Can you please explain cash value?

Answer 1

Cash value is a characteristic of whole life insurance (sometimes called "permanent insurance"). It does not exist in the context of term insurance.

With a whole life policy, a portion of the periodic premium is used to pay the amount needed to cover the death benefit (determined by insurance actuaries), and a portion of the premium is credited to the cash value. VERY broadly, you might think of cash value as an element of savings that is built in to the insurance policy, but do not draw a parallel to a savings account as such.

Cash value accumulates slowly, and is generally de minimus in the early years of the policy. However, the cash value is a store of value that can be accessed by the insured, according to the terms of the policy, once a certain amount of time has passed or an amount of cash value has accumulated. For example, the insured can usually take a "policy loan" against the accumulated cash value. Typically, the interest rate charged by the insurer for such a policy loan is lower than other sources of loans. Interest will accrue on the loan, and if the loan and interest is not fully repaid by the time the insured dies, the balance of the loan will be deducted from death proceeds.

One of the reasons that whole life insurance is sometimes called "permanent insurance" is because there comes a point in the life of the policy when the cash value can support the future premiums and the insured does not have to pay further premiums. Stated otherwise, the policy becomes "fully paid-up" at a point in time specified in the policy.

In contrast, with term insurance, the insured is, in a sense ,"renting" the death protection; it remains in force only as long as the periodic premium is paid. Further, if the insured does not die while the policy is in force (often anywhere from 10-30 years depending upon the duration selected by the insured at the inception of the policy and presuming that premiums continue to be paid), coverage terminates, no benefits are paid, and no "value" (such as "cash value") accrues. This does not mean that term insurance is not worthwhile. It is generally less costly than whole life, and therefore, a person may load up on term insurance when they are young and, for example, raising and educating children. This would be done to ensure that sufficient money is available to finance child rearing expenses upon a parent's premature death.