There are some ways around that, but basically you're correct. (For example, you could store the user key, or an additional randomly-generated password, persistently on client machines, so that you can usually recover from password loss; and you could use a tree of session keys to minimize the amount you have to re-encrypt. But basically you're right.)

It's understandable that they chose a less-secure system design. It's not understandable that they chose to lie to their customers about it.

Oh, I totally agree. Honesty up-front would have been a much, much better policy.