whole life insurance

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Whole life insurance, or whole of life assurance (in the Commonwealth), is a life insurance policy that remains in force for the insured's whole life and requires (in most cases) premiums to be paid every year into the policy.

History

All life insurance was originally temporary (term) insurance. However, because term life insurance only pays a claim upon early premature death within the stated term, a number of term insurance policy holders became upset over the idea that they would most likely be paying premiums for 20 or 30 years and then wind up with nothing to show for it. Temporary insurance only pays out 2-3% of the time. This has become known as the "Lost Opportunity Cost" called term insurance.

In response to market pressures, actuaries produced an insurance policy with level contributions that would last a lifetime. These contracts would offer a "cash value" which was designed to be a cash reserve that would build up against the known claim-–the death benefit. These policies would also credit guaranteed interest to the cash value account. Upon maturity of the contract (usually at age 95 or 100), the cash value would equal the death benefit. By guaranteeing the death benefit, the policy owner was assured that insurance coverage would be in force when the insured died, allowing them to unlock and exploit other assets. Upon the death of the insured, the cash value would be surrendered to the insurance company and the beneficiary would receive the death benefit. If, before their death, the insured wished to borrow the cash value and forfeit the death benefit, the cash value would be paid back with interest minus dividends paid, making it the lowest cost way to access one's wealth^{[citation needed]}.

Types

There are several types of whole life insurance policies. New York State defines six traditional forms: non-participating (aka "non par"), participating, indeterminate premium, economic, limited pay, and single premium.^[1] A newer type is known generally as interest sensitive whole life. Other jurisdictions may classify them differently, and not all companies offer all types. There are as many types of insurance policies as can be written in their contracts while staying within the law's guidelines.

Non-participating

All values related to the policy (death benefits, cash surrender values, premiums) are usually determined at policy issue, for the life of the contract, and usually cannot be altered after issue.

This means that the insurance company assumes all risk of future performance versus the actuaries' estimates. If future claims are underestimated, the insurance company makes up the difference. On the other hand, if the actuaries' estimates on future death claims are high, the insurance company will retain the difference.

Participating

In a participating policy (also par in the USA, and known as a with-profits policy in the Commonwealth), the insurance company shares the excess profits (variously called dividends or refunds in the USA, bonus in the Commonwealth) with the policyholder. Typically these refunds are not taxable because they are considered an overcharge of premium. The greater the overcharge by the company, the greater the refund/dividend. For a mutual life insurance company, participation also implies a degree of ownership of the mutuality.^[2]

Indeterminate premium

Similar to non-participating, except that the premium may vary year to year. However, the premium will never exceed the maximum premium guaranteed in the policy.

Economic

A blending of participating and term life insurance, wherein a part of the dividends is used to purchase additional term insurance. This can generally yield a higher death benefit, at a cost to long term cash value. In some policy years the dividends may be below projections, causing the death benefit in those years to decrease.

Limited pay

Similar to a participating policy, but instead of paying annual premiums for life, they are only due for a certain number of years, such as 20. The policy may also be set up to be fully paid up at a certain age, such as 65 or 80.^[3] The policy itself continues for the life of the insured. These policies would typically cost more up front, since the insurance company needs to build up sufficient cash value within the policy during the payment years to fund the policy for the remainder of the insured's life.

Single premium

A form of limited pay, where the pay period is a single large payment up front. These policies typically have fees during early policy years should the policyholder cash it in.

Interest sensitive

This type is fairly new, and is also known as either excess interest or current assumption whole life. The policies are a mixture of traditional whole life and universal life. Instead of using dividends to augment guaranteed cash value accumulation, the interest on the policy's cash value varies with current market conditions. Like whole life, death benefit remains constant for life. Like universal life, the premium payment might vary, but not above the maximum premium guaranteed within the policy.^[4]

Requirements

Whole life insurance typically requires that the owner pay premiums for the life of the policy. There are some arrangements that let the policy be "paid up", which means that no further payments are ever required, in as few as 5 years, or with even a single large premium. Typically if the payor doesn't make a large premium payment at the outset of the life insurance contract, then he is not allowed to begin making them later in the contract life. However, some whole life contracts offer a rider to the policy which allows for a one time, or occasional, large additional premium payment to be made as long as a minimal extra payment is made on a regular schedule. In contrast, Universal life insurance generally allows more flexibility in premium payment.

Guarantees

The company generally will guarantee that the policy's cash values will increase regardless of the performance of the company or its experience with death claims (again compared to universal life insurance and variable universal life insurance which can increase the costs and decrease the cash values of the policy). The dividends can be taken in one of three ways. The policy owner can be given a cheque from the insurance company for the dividends, the dividends can be used to reduce the premium payment, or the dividends can be reinvested back into the policy to increase the death benefit and the cash value at a faster rate. When the dividends paid on a whole life policy are chosen by the policy owner to be reinvested back into the policy, the cash value can increase at a rather substantial rate depending on the performance of the company. The cash value will grow tax-deferred with compounding interest. Most whole life policies can be surrendered at anytime for the cash value amount, and income taxes will usually only be placed on the gains of the cash account that exceeds the total premium outlay. Thus, many are using whole life insurance policies as a retirement funding vehicle rather than for risk management.

Liquidity

Cash values are considered liquid enough to be used for investment capital, but only if the owner is financially healthy enough to continue making premium payments (Single premium whole life policies avoid the risk of the insured failing to make premium payments and are liquid enough to be used as collateral. Single premium policies require that the insured pay a one time premium that tends to be lower than the split payments. Because these policies are fully paid at inception, they have no financial risk and are liquid and secure enough to be used as collateral under the insurance clause of collateral assignment.)^[5] Cash value access is tax free up to the point of total premiums paid, and the rest may be accessed tax free in the form of policy loans. If the policy lapses, taxes would be due on outstanding loans. If the insured dies, death benefit is reduced by the amount of any outstanding loan balance.^[6]

Internal rates of return for participating policies may be much worse than universal life and interest-sensitive whole life (whose cash values are invested in the money market and bonds) because their cash values are invested in the life insurance company and its general account, which may be in real estate and the stock market. However, universal life policies run a much greater risk, and are actually designed to lapse. Variable universal life insurance may outperform whole life because the owner can direct investments in sub-accounts that may do better. If an owner desires a conservative position for his cash values, par whole life is indicated.

See also

• Life insurance
• Permanent life insurance
• Term life insurance
• Theory of Decreasing Responsibility
• Buy term and invest the difference
• Universal life insurance

References

1. ^ "Basic Types of Policies". New York State Insurance Department. http://www.ins.state.ny.us/consumer/life/cli_basic.htm. Retrieved 2007-01-15. 
2. ^ Alexander B. Grannis, Chair. "The Feeling's Not Mutual". New York State Assembly. http://assembly.state.ny.us/Reports/Ins/199803/insureport.html#t08. Retrieved 2007-01-15. 
3. ^ "A Guide to Life Insurance". The Association of British Insurers. Archived from the original on 2006-12-10. http://web.archive.org/web/20061210015247/http://www.abi.org.uk/Display/default.asp?Menu_ID=1140&Menu_All=1,946,1140&Child_ID=413#Whole. Retrieved 2007-01-16. 
4. ^ "glossary". Life and Health Insurance Foundation for Education. http://www.life-line.org/build/glossary_c/index.php?pt=glossaryc&m=blank#cur. Retrieved 2007-01-15. 
5. ^ Florida Life and Health Study Manual, 12 edition
6. ^ "Whole Life Insurance". The Asset Protection Book. Archived from the original on 2007-01-14. http://web.archive.org/web/20070114153900/http://www.assetprotectionbook.com/whole_life.htm. Retrieved 2007-01-17. 

External links

• Chart Comparing Different Types of Life Insurance
• Learn About Life Insurance – Insurance Information Institute Life Insurance Learning Center
• The Life and Health Insurance Foundation for Education
• A History of Life Insurance in the United States through World War I
• Illinois Department of Financial & Professional Regulation, Division of Insurance, Slavery Era Policies Report August 2004
• Code of Ethics, National Association of Insurance and Financial Advisors