A term life insurance policy DOES NOT include cash value. That is a unique feature avaialble for permanent (whole life) policies. The following is a basic illustration of how a cash value life insurance policy works: Premiums are paid into the insurance on a regular basis (annually, semi-annually, quarterly, or monthly). This raises the water level in the barrel. The insurance firm spits out its expenses (EXP) and mortality charges (cost of insurance/COI) on a monthly basis. The coverage will lapse/terminate if there isn’t enough water in the barrel. The aggregated value is the remaining water in the barrel. Subtract the surrender fees from the surrender value, and you get your surrender value.
How can I tell the difference between the many types of whole life Insurance?
Whole life insurance, also known as ordinary life insurance or straight life insurance, was the first permanent life insurance policy and is still the most prevalent in-force life insurance policy today. The premise is straightforward: (1) premium payments are made for the rest of the applicant’s life at a rate determined by the company and agreed upon by the applicant; (2) when the named insured dies, the company pays the face amount to the named beneficiary. That’s all there is to it. As long as the payment is paid on time, the firm can never raise the premium rate or terminate the policy (absent fraud, in which case the policy can be rescinded, but fraud claims are very rare). As a result, the insurance company promises to pay the face value upon death, whether it occurs on the first day of coverage or at age 99. To meet this commitment, the company hires actuaries to calculate the premium payment levels that will be sufficient to fund the policy’s guarantees. Actuarial science in life insurance companies is, as the name implies, quite scientific and accurate. It entails the pooling of risks across a large number of covered people. The corporation has no way of knowing which specific insured persons will die in any given year, but it does know how many will die each year and what their age distributions will be. Actuaries use this information to compute premiums and set proper reserve levels in order to uphold the company’s obligations. If the insured individual lives to the end of the stipulated mortality table, the firm normally deems the policy “endowed” and pays the full face amount to the policy owner, despite the fact that this is not usually specified in the policy. With the introduction of universal life, variable life, and variable universal life in the last 20 years, whole life has become significantly less popular. In the sense that premiums must be paid on time or the policy “lapses,” whole life policies are more inflexible than adjustable life, universal life, and variable universal life policies (i.e., ceases or goes into a so-called non-forfeiture option mode, such as extended term coverage or reduced paid-up life insurance). The “automatic premium loan” option on whole life policies allowed the firm to cover any outstanding premium payments by taking a loan from the cash value. The simplicity of the whole life policy is its distinctive trait. If you pay your premiums on time, the policy will pay out when the insured dies. The main disadvantage of whole life insurance is the greater premium payment compared to universal life, variable universal life, and its variants. The coverage will lapse if the policy owner is unable to pay the premiums due to job loss, illness, or other causes.
Policy loans are normally accessible, but if the loan is not repaid, the policy will lapse. For additional information on policy loans, see Chapter 10, Questions 106–109, which go through them in depth. Policy loans can be a highly complicated and damaging part of your coverage. The insurance firm invests the cash value of a whole life policy through its general investment portfolio. Variable universal life plans, on the other hand, have the cash value component invested in different accounts (more on this later). Participating or non-participating policies cover the entirety of one’s life (par v. non-par). A participation policy has a higher premium and gives the policy owner periodical profits in exchange. Non-par insurance do not pay dividends and have lower premiums than par plans. Dividends can be applied in a variety of ways. Dividends are not promised and are based on the company’s actual experience with its book of business in force. The following dividend options are available: (a) cash; (b) purchase of fully paid-up life insurance in small increments with each dividend; (c) reduction of the next premium payment; (d) retention by the company at interest; and (e) purchase of one-year term insurance in an amount equal to the cash value at the time (the so-called fifth dividend option; that was popular with policy owners who wanted to maximize the face amount of coverage during the early in-force years). When you apply for a participating policy, you must understand that dividends are purchased and paid for. Higher premiums are the price of dividends.
Whole Life is a permanent life insurance policy with premiums payable for the rest of one’s life. The original whole life policy, also known as straight life or continuous premium whole life, is still in use today. Ordinary life insurance products give perpetual coverage for a fixed annual payment (the mortality costs are spread over the life of the policy). Cash values often increase at a steady rate, eventually reaching the face value at the age of 100. Due to the high expenses of policy sale and issuance, cash values in the early years are often low. Underwriting and administrative expenses account for the majority of these costs, with the agent’s fee accounting for 40 percent to 80 percent or more of the first-year premium.
How does the premiums paid accumulate cash value?
The insurance company receives the premium and deducts the expenses (the contract specifies the maximum that can be charged; however, most companies usually charge less). Instead of stated expense charges, many of these policies feature higher mortality charges and a margin built into the interest earnings credited to the cash value. To arrive at a beginning year balance, the net amount remaining is added to the previous year’s cumulative fund balance. Interest is calculated at the current rate of the insurer and added to the balance. Then there are charges for mortality (these charges are calculated based on the maximum permissible rates as set forth in the contract or, more often, on lower current rates). This rate is applied to the net amount at risk of the insurance (face amount less cash value). Surrender charges are usually paid against the fund balance to arrive at the net surrender value in most contracts. This value is never less than the non-forfeiture law’s minimum requirement. These are available in a variety of forms, including limited-pay and lifetime-pay premiums. The higher the premium, the shorter the premium payment time. The corporation determines the premium rate and subtracts certain costs from premiums received. Although corporations frequently charge less, the contract specifies the maximum premium that can be charged. To arrive at a beginning year balance, the remaining net amount is added to the previous year’s cumulative fund balance. The insurance then applies interest to the balance, after which mortality charges are applied. These fees are determined using either the contract’s maximum authorized rates or, more commonly, lower current rates. To arrive at the net surrender value, most of these contracts indicate that surrender charges will be applied to the fund balance. This value is never less than the non-forfeiture law’s minimum requirement. Surrender charges normally decrease by a percentage each year and endure for 10 to sixteen years.
Summary
Cash value is an exclusive benefit of permanent (whole life) insurance and adds to the death benefit of the policy. However if you are looking to purchase pure life insurance protection, the best value is term life insurance. ProtectQuote offers the most simple way to obtain affordable term life insurance quotes.
