In all the insurance markets, there is one underlying truth. The insurance companies are for profit and they will always act in their own best interests and not yours. For planning purposes, you should always assume there are better ways of doing things than the ways suggested by your own insurer. Let us take the question of the cash value in permanent life policies. All these policies have a value. If you approach your insurer and ask how this value can be realized during your lifetime, two answers are given. The first is the option to surrender the policy. This is an early termination of the policy. Thus, the insurer is no longer obliged to pay the sums estimated or guaranteed at the end of your life, but pays you a proportion of those benefits based on the amount you have paid in. The second option is a loan. This can either be a loan of some or all of the cash value, or it can be a free-standing loan with the cash value account used as collateral. Obviously, loans come with interest obligations attached. Borrowing your own cash value attracts a lower rate. Free-standing loans have higher rates. What, if anything, is wrong with these options?
The insurer will calculate the surrender value by counting how much you have paid in premium instalments, deducting any commission, management fees or expenses, and adding a sum of interest. You therefore receive more than you paid in but significantly less than would be paid out if you kept the policy in being. As to the loans, unless you repay the loans in a timely fashion, the interest eats away at the remaining value of the policy. It is not unusual for people who take a loan to find all the value in their policy wiped out by the interest. Obviously, this defeats the purpose in keeping the policy in being because your dependents will get little or nothing when you have gone. more…