I’ve recently had the pleasure of taking the College for Financial Planning CFP® Certification Education Program.
While most of the coursework makes me proud to be a part of the financial planning profession, I found some of the topics covered in the insurance course, FP512, occasionally cringey. Insurance salesmen are a large part of the financial profession, and they were the clear authors of this portion of the coursework.
With life insurance salesmen, life insurance often becomes the hammer and any client concern a nail.
My textbook for the class almost echos this sentiment writing:
The planner’s attitude toward the various life insurance products should be neither for nor against. Life insurance products are simply tools that help fix problems.
Sadly, this logic even proves helpful when dealing with exam questions. Questions will give an example of a client couple and their current insurance package (be it home, auto, life, or disability). The question will then ask what you recommend they do from the options: A) reduce their coverage, B) do nothing, C) increase their coverage, or D) increase their coverage in a different way. We don’t even know the details, but inevitably insurance logic means that we know the “right” answer is either C or D.
I was talking about this phenomenon with my professor and asked him if he could think of a case where reducing the client’s insurance or keeping it the same could be the right answer on an exam. His reply? “I suppose if they are in credit card debt.” Put another way: So long as you have money to spend, there is more insurance that can be sold; that is the logic that must be used to get the “right” answer on the exam.
If you talk to an insurance broker about your concerns, they will most certainly encourage you to buy insurance as the solution. If encouragement doesn’t work, then they may push other emotions. There doesn’t really exist an insurance provider who will give you an opinion on whether or not you should carry a type of insurance. If you ask, the broker will gladly tell you how much of that type they’d recommend getting, but not whether you need it in the first place.
Throughout my life, there has been one consistent advice my family has offered regarding life insurance: Buy Term and Invest the Difference. This piece of advice played a large role in my grandfather coming to investment management in the first place. The idea is that instead of buying high-cost whole life insurance, you buy low-cost term insurance and invest the difference in premiums in the stock market. With term life insurance premiums typically only a quarter of the cost of whole life insurance, this advice is a low-cost, simple strategy for building compounded wealth.
Because of this history, I read with great interest in Risk Management, Insurance, and Employee Benefits Planning (2022 Required Education), the FP512 Kaplan course textbook, a section about the classic advice “Buy Term and Invest the Difference.”
Interestingly, they had the following passage under the heading of “Pitfalls” on pages 127-128 of the textbook:
The pitfalls of the life insurance product selection process usually can be avoided. Most problems result from making unwarranted assumptions. The planner must take care to ensure the accuracy of the assumptions upon which conclusions are based. Following are some common pitfalls.
Buy Term and Invest the Difference
A third pitfall, related to the previous one, is to assume as a matter of course that a client can invest their own money to get better returns than an insurance company. Many insurance companies are multibillion-dollar businesses with full-time investment departments. With much of their asset base in exceptionally conservative investments, they still consistently earn returns well in excess of the typical investor’s average return.
This is the emotional manipulation of insurance salesmen. They prey on your insecurities and fears to sell insurance. You have a small fear “What if I can’t beat the whole life insurance return?” and so the insurance company pokes their finger in it: How could you expect to beat our multibillion-dollar business with a full-time investment department?
But it does not take a full-time investment department to beat a whole life insurance company. It only takes a portfolio of Treasury bonds.
Life insurance companies are bound by industry regulations to follow conservative investment strategies. To maintain their state accreditation and insurance rating, they must focus most of their portfolio on investment-grade bonds. An individual investor who invests directly in a low-cost bond portfolio should expect to outperform an insurance company’s portfolio after overhead and fees are subtracted.
Don’t fall prey to their fearmongering. If a portfolio of Treasury bonds is expected to beat a whole life insurance company, imagine what the stock market could do.
The textbook continues:
Another problem with the “buy term and invest the difference” concept is that most people who buy term spend the difference. Because the difference would not be invested in this case, the client would clearly have more cash value in a life insurance policy.
EXAMPLE: Buy term and invest the difference
You may have a client who likes the idea of buying term and investing the difference. After a year or two, if the client’s actions show that the difference is not really being invested for the long term, a move to permanent insurance may be appropriate.
This is more insurance logic at play. Insurance salesmen say one of the advantages of whole life insurance is forced savings, but this is deceptive.
First, during the first several years, all of your premiums are going to pay commissions and fees. This means that any saving, even just saving in cash, will easily beat whole life insurance during this time.
Second, if you drop the policy, then you only get to keep the so-called cash surrender value. Surrender charges take away even more of your cash value, and most whole life policies are eventually surrendered .
While there will always exist a person who spends every dime they have and then dips into credit card debt, we should not make our financial decisions based on that financially unhealthy individual.
In this day and age, it is easy to set up the automatic millionaire and force yourself to save. And you don’t even need to buy any kind of life insurance to do it.
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