This can vary from company to company.
Now, if it were a universal life insurance contract, the guaranteed rate is the net number that will be credited to your cash accumulation account.
Some companies will tout the fact that there products perform really well based on the guarantees. In our experience, that's most likely because they don't perform very well anywhere else.
Another to keep in mind…guarantees are based around a worst case scenario. This means mortality costs would have to dramatically increase (people would suddenly have to start dying en masse much earlier than they do now) and economic conditions would have to get to a level the likes of which we have never experienced and stay at that level for an extended period of time.
We're talking about a world where clean water and bullets would likely be a more valuable commodity than any currency. In that sort of scenario, vienna sausages and spam would probably be of greater value than your money.
Could it happen? Anything is possible but it's not likely.
There's No Magic Here
It's all about probability. If I were to flip a coin 10 times in a row and I guarantee you that one out of ten times I flip this coin, it will come up heads, all I'm doing is taking advantage of the probability that 1 out of 10 times, I'll be right.
There is a 50% chance that the coin will come up heads every time I flip it. I'm just guaranteeing you that I'll get heads 1 time out of 10. That's not magic.
A more magical guarantee would be that I flip the coin one time and guarantee it comes up heads.
And the reality is that life insurance guarantees are built on the same sort of probabilities except instead of 1 out of 10, they are dealing with numbers that are more like one out of 1,000. There's no magic in that.