Markey: Promoting the purchase of temporary insurance to protect against a permanent risk as Dave Ramsey does (above) is bad advice.

I’m often asked, “Why do you think people like Dave Ramsey so much, and why don’t you like him?”

First, it’s not that I don’t like Dave Ramsey. One of my core beliefs is that everything can be broken down into a simple mathematical equation, including Dave’s advice. Math is math. It’s simple. It’s not personal; it’s just math. Dave seemingly doesn’t use math. Instead, he focuses on preconceived notions, many of which were birthed when Prince was still making hit albums.

Dave’s preconceived notions include “buy term and invest the difference (BTID).” He can persuade his listeners to buy identity theft insurance in perpetuity, but he cannot bring himself to do the same with permanent life insurance. Why? It’s not because of the math. BTID makes three flawed assumptions (outlined below) that are riddled with bad math.

Before you chalk this up as just another brigade against Dave Ramsey, just another attempt by a licensed life insurance representative to sell “overly priced, high commissionable” permanent life insurance, stop, take a deep breath, and read the next paragraph.

By definition, term insurance protects against a liability or a risk for a set period of time. Term insurance is, therefore, temporary. And stay with me; give me a minute, you already clicked on the article so you might as well … isn’t all insurance a bet or a gamble? When you buy term insurance, you might pass within the period or you might not. The gamble might pay off or it might not. If you’re the one betting, then who’s the house? The insurer is. They’ve been studying and gathering data about mortality for centuries.

This has nothing to do with probability or compounding interest rates. IF you purchase temporary insurance for a permanent need, THEN you’re sitting down at the blackjack table inside the life insurance casino … and you’re betting 10, 20, 30 years’ worth of payments. The insurer is betting you will still be living when the policy expires, and you’re betting you’ll be dead. It’s probably not a bet you even WANT to win, and frankly it’s a bet you’re almost destined to lose. The insurer is much better at this kind of bet than you.

DON’T MAKE A BET WITHOUT KNOWING THE ODDS

LIMRA found that the top reason for purchasing life insurance is for burial expenses (87 percent), yet 37 percent of all policies are term. Carriers tend not to share how many insureds pass during the initial term, however I have seen data that suggests that less than 1 percent of insureds pass within the policy term.   

DON’T BUY A TEMPORARY POLICY FOR A PERMANENT NEED

Now, I couldn’t find a list of assumptions for BTID, but from reading and listening to more Dave Ramsey advice than even his wife Sharon would care to do, I’ve broken it down to these three:

  1. You ACTUALLY invest the difference.
  2. Your investment earns 12 percent rate of return. 
  3. You reach a point where life insurance is no longer needed.

Math gurus — and those not so good at math — relentlessly debate the first two assumptions. By now you’ve likely made up your mind about where you stand with these, and any statistics I present to the contrary will be heard with less reverence than the Charlie Brown wah-wah sound. So, I’ll ignore assumptions one and two after making one quick point. Briefly, let’s discuss if people will — or, more accurately, can — invest the difference. 

According to a LIMRA study, life insurance ownership and household income move concurrently; therefore, lower income means lower life insurance ownership. In fact:

  1. Households with a mean income up to $50,000 are 30 percent less likely to own life insurance than households with $75,000 or more.
  2. Nearly half of the middle-market consumers ages 25-64 have no life insurance AT ALL. 

Both groups are arguably core demographics for the Dave Ramsey Show. So, riddle me this, Sir Dave: You want a family who has little or no coverage now, with little to no discretionary income, to not only go buy term insurance (an additional cost since they didn’t have coverage) but to also invest “the difference?” 

How likely is this demographic to:

  1. Invest the dollars?
  2. Leave these funds to grow untouched, even in the case of emergencies, if they do invest the difference?

Neither is probably a likely outcome. This is not a statistic; it’s just common sense. 

See I was brief. If you’d like to dive deeper into the first two assumptions, then I suggest reading some of CFP Wade Pfau’s research on this matter. 

Now, on to the third assumption, which is rarely discussed.

YOU WILL COME TO A POINT IN LIFE WHERE LIFE INSURANCE IS NO LONGER NECESSARY

This is a mathematically valid argument, but it’s not always true. First, do you think there are Dave Ramsey listeners who won’t reach the level of wealth necessary to validate this statement? Absolutely. You might say, “I think Dave would then change his math.” I’d think the same. But there’s evidence against this, which I’ve written about before.

On July 14, 2014, a listener called into the Dave Ramsey Show to ask if his 71-year-old mother should continue to pay on a universal life insurance policy or if she should instead invest the money. The stated purpose was to create an estate. Dave says:

  1. Life insurance isn’t used to create an estate. (Seriously Dave? This is one of the main benefits of life insurance.)
  2. If in good health, she can invest the money in four good growth stock mutual funds (watch out for not good growth!), and she’ll have the death benefit in about 13 years. 

Keep in mind:

  1. The woman has a life expectancy of less than 16 years.
  2. The investment will be worth the death benefit in 13.75 years, but this assumes a 12 percent compounded annual growth rate — which even Dave admits is for inspirational purposes.

Additionally, this assumes no taxation. Yet, mutual funds can create taxable liabilities even without selling and, surprisingly enough, even when the purchaser experiences an unrealized loss. Also, with the assumed growth, there would be a minimum of capital gains tax due to rebalancing.

Dave’s calculations also assume:

  1. No sales charges or fees.
  2. That the woman, who has few other assets, will be able to ignore substantial fluctuations and continue to invest.

At a more reasonable rate of seven percent (net of fees and sales charges), the amount of time necessary to exceed the guaranteed death benefit of the policy would exceed her life expectancy. At six percent before fees and taxes, due to rebalancing, the time necessary exceeds life expectancy by nearly five years.

From this illustration, we can see that:

DAVE DOES NOT CHANGE HIS MATH FOR PEOPLE WHO HAVE A SHORTER LIFE EXPECTANCY, OR, PRESUMABLY, THE FINANCIAL INABILITY TO MATHEMATICALLY ELIMINATE THE NEED OF LIFE INSURANCE THROUGH THE CREATION OF WEALTH.

Let’s address another key point: The need for life insurance doesn’t always expire, even with the creation of wealth. Dave Ramsey admits he still carries several million dollars in term life insurance. With an estimated net worth of $60 million, you might not think he would need this coverage. Yet he still pays for it. Why? In his own words, “SWI” — because Sharon, his wife, wants it. She, like many spouses, feels better having the coverage.  Thus:

THE SECURITY OF LIFE INSURANCE DOESN’T BECOME LESS VALID WITH THE CREATION OF WEALTH.

Now, let’s talk about the need for perpetual life insurance to replace income. Dave Ramsey says this is not needed if the house is paid for, the kids are out of the nest, and there’s a few hundred thousand in retirement savings. But this simply isn’t true.

According to the Center on Budget and Policy Priorities, 35 percent of retirees get 90 percent of their income from Social Security, and an average widow(er) benefit just shy of $1,300. The Motley Fool states the average household Social Security benefit is $2,212 per month. In other words, about $900 is lost upon the death of the first spouse. 

Here’s an illustration. Suppose a couple has $150,000 in retirement assets, 80 percent of their income comes from Social Security and, upon the death of the first spouse, the survivor would like to maintain the same income. After 65, it’s reasonable to need the same income since few monthly expenses fall off after a spouse’s death: a cell phone payment, maybe, Medicare Part B insurance ($104-$120/month) and supplemental insurance (many people in my area own Advantage plans with a monthly premium of less than $20). Under the Ramsey plan, there won’t be a car payment or a lease payment … or life insurance. 

Since they have no life insurance, the wife will need to use retirement dollars to cover the cost.  If she only spends $15,000 on funeral arrangements and final medical bills, then she’s left with $135,000 in retirement assets. In order to maintain the same income, she’ll need to withdraw $900 per month in addition to the previous amount. Her annual withdrawal jumps from $6,456 to $17,400. That’s about a 13 percent annual withdrawal rate, meaning the account must make a minimum 13 percent rate of return for her to not spend principal. This is important, because withdrawals that reduce principal lead to an exponentially increasing withdrawal rate. If she only replaces half of the income, the withdrawal rate is still nearly 9 percent annually. Thus:

FOR MANY, THE NEED FOR INCOME REPLACEMENT IS A PERMANENT, NOT A TEMPORARY, NEED

But what about the cash value component of personal life insurance being a poor investment? As you can see, this is really Dave’s only potentially valid argument. What happens if we just agree? Does it validate BTID as the unequivocal superior method? Of course not! I do not want to get into an argument about whether or not the permanent life insurance policies available today, like Indexed Universal Life (IUL), can provide cash accumulation. (Do not write to me about the value of IUL; instead send those warm and fuzzy thoughts to my editor at nmorford@alm.com.) This is an argument for the first two assumptions, one of which has already been debunked. 

Comparing the fixed benefits of whole life polices and/or indexed universal life policies (IULs) to the benefits of the stock market is like comparing a Dodge Viper to a Toyota Prius. I dare you to find one statistical performance category in which the Prius outperforms the Viper. You can’t. (Again, if you so dare, send your thoughts to nmorford@alm.com) Even if Dave is right and the cash value component is a horrible investment, it doesn’t mean BTID is a winner. The Prius may be horrible when it comes to performance metrics, but it’s pretty good on gas mileage.  

Although there are times when the cash value accumulation within a whole life policy is favorable, overall we’d expect stock market returns to outperform. So, if we’re acquiescing to Dave’s assertion, we need to amend it to read:

BUY TERM AND INVEST THE DIFFERENCE, IF YOU’RE PURCHASING THE WHOLE LIFE POLICY AS AN INVESTMENT* the cash value component of the insurer might be a poor investment, but the need for a permanent death benefit can still be valid.

In addition, to a period of abnormally inflated interest rates, the misuse of life insurance also led to the birth of BTID. For example, a permanent policy sold to protect against an impermanent need, such as mortgage protection, is a valid BTID argument. However, if we can improperly use permanent insurance to protect against an impermanent risk, then certainly the opposite can be true. Some purchase temporary insurance, also known as term insurance, to protect against a permanent risk. This is when a BITD discussion is often invalid. 

Here’s another illustration. Recently I met a gentleman in his mid-60s; we’ll call him Bob. Bob wanted to leave $1,000,000 to his children. About ten years ago, he purchased a 20-year term policy that expires when he turns 75 years old. 

ME: Bob, do you no longer wish to make this gift when you’re 76 years old?

BOB: Of course I still want to make the gift. Why?

ME: It’s a permanent desire then, not a temporary one?

BOB: Correct. Again, why?

ME: Because, Bob, the day you turn 76, the policy will no longer payout a death benefit.  Why on earth did you purchase a temporary policy for a permanent need? 

BOB: I’m not sure.

ME: Will you have saved this amount extra in your investments by then?

BOB: No, I can’t see that happening.

ME: Will you change your spending to make this happen?

BOB: No.

I wondered then what I still wonder whenever people tell me they have purchased term insurance: Who will they be mad at when they live past the term of the policy?  Will they be mad at the insurer, or at the one who gave them the bad advice to purchase a temporary policy for a permanent need? Often, it’s the former. 

BTID doesn’t work here. Bob purchased term insurance and doesn’t have more money to comfortably invest. I suppose we could argue he should’ve bought less so then he could invest more. But given the assumptions listed earlier, oftentimes this doesn’t work. Instead, the simple answer, one void of a BTID argument, would have been to buy the amount of permanent coverage offered at the same premium as the term purchased.

SO WHY DO PEOPLE LIKE DAVE RAMSEY SO MUCH?

I almost forgot to answer this question. A few weeks ago, I was up in Sturgeon Bay, Wisconsin (shout out, hey-o!). Sturgeon Bay is small town America with old-fashioned values, littered with hardworking families who don’t buy the newest gadget in an attempt to keep up with the Jones’. People adore Dave Ramsey because they say he represents values last seen in their grandparents’ generation. But that generation bought permanent policies for permanent liabilities, and the only money they invested in the stock market was money they.were.willing.to.LOSE. Not money they relied on for living expenses, final expenses or income replacement. Dave Ramsey doesn’t represent your grandparents’ lost values; he represents the reproduction of them. It’s like the reproduction of an old baseball card. They’re cool, but they’re not unique or valuable. As grandpa would say, “They’re a dime a dozen.”