Life Insurance: Pros and Cons of Non-Guaranteed and Guaranteed
Fifty years ago almost every life insurance policies sold were guaranteed and offered by mutual fund companies. Choices were limited to either term or endowment or whole life. You paid a high set premium and the insurance company guaranteed the death benefit. All of that changed in the 1980s. Interest rates soared and policy owners surrendered their coverage to invest the cash value in higher interest-paying non-insurance products.
Life Insurance: Guaranteed vs. Non-Guaranteed Policies
In these days companies mostly offer a broad range of guaranteed and no guarantee life insurance policies. A guaranteed policy is one in which the insurer assumes all the risk and contractually guarantees the death benefit in exchange for a set premium payment. If investments underperform or expenses rises then the insurer has to absorb the loss.
With a no guarantee policy the owner in exchange for a lower premium and possibly better return, is assuming much of the investment risk as well as giving the insurer the right to increase policy fees. If things don’t work out as planned then the policy owner has to absorb the cost and pay a higher premium.
Understanding Term Life Insurance
Term life insurance is guaranteed. The premium is set at issue and clearly stated right in the policy. An annual renewable term policy has a premium that goes up every year. A level term policy has an initially higher premium that does not change for a set period which is usually 10 to 20 or even 30 years and then becomes an annual renewable term with a premium based on your attained age.
Deciphering Permanent Life Insurance
Permanent coverage: whole, universal and variable life is more confusing since the same policy which depends on how it is issued, can often be either guaranteed or non-guaranteed. All permanent life insurance policy illustrations are hypothetical and include ledgers that show how the policy could perform under both guaranteed and non-guaranteed assumptions. The rates of return and policy fees are usually displayed at the top of each ledger column, and some policies, such as variable or index life, are sometimes illustrated assuming very optimistic 7%-8% annual returns.
Factors to Consider When Choosing Guaranteed or Non-Guaranteed Coverage
Whether you should buy guaranteed or non-guaranteed life insurance coverage depends on many factors. Here are some factors to consider:
Can You Pay Higher Premiums?
Most people who bought universal life policies 10 to 20 years ago, when 5%-7% fixed interest rates were the norm, never envisioned the financial collapse in 2008 or the extended low-interest rates that we are currently experiencing. Those policies are now only earning around 2%-3%, and the owners, often retirees, are faced with paying significantly higher premiums or losing the coverage.
Why are You Buying Life Insurance?
If like most people, you are buying life insurance for the leverage (small premium/large death benefit), you may prefer not having to worry about the policy staying in force.
Should you Invest the Premium and Grow the Cash Value?
Many insurers promote the ‘living benefits’ of permanent life insurance that include the tax-free growth of the cash value, the ability to invest in mutual fund sub-accounts or index products, and taking loans against the cash value or surrender a portion of the cash value. If these benefits are important to you, then guaranteed coverage may not be the best choice.
How Long Do You Need the Coverage For?
For many people, a 20- or 30-year level term policy may be adequate to pay off a mortgage or provide funds for your children’s education. And some term insurance can be converted.
Making an Informed Decision
It is really important to think about why you are buying life insurance and how it fits into your financial picture. If the primary reason for having insurance is to help transfer risk then adding risk to the insurance may not make sense. Consider your financial goals, budget, and long-term plans before choosing between guaranteed and no guarantee coverage.