We have a kitchen drawer handle that gets loose frequently. It’s attached with a Philips Head screw. This one particular screw is very easy to screw in with a tool at hand in the kitchen – a butter knife! It just so happens that the screw is the perfect size and the butter knife does as good a job as a real screwdriver in tightening it up. Which is convenient since there are lots of butter knives around the kitchen, but the screwdriver is in the garage.
Now, despite the fact that the butter knife is great for that particular screw, I would not put one in my toolbox. I wouldn’t pack it up if a friend asked me to come over and help put up a swing set – unless I was planning on making toast or a sandwich - because outside that one perfect screw the butter knife is a lousy screwdriver (believe me, I’ve tried). Which of course reminds me of insurance…
For many years I had my insurance license, but I recently let it go. I had the license so I could easily get my clients term insurance if they need it. But recently there are many on-line companies that have opened selling term insurance just as cheaply and effectively as I ever could. As long as my clients have good options, I don’t need to maintain the certification for insurance sales.
For those of you who don’t know - term insurance is the most basic (and inexpensive) type of insurance out there. It’s also the only type of insurance most people will ever need. It insures a life against the risk of premature death. So if you are a parent worried about your kids, you might have an a term insurance policy for say 20 years while your kids grow up. That way if you die prematurely your spouse or partner could have the funds to raise your kids without financial strain. It’s pretty straightforward. Most responsible parents seek out and obtain this type of insurance – its good, basic, personal finance. This type of insurance has a very low payout ratio: most policies expire after their term unused.
There is another type of insurance called permanent insurance or “cash value”insurance. This type of insurance is the Philips Head screwdriver of insurance. It serves a very specific purpose. As the name implies, permanent insurance is designed to be permanent, or last your whole life, i.e. it is designed to pay a death benefit 100% of the time. If you get permanent insurance, and you pay your premiums for your entire life, the policy will pay out a guaranteed death benefit when you die. To construct a policy like this, permanent insurance has an insurance component – like term insurance – and an investment component. This is because to ensure it can pay out the investment component must grow large enough to support the death benefit. Permanent insurance policies are designed to do this; the investment component grows over time to equal the death benefit to be paid out. Otherwise the cost of insuring someone at an old age would be prohibitively expensive. And here’s the kicker, the cash value growth inside the insurance policy grows tax-free while it remains part of the insurance contract. These types of policies are used for estate planning, business planning and tax purposes, as well as for caring for children that have special needs and financial needs that may outlive their parents. So again, it’s a particular niche that this product fills.
Despite this, I have sat through dozens of presentations from insurance brokers that are designed to help agents sell these types of policies to just about anyone. You can get an enormous number of bells and whistles to hang on an insurance policy. You can invest the cash values in all types of mutual funds and other assets. You can get inflation guarantees. You can get index-linked growth of the cash value with caps and floors, and riders to cover disability and all kinds of interesting things. This type of product can become confusing very quickly.
Since I am a fiduciary, I always wanted to understand the product proposed well enough to be able to recommend it. I haven’t been able to do that even once. I have been shown policies designed to help with retirement and college savings. I’ve been shown products that are designed to pay out a lifetime income. I was never able to understand them well enough to recommend them, as the complexity of the product increased, the cost also increases. I always felt there were better ways to solve the problem than recommending an expensive and difficult to understand insurance contract. Don’t get me wrong; some permanent policies are needed and applicable in the right circumstances. They are truly the specialized Philips Head screwdrivers of insurance products. However, these types of products are more often sold than bought. They are much more lucrative for the agent and insurance company than term insurance. In most cases, the majority of the first year of premium is paid out to the agent as a commission and a small percentage continues to be paid out as long as the policy is in force. So there is a large incentive to market these products to as wide an audience as possible.
I don’t know who the right client is for a some of these complex and costly insurance products – but I expect this is the butter knife fitting the Philips Head screw in my kitchen: a very rare occurrence. If you run into someone who is telling you this type of product is the answer to your problem, I would be very skeptical.
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