Whole Life Insurance - What Should I know?

As we discussed in another article, insurance is a way to manage risk.  Life insurance can cover the risk of leaving your loved ones with a lifestyle they won’t be able to afford.  You can manage (or transfer) that risk by buying life insurance from a certified company.  The two most common types of life insurance are whole life insurance and term life insurance.

So what should you know about whole life insurance?  You should know about maturity, insurability, death benefits, premiums, cash values, dividends, riders, beneficiaries, ownership, advantages, and disadvantages.  Let’s take it one step at a time.

First Thing’s First: Know the Terms

Before going any further, the most important thing we can communicate to you is to know the terms of the policy contract.  The policy is a legally binding contract between you, the owner, and the life insurance company.  Know all of your options and what your contract says before signing anything!   Go to your attorney, accountant, financial advisor, and certified life insurance agent for their professional advice. That’s why you pay them.  We feel much better now knowing that you’ll do your due diligence before signing anything.  Now, on to the subject of maturity.

Whole Life Insurance Maturity

One of the biggest differences between whole life and term life is maturity.  When will the policy pay the beneficiaries?  In term life insurance, the maturity is only if the insured dies within a certain block of time, such as 1, 5, 10, or 20 years.  It is possible that the insured could not die within that space of time and the beneficiaries not receive any payment.  In whole life insurance the term is for your whole life life, hence the name “whole life insurance.“   The insured is covered for his/her entire life as long as the conditions of the policy are met.

Insurability

Whole life insurance is no different from any other insurance you buy.  The insurance provider must know it’s a good deal for them.

Remember that actuaries provide insurance companies with data to reflect the probability that a person with certain characteristics will pass away.  How well you measure up to those data tables determines whether or not you will be approved by the underwriting process.

Factors, such as smoking, drinking, diabetes, health conditions, family health history, recreational history, and traveling history all can have a negative effect on a person’s insurability.  You may be asked loads of questions and be required to complete a health exam before you are granted life insurance.  

Whole Life Insurance Death Benefits

The death benefit, or the face value, is paid to the beneficiary if the insured dies or reaches the maturity age (usually 100 years old).   The death benefit is usually guaranteed to never decrease.  The death benefit of a whole life insurance policy is different from a term life policy in that they oftentimes go up with time.

Whole Life Insurance Premiums

Premiums are paid by the policy owner to the insurance companies.  Premium is a fancy word for the money you give to an insurance company in exchange for their service.  Payments for a whole life insurance policy are generally higher than term because the length of coverage is greater.  Think of it from a life insurance company’s perspective: “I have to make a payment sometime in the next 100 years if I sell whole life insurance” vs. “there is a 15% change that I might have to make a payment in the next 20 years if I sell term insurance.”  You can logically see that the risk to a life insurance company in whole life is much greater than term life, so companies will charge more to compensate for the increased risk.

Whole life insurance and term life insurance premiums are typically guaranteed never to go up over the term of the policy.

Whole Life Insurance Cash Values

Another important aspect of a whole life insurance policy is the cash value that is created.  The cash value is the same as the surrender value or the cash surrender value.  This value increases over time. 

You can also borrow from this cash value.  It works in much the same way as borrowing money from the local bank.  You borrow a certain sum of money and pay it back with interest.

The policy owner can also cancel the policy at any time in exchange for the cash value.  The cash value can be referred to as the surrender value because you can surrender your right to insurance for this money.

Whole Life Insurance Dividends

If a whole life insurance policy is a participating policy, the cash value may be increased by dividends.  This happens when an insurance company makes a profit and decides to share that profit with its “participating” members. 

Life insurance dividends are tax-free if they don’t exceed the total premiums you have paid.  Ask your accountant for more details.

Whole Life Insurance Riders

Riders are additional conditions to a life insurance policy.  Examples include additional premium, waiver of premium, accelerated death benefit, accidental death benefit, accidental dismemberment, disability income, guaranteed insurability, and level term riders.  There can be many other varieties of these riders. 

Beneficiaries

The death benefit is paid to the beneficiary.  There can be one or in special cases thousands of beneficiaries associated with one insurance policy.  The policy owner can designate an individual or entity to be a beneficiary.  For example, your uncle Joe could designate you as the sole beneficiary or leave you out of it all together and assign the Red Cross to receive a death benefit.  Joe could also give you 95% and the Red Cross 5%.  He could give leave his wife 100% if she were alive when he passed on and leave instructions to give you 95% and the Red Cross 5% if his wife were not alive when he passed on.

The possible combinations for beneficiaries and beneficiary entitlements are endless.  We recommend that you consider this point carefully.  Every situation is different.  We also recommend that you designate at least 3 levels of beneficiary conditions.  What we mean by this is to include something like “my wife gets 100%.  If she were to predecease me (die before I do), my four children get 25% each.  If my wife and any of my four children were to predecease me, the remaining children split the benefit equally.  If my wife and all children were to predecease me, my friend, Lucy Doe, gets 75% and the Red Cross gets 25%.”

Whole Life Insurance Ownership

The individual or entity who signs as the life insurance policy holder is the owner.  This person or entity has the power to choose the beneficiary or beneficiaries are and how the benefit will divided among beneficiaries.  This person or entity has the contractual obligation to pay the premiums.

It may be confusing when we say that an entity can own a life insurance policy.  Let’s say you want to create a corporation for your family restaurant, Bob’s Food Place, for liability and tax purposes.  Bob’s Food Place now becomes Bob’s Food Place, Inc., and it is now a separate, legal entity from yourself.  Now suppose that after careful consideration with its professional accountants, attorneys, financial advisers, and life insurance agents Bob’s Food Place, Inc. wants to insure the business against the loss of key business personnel.  Bob’s Food Place, Inc. can buy a life insurance policy for you and another one for your brother, Bob.  Bob’s Food Place, Inc. is now the policy owner, is responsible for paying the premiums, and is free to designate itself as the sole beneficiary.  Companies do this sort of thing all the time.

Advantages of Whole Life Insurance

The primary advantages to a whole life insurance policy are:

1. The coverage of the insurance is for the entire life of the insured.  You won’t have to renew the insurance ever again unless you want to add more insurance.
2. The insured will only have to pass the underwriting process once.  Future declines in health or an increase in dangerous activities will not increase your premium.
3. Cash value builds in the policy.
4. You can borrow against the cash values of the policy.
5. Dividends can usually be taken out tax free.

Disadvantages of Whole Life Insurance

The primary disadvantages of a whole life insurance policy are:

1. You are stuck with the same premium for the life of the insured.  If you decide to cancel the policy, you get the remaining cash value.  The isn’t always a bad thing, though, because the cash value usually exceeds have much you have paid after about 3 years.  Basically, you come out ahead after 3 years.
2. The premiums are usually higher for the same coverage amount than term life insurance.  This is because the life insurance company is taking on more risk because they know the insured will die at some point in the future.

Remember to consult with your professional advisers and know your options and the terms of the contract before purchasing any type of insurance.  Good luck.

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Tags: Whole Life Insurance

This entry was posted on Thursday, January 24th, 2008 at 10:32 am and is filed under Whole Life Insurance. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.