The mistruth about life insurance

By Chris Conklin

Insurance Insight Group


As both an agent and someone who trains other agents, I am amazed at how often I am asked to respond to Dave Ramsey's opinions on cash-value life insurance. Cash-value life insurance combines a death benefit component and a savings component. Dave Ramsey criticizes the savings component, calling cash-value life insurance "one of the worst financial products available."

Dave Ramsey is a well-known personal finance author and one of the top-rated nationally-syndicated radio talk show hosts. He generally preaches a very simple message: If you spend less than you earn, you will get out of debt, and you will experience financial peace. I couldn't agree more with this philosophy, and by influencing perhaps millions of people to embrace it, there is little doubt that he has done a tremendous amount of good.

But I get restless whenever he discusses cash-value life insurance, because he makes a number of statements that I believe are misleading. Thus, I would like to address them.

Each of the statements below came from his article "The Truth About Life Insurance," which you can find here.

"Your insurance person will show you wonderful projections, but none of these policies perform as projected." -- Dave Ramsey

The sales process for cash-value life insurance is unusual in that insurance agents routinely show consumers projections of possible values far into the future. The purpose of these projections is to help explain to consumers how the cash-value life insurance works, not to purport to make a precise projection of future policy values. The primary use of the projections is as an educational tool. Once you own a policy, you should request updated projections frequently.

By analogy, let's suppose that you were considering moving to a new city and were unfamiliar with the weather there, so your real estate or relocation agent showed you a long-term forecast to help you understand the typical weather during each season of the year. You would find that forecast to be helpful, but you would also understand that it is not intended to be a precise forecast of each future day's weather. Once you actually moved, you would still obtain new weather forecasts frequently.

As an alternative to cash-value life insurance, Dave Ramsey recommends buying 20-year term insurance and investing in a mix of equity-based mutual funds, which he asserts will average a 12 percent annual return. After having experienced negative equity-based returns for the past decade, I think few financial experts would agree that any projections based on a 12 percent forecasted return would be even remotely reliable.

"The return will average 2.6 percent per year for whole life, 4.2 percent for universal life, and 7.4 percent for the new-and-improved variable life policy that includes mutual funds. The same mutual funds outside of the policy average 12 percent." -- Dave Ramsey

In the world of finance, there is a relationship between risk and anticipated return. Even a financial novice understands that banks can attract money into savings accounts at interest rates under 1 percent because your money is safe there, whereas to entice consumers to put money into risky equity-based mutual funds, a much higher return must be possible. However, if you chase the high possible returns in equity-based mutual funds, you accept the possibility that you may instead lose money.

Whole life and universal life cash values are much safer than money in equity-based mutual funds. The insurance cash values are credited with fixed rates of interest that fluctuate very little from year to year. The interest credits are never negative.

The typical variable life policy is also safer than Dave Ramsey's recommended mix of mutual funds. In a variable life policy, customers have choices of a wide range of subaccounts, ranging from very safe money market subaccounts, to riskier bond subaccounts, to very risky equity-based subaccounts. A customer allocating money across a variety of subaccounts would anticipate a lower return than someone who allocated all of their cash value solely to the very risky equity-based subaccounts.

By quoting a 12 percent return and underemphasizing discussion of the associated risks, Dave Ramsey may be misleading his listeners into thinking that investing in equity-based mutual funds is safe, and that any fluctuation in values will be merely short-term in nature. It is not safe, even over long periods of time.

Zvi Bodie, Ph.D., Professor of Finance and Economics at Boston University and author of the top-selling college and post-graduate textbook on investments said this in his book Worry-Free Investing: "The conventional wisdom about investing says that a diversified portfolio of stocks" -- such as equity-based mutual funds -- "is not risky in the long run. The conventional wisdom is wrong! It has caused much grief and pain to millions of investors, who have lost billions of dollars because they relied on that advice. ...Stocks are risky, and remain risky, no matter how long you own them."

"Worse yet, with whole life and universal life, the savings you finally build up after being ripped off for years don't go to your family upon your death. The only benefit paid to your family is the face value of the policy." - Dave Ramsey

This statement is also misleading. Many whole and universal life insurance products include death benefit options which provide for the face amount, plus the cash value to be paid to the beneficiaries at death. In addition, the charges built into the policy to pay for the life insurance protection are based only on the amount that the death benefit exceeds the cash value. Thus, if you choose the option to simply have a level death benefit and you die, you were not ripped off, because your insurance charges were based upon only the portion of the death benefit that was in excess of your cash value.

What was omitted by Dave Ramsey

One fact the general public often doesn't know about life insurance is that it is possible to pull out cash over time well in excess of the amount you paid in and pay no income taxes at all on the growth. You accomplish this through the use of policy loans that are paid off by the policy's death benefit. Unless they are held in a Roth IRA or invested solely in municipal bonds, mutual funds can't make this claim.

Also, the life insurance industry is very competitive, and thus, innovation occurs. One of the industry's latest innovations, indexed universal life insurance, provides a very attractive interest-crediting mechanism which could be ideal for today's uncertain economic conditions. Interest crediting is based on a market index, and if the index increases during the period measured, the result can be a relatively high interest credit. On the other hand, if the index declines over the period measured, the policyholder is protected from the decline.

Last, but not least, let's consider what consumers want when they are putting their money away for retirement or any other purpose. Surveys that my firm has conducted have shown that for most people, the safety of their money is a more important priority than the potential for a high rate of return on their money. If you agree, then cash-value life insurance is very much worth your consideration, because it is much safer than the type of mutual funds recommended by Dave Ramsey.

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