Traditional whole life products

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Traditional Whole Life Products

Whole life insurance is permanent coverage: as long as premiums are paid, the policy stays in force for the insured's entire life, and the death benefit is guaranteed rather than dependent on the policy still being in force at an arbitrary end date the way term insurance is.

The three guarantees

A traditional whole life contract makes three guarantees to the policyowner:

A level premium that never increases, even as the insured ages and mortality risk rises.
A guaranteed death benefit amount, fixed at issue.
A guaranteed minimum cash value, which grows on a schedule set out in the policy from the day it is issued.

The insurer can make this work because the level premium in the early policy years is more than the pure cost of insurance at that age. The excess is set aside and credited with interest, building the cash value that subsidizes the premium in later years, when the pure cost of insurance would otherwise exceed a level premium.

Cash value and nonforfeiture rights

Cash value is not a side account the owner can add to or withdraw from freely -- it belongs to the policy. If the owner stops paying premiums, state nonforfeiture law requires the insurer to give the owner one of several options rather than simply keeping everything paid in: a lump-sum cash surrender, a reduced paid-up policy (a smaller death benefit, fully paid, for life), or extended term insurance (the original death benefit, but only for a limited number of years). !Whole life premium and cash value relationship

Premium-payment variations

"Traditional" whole life covers a family of designs that differ only in how the level premium is scheduled, not in the underlying guarantees:

Straight (ordinary) whole life -- premiums are payable for the insured's entire life.
Limited-pay whole life (e.g., 20-pay life, paid-up-at-65) -- premiums are compressed into a shorter payment period, after which the policy is fully paid up but coverage continues for life. Because the insurer collects premiums for fewer years, each premium is higher than an equivalent straight life premium.
Single-premium whole life -- the entire cost is paid in one lump sum at issue; there is no future premium obligation at all.

Participating vs. non-participating

A participating policy is issued by a mutual insurer (or a participating line from a stock insurer) and may pay dividends -- a return of excess premium when the insurer's actual mortality, expense, and investment experience is more favorable than assumed in pricing. Dividends are not guaranteed and are not taxable income (they are treated as a return of premium) unless they exceed total premiums paid. A non-participating policy pays no dividends; its premium is fixed with no experience-based adjustment.

Key terms

Sample questions

What makes traditional whole life insurance "permanent" coverage?

The premium can be skipped in any year without affecting the policy.
The death benefit increases automatically each year the insured survives.
As long as premiums are paid, the policy stays in force for the insured's entire life.
The policy converts to term insurance once the cash value reaches the face amount.

Reveal answer

Correct answer: As long as premiums are paid, the policy stays in force for the insured's entire life.

Whole life is permanent because it is designed to remain in force for the insured's whole life, provided premiums are paid. The death benefit is guaranteed rather than dependent on death occurring before an arbitrary end date, which is what distinguishes it from term insurance.

Which of the following is NOT one of the three guarantees a traditional whole life contract makes to the policyowner?

An annual dividend payment
A level premium that never increases
A guaranteed death benefit fixed at issue
A guaranteed minimum cash value that grows on a set schedule

Reveal answer

Correct answer: An annual dividend payment

The three guarantees are the level premium, the guaranteed death benefit, and the guaranteed minimum cash value. Dividends are never guaranteed; they are paid only on participating policies and only when the insurer's experience is more favorable than assumed.

How is an insurer able to charge a premium that stays level for the insured's entire life even though mortality risk rises with age?

It reduces the death benefit each year to offset the higher mortality cost.
The level premium in the early years exceeds the pure cost of insurance, and the excess is set aside with interest to subsidize later years.
It charges an additional annual fee once the insured passes a set age.
State law caps what an insurer may charge for mortality at any age.

Reveal answer

Correct answer: The level premium in the early years exceeds the pure cost of insurance, and the excess is set aside with interest to subsidize later years.

In the early policy years the level premium is more than the pure cost of insurance at that age. The excess is set aside and credited with interest, building the cash value, which then subsidizes the premium in the later years when the pure cost of insurance would exceed a level premium.

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