Few aspects of life insurance are more misunderstood than the guarantees of a permanent life insurance contract (particularly whole life insurance). You wouldn't believe many of the claims we've heard concerning life insurance guarantees, and we continue to be astonished at the perpetuation of inaccurate statements that surround discussions of guarantees.
Some of my personal favorites include:
Listen I understand the appeal of the word guarantee. It solidifies a sense of safety and calm in an otherwise chaotic world where we mostly worry nonstop about our demise.
The word, “guarantee” brings a lot of power to the table and I've often wondered if its use with life insurance doesn't bring some people to develop an unrealistically high expectation about what life insurance has to offer.
We need to understand that in life ultimately nothing is guaranteed nor is anything permanent. If we accept this, we can shed necessary worry and focus on riding waves when they are in our favor.
Let's stop thinking about guarantees as never-ending minimums and instead about long-term obligations. In the spirit of life insurance, it's the insurer's commitment to policyholders to uphold various aspects of an insurance contract almost entirely concerned with the continued establishment of the death benefit.
Notice I didn't say cash value or cash value accumulation. I want to be very clear in pointing out that the guarantees associated with life insurance have everything to do with death benefit and almost nothing to do with cash value and its accumulation–at least as it relates to cash benefits usable by a policyholder.
I'll make it even simpler for you. 99.99% of a life insurance contractual guarantees are concerned with guaranteeing a certain level of death benefit in exchange for a certain payment of premium. That's it–end of story. Whole life insurance, no matter how manipulated to accelerate cash value growth, is no different.
The largest source of misunderstanding life insurance guarantees lies in the very tool regulators sought to help understand proposed life insurance contracts–the voluminous depiction of policy details in both written and numerical delineation known colloquially as the “illustration.”
If you've never seen one, simply understand that it's a 10-50 page document that includes a lot of information regarding the proposed insurance contract. This information includes both a narrative outline that defines certain terms and details the functionality of various policy features and benefits. These documents also include a numerical depiction of guaranteed and projected policy values given the life insurance policy and design chosen.
Illustrations are a handy tool used to introduce the concept of life insurance to an otherwise unknowing crowd. They were also once a source of rampant manipulation used to twist facts and dupe unsuspecting people into buying life insurance–or a specific type of life insurance.
To combat the issue, regulators established a basic protocol for illustrations that chose specific attributes that must appear in the document. Guarantees were very important when the model for unifying illustrations originally came into existence because of the misuse of projected values that existed at the time.
The prevailing thought was that this unification of illustrations would create a level playing field for comparison and prevent unscrupulous individuals (be they agents or insurance companies) from embellishing facts about a proposed life insurance contract.
Like all forms of regulation, there's good and bad.
The good comes from the basic protocol that forces all insurers to report certain information that is somewhat standardized. The bad comes from the ongoing attempts to game this standardization and the misinterpretation others make on the behalf of this information.
One of the best examples I can think of to present the high probability of misunderstanding that comes from life insurance illustrations involves paid-up additions. Some insurance companies still omit the cash value generated by this rider from the guaranteed column in basic illustrations. The reasoning for this varies, but the potential to misunderstand poses a serious risk to making an uninformed and less than optimal decision.
If company A has provisions that make it better than company B, but company A omits paid-up additions cash values while company B includes them, a policy design that makes heavy use of this rider might make company B look better on paper. In truth, company A is the company with far better potential to accumulate cash value and disclosure of this exists on the supplemental illustration that does include paid-up additions.
The uninformed, inexperienced, and unwilling-to-listen out there will head in the wrong direction towards company B because they misunderstand what guarantees mean. Not because they somehow misunderstand the dictionary definition of “guarantee” (understanding that is immaterial in this discussion). The problem lies in the insurance company's interpretation of the regulation related to guaranteed.
If I'm an agent at company B and I know company A is the serious competition I might just present company B illustrations to potential clients and exclaim “our guarantees are higher and therefore we are better!” If you think this sounds outrageous, I can give you a dozen or two first-hand accounts where this very scenario unfolded.
Think for a moment about what a guarantee means. Not how a guarantee benefits you, but more along the lines of what making that guarantee means to the person or company making it.
Imagine a situation where you needed to make a guarantee to someone else.
Let's assume it's a situation where you are contracted to sell a certain number of services for a company and they require a written guarantee for the number of contracts you will sell for the year. They aren't really worried about how many contracts you will actually sell, just that you must sell at least the numbers that you guarantee or else there will be very serious consequences for your failure to live up to your promises.
How many contracts would you tell the company you are going to sell?
If you answered any more than one you should be very careful about how you handle yourself in vulnerable moments.
Keep in mind that selling more than one contract has no negative consequence. Even if you are extremely certain that you can sell five, what benefit is there to you to admit that?
There's no upside to you promising more and missing your target.
Wouldn't things look better for you if you guaranteed one and ended up way ahead at five by the end of the year? You're happy, the company is happy, no one is stressed out, disappointed, or now looking for a new job.
Life insurance guarantees, and pretty much all financial contract guarantees, follow this same logic. Guarantee as little as we need to. This isn't a claim of evil greed by the way. Nothing stops a life insurer (or other financial institution) from providing you with more benefit than the guarantee–in fact, this usually happens.
The big takeaway here is that guarantees pose a very serious risk to the life insurer, so they are going to opt to guarantee as little as possible. A sort worst case scenario if you will.
Your intuition might be to think that this is a safety net. At least things can't get any worse than X the guaranteed column. Fight your intuition. If the worst-case scenario plays out, you'll have many bigger things to worry about than did you get at least the guarantee promised in your life insurance policy.
You know why mutual funds aren't sold with illustrations like life insurance is? Because the guaranteed ledgers would be blank (awkward silence from the really bad insurance joke).
While the guarantees found in life insurance contracts are really nothing to get too excited about from one company to another. They do exist. And this is a lot more than we can say for 99% of all the other financial products you could own.
It is imperative that you understand what the guarantee means and also understand that a lot of people seek to twist the reality of guarantees both good and bad. It's fine to take a look at the guarantees, but it's more important to look at what else you have to gain from a policy.
Brandon launched the Insurance Pro Blog in July of 2011 as a project to de-mystify the life insurance industry. Brandon was born in Northern New England, and he currently calls VT home. He attended Syracuse University and graduated with a triple major in Economics, Public Administration, and Political Science.