The process of buying and maintaining a life insurance policy can be misleading. Agents and consultants often sell life insurance based on the characteristics of the policy, such as cash value and perhaps lower premium payments.
When you buy a life insurance policy of cash value, you will get a projection of guaranteed and non-guaranteed features of the policy. It is important to understand that these estimates are based on three factors:
Earnings, such as dividends or interest on cash value
The cost of insurance, also known as mortality, which means the actual cost of insuring your life
Internal policy cost, also known as administrative expense
These components may have different names depending on the type of life insurance policy.
Cash value life insurance can be exceptionally complex, and an agent can gloss over the complexities to sell you a policy. Here are some things that can be easily confused.
Confusion number 1: Premium is the cost of the policy
The total “cost” of a life insurance policy is not the premium you pay. Cost is the sum of premium, mortality (cost of insurance) and internal charges. These components will vary in name depending on the policy type and company.
What difference does it make? Costs you don’t pay attention to, like internal policy costs – can reduce your potential cash value. If more of your premium goes to internal charges, then there is less of going in cash value. If you take a loan against your cash value, higher internal fees could potentially eat off the remaining cash value and your policy may be spent with an additional infusion of premiums. So that the “low premium” policy you take is not suddenly cheap.
Unfortunately these costs are not always disclosed as separate items on policy parables.
Confusion number 2: Life insurance policy is easy to compare
Life insurance policy sales pictures are usually at least 10 pages long. These examples include estimates of several scenarios.
These scenarios are based on estimates of policy components that are not transparent. It is challenging to compare estimates when there is all the information such as internal estimates and real income rates. And the sales illustration may not include historical information, which may provide context.
Confusion number 3: Life insurance is an investment
Life insurance is a form of insurance, not an investment contract.
Life insurance policies include fees for the cost of insurance. This cost makes life insurance a more expensive asset class. While life insurance policies accumulate a cash value, it is important to note that cash value is a feature of the policy, not the end game.
Confusion Number 4: Annual statements provide all the information you need
Life insurance annual statements provide a summary of the current values of your policy without reference.
Annual statements do not reflect projected estimates, so you cannot gauge if your policy is performing as expected. A small percentage of life insurance companies estimate the number of years to apply in a policy based on current assumptions.
But life insurance companies do not provide the basis for how they determine dividend or interest deposit rates. And they generally do not disclose when there has been a change in mortality.
This can really leave you in the dark as to what is going on with your life insurance policy. The solution is to order an in-force policy illustration and see what is happening and what can happen in different situations, such as the cash value loan you plan to take.
Confusion number 5: Life insurance policies do not require monitoring
The actual policy performance of cash value life insurance can easily differ from what is shown on the sales illustration.
You should request an in-force depiction every two to three years. The only way to determine if your policy is not performing as expected. In other words, it will show you whether one or more of the policy components has changed, and how this change is affecting policy performance. The bottom line is that changes in income, cost of insurance and internal policy costs will affect policy performance.
Confusion Number 6: You can always borrow or withdraw money from your life insurance policy
A cash value life insurance policy allows you to borrow or withdraw money from your cash value. But actually doing so can have a negative effect on your life insurance. It is smart to request an in-force depiction from your insurance company before withdrawing or borrowing money from the policy to determine the impact.
Here are some disadvantages of withdrawing money from the policy:
When you withdraw money or take a loan against the policy and are not able to repay it, it will reduce your death benefit on a dollar basis.