The Most Common Myths About Life Insurance

“It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so.” —Mark Twain

Our philosophy at Paradigm Life Insurance is to prove everything out and take away misconceptions and flawed information. We hear misconceptions about insurance all the time.

A lot of them originate from Wall Street and the financial institutions that compete against insurance for your investment and savings. So, as you can imagine, a lot of the information floating around about insurance as an investment vehicle is biased.

Let’s bust some myths.

Myth: Insurance Policies Are Expensive

All financial tools have expenses—administrative, operational, marketing, sales commissions, and more—with the goal of winding up with a profit.

If a company--whether it’s an insurance agency or a brokerage firm--isn’t profitable, it will go out of business. When it is profitable, the profits must go somewhere. That’s the best starting place to determine whether a financial tool is expensive or not, especially a life insurance policy.

Fact: A Mutual Insurance Company Is Run to Be Profitable to You

The profit is for the benefit of its policyholders, not to pay huge bonuses to the C-suite or dividends to shareholders. Any company will have expenses and overhead, but at the end of the year, a mutual insurance company is always profitable.

Those profits are distributed to policyowners in the form of a dividend—there are no excess expenses beyond what the company needs to operate.

A mutual insurance company has a board of directors chosen by the policyholders. The fiduciary responsibility of any board of directors is to do what's in the best interest of the owners of the company—the policyowners.

Myth: Insurance Companies Aren’t Safe

Your money is secure when you put it into a life insurance company. The business model for insurance is actuarial science—the profit for an insurance company is based on extremely accurate mathematical models.

Actuarial science tells a life insurance company exactly how much money it will need to pay out each year in insurance claims. The profit for insurance companies is designed not by a probability, but by an inevitability. Some highly predictable number of the people covered by their insurance will die each year.

Everything the company does is based on that knowledge.

Moreover, insurance companies are highly regulated at the state and federal level. Among many other strict requirements, they must have enough regulated, liquid assets in reserve to pay 100 percent of the present value of claims.

Each state has a guaranty association that acts as a safety net for policyholders in case an insurer becomes insolvent. It's as if every single state has its own FDIC.

Regulators can almost always spot a company in trouble well in advance of insolvency and force it to take steps, including selling itself to another insurer, to correct any problems.

Fact: The Insurance Industry Is Separate from the Financial Industry

Insurance companies aren’t highly leveraged like other financial institutions. If there's a stock market collapse or big adjustment, the insurance industry is typically prepared and resilient.

The money you have in your policies isn’t affected by stock market movement. In fact, when the stock market goes through a big adjustment, guess who swoops in and buys up assets at a great price? Insurance companies.

To take just one great example, in the 2003–2004 recession, right after the dot-com bubble, a mutual company wrote a check for $100 million for a couple parcels of land on Boston Harbor.  

That's a whole lot of money to have on hand, but they had it because they had liquidity, they are institutional investors, and they understand opportunities. They later sold part of the development for over $1.1 billion.

Sophisticated, institutional, conservative investors with lots of liquid capital get the deals. When there's a sell-off in oil or corporate bonds, or a sell-off because prices go down, insurance companies come in and buy what was yielding 4 to 5 percent. Because the prices had dropped through the floor, the insurance companies snap them up.

If it came down to it, most insurance companies could pay off every single policyowner with their assets and probably give each one a bonus as well. That’s not something a bank or financial institution could do—they don't have that kind of money on hand.

In fact, since 2008, over 500 banks have failed. Very few insurance companies go out of business. Back in 1991, the mutual company Equitable Life, the third-largest life insurer in the country, made a lot of poor investments and went out of business.

Despite the massive losses, all the policyholders were made whole. Every insurance policy issued by a mutual life insurance company has paid out, period. There's never been one that has been lost.

Myth: I’m Too Old

A lot of my clients think they’re too old to buy life insurance. Age doesn’t have much to do with the decision. We've done business with people over 80. Wealth strategy differs by individual. Someone over 60 typically isn’t focused on long-term objectives; someone who’s 30 isn’t focused on turning all their assets into cash flow.

Rather than looking at an age number, look at your larger goal and how a WMA improves it.

Fact: There Is Value In the Policy, Even At Older Ages

That said, if you're older (let's say in your 60s), the value of the policy is twofold. First, it becomes your legacy asset to be passed on to your heirs, as well as a location of certainty for your cash.

Second, it acts as a permission slip to maximize cash flow from the other assets you have accumulated, such as your retirement accounts, primary residence, rental property equity, business interests, and so on. If you can figure out a way to write a check for the last of your money on your deathbed, have fun.

By the time you die, you're most likely either going to be short of money or have too much. If you're short right now, somebody else has to pay for you. These strategies make sure you don't spend all your wealth by the time you pass away.

Myth: Life Insurance Policies Provide A Low Rate of Return

The low rate of return on whole life insurance policies is a common concern raised by many of our clients. The typical financial advisor usually dismisses the strategy saying it doesn’t return enough money. My response is usually, “Compared to what?” To answer this question, there must be something to compare it to.

If you compare the performance of a WMA to a long-term investment in the stock market, it will surprise you. When you factor taxes, fees, and inflation into a market-based investment, you don’t end with much more than you started with.

The money you put into mutual funds for your 401(k) isn’t available to you unless you pay a high penalty—then fees soak up some of the gain, and inflation eats away at your nest egg. The cash value of your WMA, on the other hand, is liquid; you can use the cash now.

In the long term, your cash value is subject to inflation as well, but in the short term, you can use the money to take advantage of investing opportunities.

Fact: WMA vs. Market Returns

A financial advisor will tell you that the rate of return of a stock market-based portfolio over the past 20, 30, or 40 years is 10 to 12 percent. These statements are rarely qualified, as most of us have not been taught how to check the math. In my experience, even advisors don’t know how to check it.

Unfortunately, the values used in today’s illustrations of a WMA don’t reflect the actual long-term history of their dividends, which are much higher. The dividends have varied over the years. The last several years have been some of the lowest dividend scales in history—yet the returns still measure better than a stock market-based portfolio or retirement account.

If you then factor in all I’ve explained about taxes, fees, and inflation, your return on a WMA over 30 years would still be higher than the stock market—and without the volatility that can wreck it.

Wall Street wants you to think that the stock market beats life insurance, but they have a vested interest in you putting your money in them. The truth is, we’ve all been fed a lot of myths about life insurance. The best thing you can do is educate yourself and make sure you’re making the right choice for you, not the right choice for Wall Street.

For more information on using life insurance policies as an investment strategy, check out my book, Heads I Win, Tails You Lose.