Whole Life Insurance

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The most common type of traditional life insurance sold today is known by a variety of different names, such as ordinary life, permanent life, or whole life. These policies, unlike the tax-oriented variable or universal life insurance policies provide a fixed benefit on the death of the insured. Further, unlike term insurance, the premiums remain level from the date of the inception of the policy until the maturation of the policy upon the death of the insured. They differ significantly from term insurance in three important, indeed fundamental, respects.

First, the premiums for whole life policies for relatively young adults (or rarely, young children) are initially much higher than for term insurance for the amount of insurance protection for a person of the same age. This difference in premiums may be by a factor of 10 or more percent when the insured is in his or her 30s or 40s. For example, a 35-year-old man will typically pay an annual premium of $15 or $20 per $1,000 of coverage for a whole life policy while a comparable one-year renewable term policy would cost somewhere between $2 and $5 per $1,000. The premiums on term insurance of course increase with the age of the insured. If our hypothetical 35-year-old man retained the same amount of term insurance year after year, he would be in his early sixties before the annual term insurance premium equalled the annual premium for his whole life policy.

Second, even though the premiums remain constant, the face amount of insurance provided by a whole life policy also remains constant. Whole life insurance is unlike declining balance term insurance in this respect.

Third, whole life policies develop cash values or cash surrender values each year after the policy has been in existence for a couple of years. Much of the initial excess premium over the cost of term insurance goes to building up this value.

Cancellation of the policy during its first years may involve a substantial financial loss. Furthermore, if a policy lapses as an attempt is made to replace it at a later date, the insured will find that the premium is increased because he or she is placed in an older age group when applying for the new insurance. These costs are often used by insurance agents as arguments against canceling a whole life policy, or allowing it to lapse, when they learn that the insured is having difficulty making the payments.

At first glance it may seem backward that the buildup of cash value in the earliest years is the lowest, since the pure insurance cost for protection in the earliest years is also the lowest. Several factors help to explain this structure: the administrative costs of writing a policy, including the cost of a medical examination; the commission structure for the whole life insurance agent (typically one-half or more of the first year’s premium goes to the agent as a commission for successfully selling the policy); and the desire to establish a premium structure that encourages retention of a policy rather than surrendering it. As indicated above, the cash value of a whole life policy increases gradually each year after the first year the policy is in effect. A whole life policy is an investment, an asset of the owner of the policy, much like a bank account or a deposit in a mutual fund. A whole life policy may be assigned to a creditor as security for a loan; the creditor may name itself as beneficiary so that it will receive the proceeds from the policy upon the death of the insured and repay the loan from the proceeds. The remaining balance, if any, presumably belongs to the estate of the insured or his or her heirs. During the lifetime of the insured, the creditor may also surrender the policy for its cash surrender value if a default on the obligation occurs. While loans secured by assignments of life insurance are not in common, it is a mark of some desperation by the borrower, since he or she may be depriving the family of needed insurance protection in order to arrange a loan.