Whole Life Insurance

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Whole Life Insurance

Unlike term life insurance -which has no value after a set period of time-there are some forms of life insurance that build a cash equity value over time. These are the most common kinds of so-called cash value insurance:

• whole life
• universal life
• blended whole/universal life
• interest sensitive whole life
• variable life
• variable universal life
• variable blended whole/universal life

In most of these cases, premiums start higher than term insurance-but they stay level-and the policy accumulates a redeemable cash value as time goes on. This kind of insurance makes sense if you:

• are accumulating cash for the future
• need coverage for more than 15 years
• think like a homeowner
• are in a high tax bracket
• are over 35 when you buy your first policy

The most common of these kinds of insurance is whole life. Whole life insurance is a permanent form of insurance protection that combines a death benefit with cash value.

A whole life policy, the face amount is constant, and this amount will be paid if the insured person dies at any time while the policy is in effect. Premium payments are fixed and remain the same from the original effective date to the maturity date.

The policy is designed to mature at age lOO -the age when premium payments would end and the cash value would equal the face amount. At maturity, the face amount is paid to the beneficiary if the insured person is still living.

Although whole life policies are one of the most common forms of life insurance sold, most people do not plan on paying premiums until age 100. Because cash value accumulates, the cash value at retirement may allow the policy to remain in force to age 100 without subsequent premiums. More commonly, whole life insurance is used as a form of level protection during the income producing years.

At retirement, many people then begin to use the accumulated cash value to supplement retirement income. This gradually reduces the death benefit.

Whole life plays an important role in financial planning for many families. In addition to the death benefit or eventual return of cash value, the policy has some other significant features. During a financial emergency, policy loans may be taken and the full policy values may later be restored. If the contract is a participating policy, it may also pay dividends.

Most of the preliminary language-setting provisions, terms and conditions-is the same for whole life and term life policies.

Policy Loans

The issue at which whole life policies differ from term is the fact that you can borrow against equity value you build in a whole life policy. The insurance company will make loans against the net surrender value of the policy.

Usually, borrowing is a straight forward process. Your agent or the life insurance company's home office will send you a loan form upon your request. On this form, you will be asked for the amount of the loan, your tax ID number, your address and policy number. Within a matter of weeks-or sometimes days-the insurance company will send you a check.

The policy is used as security for the loan. The insurance company will not lend an amount which, with interest, would exceed the net surrender value of the policy. However, overdue repayments plus interest can push a policy into default.

A quality product will typically show some cash value in the first year and cash value that equals at least one year of premiums by the third year. Thereafter, most of the premium is used to increase cash value.

When the owner of a policy borrows money, interest is charged just like any other loan. Therefore, if the, borrowing continues, the interest amount will increase each year.

Most companies want to see the loans repaid as quickly as possible, so they make it as easy as possible to accomplish. The loan may be paid in a lump sum, periodic payments, interest only payments, or applying any dividends generated by the policy. Details on borrowing and repayment can be obtained from an agent or directly from the insurance company.

It is possible to take money out of the policy in the form of loans and continue to keep the death benefit in force. A policy loan reduces the value of a policy. Any amount outstanding will be deducted from the proceeds if the insured dies or surrenders the policy for its remaining cash value.

Most policies provide for automatic premium loans against cash value to prevent a lapse in coverage when a premium is not paid before the end of the grace period. In order for this to take effect, the policy owner must make a written request before the end of the grace period. Once this arrangement is in effect, future unpaid premiums will be borrowed against the policy until the cash value is insufficient to cover a premium payment. As long as the policy remains in force, a policy owner may resume making premium payments without having to provide evidence of insurability. The automatic premium loan feature may be canceled at any time by written request.

Example: Sara's job was eliminated due to restructuring, and she fmds herself on a tight budget. To minimize expenses, she requests that automatic premium loans be made JO cover her quarterly life insurance payments. Two premium payments were paid in this manner. After six months, Sara found another full-time job and was then able to pay her next premium.

In order to restore a policy to its full value, an outstanding policy loan must be repaid with interest. The interest rate charged on a policy usually ranges between six and ten percent annually (though this number fluctuates with interest rates in general). Unpaid interest is added to the amount of the outstanding loan.

Some people don't understand why they have to pay interest on their own money-the cash value they have borrowed. The reason is that the insurance company no longer has use of this money-it is no longer earning interest for the company. Projected policy values (the face amount, cash value on future dates, etc.) are based on the assumption that premiums will be paid to cover costs and expenses-and that there will be enough left over to invest and earn interest and equal the cash value. When the company does not have use of the money, these values fall short. So a policy loan must be repaid with interest to restore the contract to its full value.

Participating Policies

Like term insurance, a whole life policy can be either participating or non-participating. A participating policy is usually preferable, because it can pay dividends. Don't confuse premiums with cost. Premiums may be a little higher but net cost (premiums less dividends) may be lower.

The policy owner has options as to how dividends will be received. They can be taken in cash or applied toward premium payments. They can also be used by the insurance company and earn interest-then transferred later. Finally, they may also be used to buy additional amounts of whole life insurance or one year term insurance additions.

When whole life additions are purchased with dividends, they usually comply with the terms, provisions and schedules that apply to the underlying policy.

Term Additions

Additional amounts of term insurance are available only if the policy is in a standard premium class, and it is requested in the application or by a later written request. When a policy is issued as nonstandard, it means the insured person poses a higher risk. An insurance company is not usually willing to provide additional amounts of coverage under this option.

When term additions have been purchased, the additional benefit is payable when the insurance company receives proof that death occurred within one year after the dividend was paid. Term additions usually expire an the next anniversary date, So they may not accumulate from year to year. The premium charge for term additions is based on the extended term mortality table being used by the insurance company for the policy in effect.

An insurance company will usually provide life insurance coverage in increments of $1,000. If term additions are elected, any part of a dividend not used to buy additional insurance may be taken in cash, applied toward a premium, or left with the company. If no other option has been elected, the insurance company will automatically apply dividends toward premium payments for existing coverage (it will reduce the net amount due).

The premium charge for term additions is based upon the extended term mortality table being used by the insurance company for the policy in effect.

Lapse or Surrender

A whole life policy has a cash value, certain values are guaranteed upon the lapse or surrender of the policy. Any of these options (which are known as nonforfeiture options) may be elected in writing by the owner within 90 days of the due date when a premium is in default. If no election is made, one of the automatic options will apply-non-participating extended term insurance for a standard premium class policy; or participating paid-up insurance for a special premium class policy.

The net surrender value is the cash value, plus the present value of dividend accumulations and additions, minus any outstanding policy loans. Values are determined as of the last premium due date. Any outstanding loans that are subtracted from the surrender value will include any interest or other amounts charged against the policy after the due date. When the policy is turned in for its surrender value, the cash value will be paid (minus any loans and interest). Top quality companies usually pay almost immediately. However, poorer quality companies may delay payment for up to six months, in which case it will pay 3 percent annual interest on the amount held more than 30 days.

Surrender Charges

The surrender charge is a penalty the company charges the policy owner for terminating the policy during the first few years. It reduces the cash value of a policy to its surrender value.

Example: Andy paid two years of premiums in advance on his universal life policy. Six months later, he lost his job and wanted to get some of his cash back. The company's surrender charges were more than 200 percent of his premium. The result was, after Andy had paid a two year premium and only had the policy for six months, the company refused to return any premium or cash value.

Surrendering to Purchase More Insurance

When used to purchase paid-up participating insurance, the surrender value will be used as a single premium to purchase as much paid-up whole life insurance as possible at the insured's attained age. The amount may not exceed the death benefit under the current policy plus additions and dividend accumulations (normally, it would be considerably less). Since this additional insurance is paid-up, no further premiums will be due.

Example: Upon surrender of a $100,000 whole life insurance policy, Sam selects the extended term insurance option. The policy being surrendered has been placed for 7 years and 102 days. It includes $6,000 of additional paid-up insurance and $4,000 of dividends being held by the insurance company. The surrender value purchases a $110,000 fully paid-up term life insurance, which will remain in effect for 12 years and 263 days (the balance of a 20 year term).

While it remains in force, participating paid-up insurance or extended term insurance may also be surrendered for its present value. This value includes any cash value, the refund of unused premium due to early termination of the paid-up contract, plus any dividend additions or accumulations.

Basis of Values

The following passage-common in many whole life polices-explains how values are determined under the policy:

All net single premiums and present value referred to in this policy are based on the Commissioners 1958 Standard Ordinary Mortality Table, except that net single premiums for extended term insurance are based on the Commissioners 1958 Extended Term Insurance Table. The calculations are based on continuous functions, age nearest birthday and with an interest rate of 3 percent per year.

On any policy anniversary the tabular cash value of this policy shall equal the excess, if any, of

• (a) the then present value of the future basic benefits as deIfied in the policy schedule, over
• (b) the then present value of a series of annual amounts beginning on such anniversary and continuing during the remaining premium paying period.

Any supplemental agreement attached to this policy will not increase the cash values or paid-up insurance benefits unless otherwise provided in the agreement.

The Table of Guaranteed Values gives the values for the full face amount of this policy, provided this policy is free of indebtedness and has neither dividend additions nor accumulations. Allowance shall be made for lapse of time and payment of premiums beyond the beginning of each policy year. Any values not shown will be quoted on request. The entire loan value at the end of any policy year, less interest for the intervening period, will be available during the same year if the entire premium for that year has been paid.

In this case, net premium values and present values are based on the mortality tables used for the kind of policy in question. Calculations include use of a person's age as of the nearest birthday and an interest rate of 3 percent annually. The dollar amounts related to cash values are shown in the table of guaranteed values attached to the policy, and all values must be at least as great as the minimum amounts required by state law:

The table shows values for the full face amount of the policy. If there is any outstanding policy loan, it will reduce the value. If there are dividend accumulations, it will increase the value. Any values not shown will be quoted by the insurance company on request.

Conclusion

Whole life insurance coverage provides protection and savings that remain in effect for the whole of your life. This type of life insurance is preferred by many and used widely for security because it combines protection and savings-two major factors in the financial plans of most families.

When you're considering a whole life policy, there are several questions you should ask your agent or insurance company. These include:

• What are the company's third party ratings by Weiss Research, A.M. Best Company, Standard and Poor's and Moody's rating services?
• How does your company's rating compare to the highest rating?
• What percentage of your invested assets are in high risk assets (for invested assets, exclude separate accounts and non-income or non-appreciating assets; for high risk assets, include bonds of below average or non-investment grade quality, bonds in or near default, mortgages in foreclosure or with payments overdue more than 90 days and real-estate acquired by foreclosure)?
• What is the company's Moody's Risk Adjusted Capital Ratio?

• Most Current Year End
• Prior 5-Year Average
• Ratio of Capital and Surplus (plus AVR) to Liabilities (Less AVR) and Separate Accounts
• Lapse Ratio
• Renewal Expense Ratio Mortality Margin
• Total Investment Return (Excluding Policy Loans, including Capital Gains)

• "I don't have access to this information (because the company doesn't provide it or because the agent doesn't understand it)."
• "That's not important (because the insurance company is so good, so old, so highly rated....)"
• "Would you like the summary version or the detailed version of this information?"