Updated: October 2017
Myth: Cash value life insurance is one of the worst financial products available.
Truth: Many lives will be financially devastated by Dave Ramsey’s advice on life insurance.
Dave Ramsey and his advertising client Zander Insurance make their case that cash-value life insurance is a rip-off. Dave holds a great deal of credibility in many people’s eyes, but I urge you to be wary of his advice when it comes to life insurance.
Dave says “Do not invest money in life insurance; the returns are horrible. Your insurance person will show you wonderful projections, but none of these policies perform as projected.” In contrast to this statement, most cash value life insurance contracts have a minimum guaranteed return of three to four percent that looks pretty good compared to other options in today’s low interest environment. The National Association of Insurance Commissioners adopted model regulations for life insurance policy illustrations many years ago to insure the accuracy of their projections. Clearly, nobody can predict future interest rates so when evaluating cash-value life insurance focus on the guaranteed values.
Term insurance proponents set up their arguments in favor of term as an investment decision when it is really a risk management decision. When you “buy term and invest the rest” you assume the risk the insurance company leaves on the table. This risk primarily manifests itself in the form of your future insurability and is almost completely out of your control to manage. If your investment plan fails (another risk you assume) you will be without any life insurance OR invested assets.
The following statement is quoted from Dave Ramsey’s blog:
“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.”
This statement is a common misconception that many people do not understand, but Dave should know better. He is correct that in most cases a life insurance policy with a face amount of 150,000 and a cash value of $100,000 will pay a death benefit of $150,000 and not $250,000 (150,000 + 100,000). But your insurance costs are calculated on the difference between the face amount and cash value, called the corridor of coverage. The cash buildup within a policy reduces the amount at risk to the insurance company, and therefore reduces the total cost of insurance. In this example the insured only paid for $50,000 of coverage (150,000 face amount – 100,000 cash value) in the final year of his or her life. The cash value accrues on a tax-advantaged basis and is available to the insured for any reason during the life of the policy in the form of cash surrender or loans. Cash value life insurance is sometimes referred to as a “forced savings vehicle” because it makes you save money within your policy to make sure you are not left without anything to show for the premium you paid. See related post: Do you need long term care and life insurance in retirement?
There is no denying the fact that cash value life insurance usually has a higher cost of insurance factor than term. However; the difference in cost is not proof that cash value life insurance is overpriced. In reality, much of the difference in cost between term and cash value life insurance is a difference in exposure to risk. Think of exposure in this situation as time. The longer an insurance carrier is exposed to the risk of a person dying, the greater the risk and therefore the higher the cost of insurance per unit of exposure. Term and cash value policies operate under two distinctly different risk parameter assumptions. Cash value policies assume there is a 100% chance the policy will have to pay a death claim at some point in the future. With term policies, the insurance company takes the safe bet that the term will expire before you do, so the cost of insurance is lower.
As far as cost is concerned, the real cost suck is commission to the agency or broker, but these days commission is generally higher as percentage of premium on term products than on permanent ones. How do you think the Zander Insurance Group pays Dave for his endorsement?
Over the years, many advocates of the “buy term and invest the difference” mantra have repeated this statement over and over again to the point where many people believe it to be true without the need for sound basis of fact. Unfortunately, this myth is having a devastating effect on peoples’ lives. Americans are underinsured as it is, and when Dave wrongly demonizes life insurance companies and their agents as rip-off artists it does not help matters. We now have an entire generation of people who are not only woefully unprepared for retirement, but also completely exposed to the financial risks of death.
If you need life insurance and have limited resources, do not wait another day and go make application for a term insurance policy. Life insurance is too important for you to put it off, and term is really really inexpensive. But please understand; it’s inexpensive for a reason. You get what you pay for, and term will leave you exposed later in life with nothing to show for any of the premium you paid. If you have means, a solid cash value life insurance policy could be a good way to protect your family for the rest of your life, with the cash accumulation feature as an added security benefit.