Avoiding the discussion on the need for life insurance in the first place is a common trait among humans. No one really wants to think about their eventual demise. However, there are many reasons to learn about life insurance.
Life Insurance is more than just about a death benefit to your loved ones and protects them financially. It is about the living benefits as well that will benefit your life. It is about leverage! So let’s begin with whole life.
It is called whole life because you get to invest in it for your whole life! Sounds like a long time, and well, it should be! Whole life goes by other names such as Straight Life, Traditional Life, and Permanent Whole life. However, a goose by any other name is still a goose. And Geese are awesome!
So diving into this idea of whole life insurance, just know that it has been the mainstay of the life insurance industry in America along with term life insurance. So let’s take a high-altitude look at it and then swoop down for a closer look.
With a whole life insurance policy, you will apply for a contract with an insurance carrier who is providing this type of contract. If you are accepted after an underwriting process, you will be offered a policy based on your age, health, lifestyle and so forth. It may be at standard premium rates, or it may be rated at a higher premium rate because the underwriting process saw you as a higher than the standard risk to offer a death benefit policy.
So let’s assume that a person applied for and was offered a whole life insurance policy and the person who applied accepted the contract. This will entail the following entities:
- Policy owner who normally pays the premiums
- The person whose life is insured and may or may not be the same as the owner
- Beneficiary(s) of the policy who will receive the death benefit
So here is what happens when you accept the policy from the whole life insurance carrier.
- Policy owner pays a premium
- The insured person receives a death benefit for their beneficiaries
- An applied for and accepted death benefit is established
- Paid premiums pay for the cost of insurance and create a cash value
It is called whole life because it is guaranteed to stay in force for the insured’s entire lifetime, provided the premiums needed for the policy are paid or until the date that it matures which is typically age 100. Because it is guaranteed to stay in effect permanently the premiums will be much higher than term insurance that has no cash value.
This looks like this graphically taken from our other articles:
Characteristics of a whole life insurance policy:
Cash Value Buildup
Okay, now let’s talk about what in the world is cash value? Think of cash value as a living benefit. This means you get to use the benefits of the whole life policy while you are still alive. Think of it as a savings account that can grow tax-deferred.
The cost of insurance (COI) is simply stated as the cost that the whole life insurance carrier needs to charge to cover death benefits, pay employees, pay for office space, pay agents and so forth. It will be disclosed in the policy and in the annual report.
After the COI is taken out after each premium payment, the balance goes into something similar to a savings account normally custodian by the carrier. The whole life insurance carrier will typically pay dividends based on their growth and profitability but are not required to pay them. They are not the same as dividends exactly, so think of them as premium overpayments.
You will see another term in your policy and annual statement. This is called the surrender value. The Surrender Value is what the Insurance carrier will charge if you surrender the policy too early in the cash value growth cycle. Think of it as the COI projected out into the future over the first 5 to 10 years of a new policy in addition to the cost that they incurred taking you on as a client in the first place.
The difference between the cash value and the surrender value is what you would get if you surrendered the policy. Once the cash value and the surrender value become the same, you are entitled to the entire cash value. This is where you now have a policy that works in your favor as a living benefit.
This is what is considered being your own bank in many discussions around whole life insurance. When accessed properly through loans and return of principal (including dividend additions), it can be received for whatever you choose to use it for, tax-free. That is a definite benefit of a whole life insurance policy.
Participating and Non-Participating
Since whole life policies have a level premium throughout the lifetime of the owner and insured, whole life carriers will have accumulated a rather reserve of assets. This represents a lot of the cost of old age payouts that were accumulated over a large span of time over 50 years or so. It was the accumulation of past premiums against a future cost.
These cash reserves are similar to bank deposits. They are liabilities to their clients on the ledger balances.
The values projected in are set at policy issue and will be maintained throughout the life of the policy. So maintaining actuarial accuracy needed for insurance carrier solvency is always an ongoing and difficult task. This is because changes in age expectancy, regulatory, political, geographical, inflationary risk to name a few all participate at all times. This makes it very difficult for insurance carriers to fully know the risks.
In non-participating policies, the insurance company bears all the risks if actual future conditions are less than par when compared to the estimates made by the actuaries.
However, they will also share in the profits when they have exceeded the actual performance from the premiums in the policy. In either case, it is incumbent upon the carrier to remain solvent throughout the lifetime of a policy which could exceed well over 50 years.
In a participating policy, the excess profits are returned to the policyholder in the form of dividend payments that are considered excess premium payments under current law. This is called a “paid in surplus. It is a ratio of refund/dividend with other factors included.
If your insurance carrier is a mutual type carrier, then this dividend over fund repayments also can mean a degree of ownership with the insurance carrier.
When we stated in the title that this was the whole scoop on whole life! There are other issues relative to the life insurance industry that could have been discussed. However, we have given you most of the pertinent information that will help you make an intelligent choice about purchasing a whole life insurance policy.