Does it make sense to buy a guaranteed life insurance policy? Generally, when you buy a product or service that is guaranteed you are making a decision to transfer, for a cost, the risk of product or service failure back to the manufacturer or provider.
We all make choices about retaining (self-insuring) or transferring risk (buying insurance) every day—sometimes knowingly and sometimes inadvertently. For example, when selecting a higher or lower deductible on your homeowner’s, health and auto insurance or when deciding whether or not to buy travel insurance for a vacation.
The challenge is understanding how the risk could affect your financial situation and whether you should retain or transfer it. The decision depends on many factors including the amount at risk, the reason for the coverage and your financial situation. For instance, if you are self-employed, and your liquidity can vary, you may opt for coverage with guaranteed fixed payments. While someone with a more stable income or greater wealth may feel more comfortable taking the chance that premium payments could vary.
Guaranteed VS. Non-guaranteed Policies
Insurance is all about the management of risk. Unlike individuals, insurers can manage risk by pooling together a large number of individual policies. Depending on the insurer’s assessment of each applicant’s risk they assign a higher or lower premium payment. Or they may decide the risk is too great and not offer any coverage.
When buying life insurance, you have the option to select from products with and without guarantees.
A guaranteed policy means as long as you pay the scheduled premium on time the coverage will not lapse. Also, the planned premium amount is guaranteed. You will not be required to pay a higher premium if the insurer elects to increase fees and expenses in the policy, or if the investment return is lower than initially projected. In exchange for your premium payment, the insurer is assuming all the risk.
In a non-guaranteed policy, the coverage is sold using a hypothetical illustration that contains several ledgers. The current ledger (best case scenario) is calculated using a higher assumed rate of return as well as the policy fees and expenses the insurer is currently charging. The guaranteed ledger (worst case scenario) illustrates what could happen if the insurer charged the highest contractually allowed fees and expenses as well as paid the lowest rate of return allowed by the policy. The planned premium in a non-guaranteed policy is typically calculated using the more favorable current illustration. So, you as the policy owner, have all the risk. If the assumptions don’t work out as expected, you could be in a situation where you could have to pay a higher premium at some point in the future or the policy could lapse.
Term life insurance offers a premium and death benefit that is guaranteed for a set duration, for example, 10, 20 or 30 years. However, once the guaranteed period ends the policy becomes annual renewable term. If you need to keep the coverage, you run the risk of having to pay a significantly higher premium that will increase each year.
One way to mitigate some of that risk is by selecting a policy with a conversion option. You may pay a higher premium, but you guarantee your ability to maintain coverage, at a more reasonable cost, by converting the term to a permanent policy at your current rating. The premium will depend on your age and the products offered by the insurer when you convert. (See also: What is a Convertible Insurance Policy?)
Most permanent life insurance policies are not guaranteed, unless the illustration and contract specifically include a no lapse rider. With a no lapse rider, the insurer contractually guarantees that the coverage will stay in force for a defined number of years. The duration of the guarantee depends on the planned premium, kind of policy and insurer. Some companies offer products, such as an index or variable policies, with limited guarantees (as few as five years), while other policies have guarantees that can last well beyond age 100. (See also: Understand Permanent Life Insurance Illustrations.)
With a non-lapse guarantee, as long as you pay the planned premium on schedule (very important), the coverage will stay in force. Even if the policy cash value drops to zero. In exchange for the guarantee, the insurer charges a higher premium and the policy may build less cash value than a comparable non-guaranteed policy.
Some whole life and current assumption universal life policies with a level death benefit, when the maximum premium is paid, can also act as a policy with a no-lapse guarantee.
The Bottom Line
Many factors should be weighed when deciding whether to buy a guaranteed or non-guaranteed policy. In making that decision, you need to realistically review your financial situation and decide which risks you can absorb and those that should be transferred. For example, purchasing a guaranteed policy to provide for your family may give you more freedom to invest in a higher risk portfolio or business, knowing if you suddenly passed away during a down market your family would be financially secure.