Ch 4 Whole Life Insurance

Annuity or Retirement Income

More and more insureds are purchasing ordinary life insurance to protect their families during the child-raising period with the specific objective of eventually using the cash values for their own retirement.

Cash Value

policy may be surrendered at any time for its cash value.

ordinary life can be regarded as an endowment

An endowment insurance contract pays the face amount of the policy, whether the insured dies prior to the endowment maturity date or survives to the end of the period. If age 100 is considered to be the end of the endowment period—as well as the end of the mortality table—then an ordinary life policy is equivalent to an endowment contract that pays the face amount as a death claim if the insured dies before age 100 or as a matured endowment if he or she survives to age 100.

Automatic premium loan option

Delinquent premium will be paid automatically by a new policy loan Automatic premium loan provision does not apply to flexible premium policies because the insurer usually deducts mortality charges and other expenses directly from the cash value. Hence no interest charges are incurred for skipped premium payments. An irrevocable beneficiary's consent may be required to obtain a policy loan. A policy loan is really an advance against the death benefit; thus the death benefit is adjusted to reflect the prior disbursement. Policy loans result in the life insurer's release of funds it would otherwise invest to earn investment income. If the rate of investment return on the insurer's portfolio is greater than the rate being applied to the policy loan, the insurer experiences a reduction in earnings. Therefore the insurance company usually takes steps to offset such loan-induced losses in order to preserve a rough equity between policyowners who leave their cash values invested and those who preclude the insurer from reaping the higher yield

Surrender options Nonforfeiture or Surrender Options

Designed originally to preserve the policyowner's equity in the policy reserve, surrender provisions are increasingly being used to adapt policy coverage to changing circumstances and needs. Most policies stipulate that the surrender value may be taken in one of three forms: 1. Cash 2. A reduced amount of paid-up whole life insurance 3. Paid-up term insurance.

Lowest Premium Outlay

Rate for an ordinary life contract is calculated on the assumption that premiums will be payable throughout the whole of life, the lowest rate is produced. If, however, the insured's objective is to secure the maximum amount of permanent insurance protection per dollar of premium outlay, then his or her purposes will be best served by the ordinary life contract. Its moderate cost brings the policy within reach of all people except those in the older age brackets.

Conversion.

giving the insured the right to exchange the policy for another type of contract, sometimes subject to certain conditions. Whether this privilege is specifically granted or not, an exchange can usually be negotiated. Virtually all companies will permit any form of permanent insurance to be converted to another form without evidence of insurability, as long as the new contract calls for a larger premium. insurers always suspect an impairment of health under such circumstances.

reduced amount of paid-up whole life

permits the insured to take a reduced amount of paid-up whole life insurance, payable upon the same conditions as the original policy. The amount of the paid-up insurance is the amount that can be purchased at the insured's attained age by the net cash value, less any policy indebtedness [policyowner loans plus accrued interest], plus any dividend accumulations) applied as a net single premium. Note that the paid-up insurance is purchased at net rates, which constitutes a sizable saving to the purchaser.

"SPECIAL" WHOLE LIFE POLICIES

preferred risks Company may justify a special low rate on a particular policy—which, in all other respects, is identical to the regular policy—by limiting the face to a specified minimum amount or by limiting its issue to preferred risks—that is, to groups that should experience a lower rate of mortality than that among insured lives generally because of more rigorous underwriting requirements. The purpose of the minimum amount is to reduce the expense rate per $1,000 of insurance.

Dividend Forms

• Cash • Applied to premium • Used to purchase more insurance (fully paid up) • Left with insurer to earn interest • Used to purchase more insurance (term) • To overpay premiums until policy is fully paid up

Joint Life Features

• Insure more than one life with one policy • Pay only one death benefit • First-to-die policies pay death benefit when the first death of the insureds occurs • Survivorship or second-to-die policies pay death benefit when the second insured person dies (no benefit at first death) • Survivorship policies often used to prefund federal estate taxes of husband and wife • May be converted to single-life policies if insureds divorce or dissolve their business relationship

Policy Dividends

• Payable on participating policies issued by either mutual or stock companies • Primarily influenced by investment results • Future dividend levels cannot be guaranteed • May decline or even cease

Cash values are not generally available during the first year or two of the insurance because of the cost to the company of putting the business on the books.

Exceptions are single-premium policies and some durations of limited-payment whole life policies whose first-year premiums are large enough to exceed all first-year expenses incurred to create the policy and maintain policy reserves

Policy Loans

In most policies over 90 percent of the cash value is available Some policies may restrict the amount of loanable funds to 92 percent of the cash value in recognition of an 8 percent policy loan interest rate—and any portion of the cash value can be borrowed. Can take out more than one policy loan as long as the aggregate amount of all outstanding loans and accrued interest applicable to those loans does not exceed the policy cash value. Policy loans do involve interest charged on the borrowed funds. The policy will stipulate either (1) a fixed rate as specified in the policy (commonly 8 percent) or (2) a variable interest rate tied by formula to some specified index. Policyowner has the option of paying the policy loan interest in cash or having the unpaid interest charge added to the balance of the outstanding loan(s) so that additional interest charges will be applied to the unpaid interest amount. Policyowner may choose to pay any part of the interest charge he or she desires since there is no repayment schedule or requirement. If the policy loan and accrued interest are not paid in cash, the life insurer can recover the outstanding balance of the loans and accrued interest in the following ways: (1) from the death benefits if the insured dies or (2) from the cash surrender value if the policy is terminated. In fact, the policy will automatically terminate if the policy loan balance plus unpaid interest ever exceeds the policy cash value.

paid-up term

provides paid-up term insurance in an amount equal to the original face amount of the policy, increased by any dividend additions or deposits and decreased by any policy indebtedness. The length of the term is what can be purchased at the insured's attained age with the net cash value applied as a net single premium.

Ordinary Life Insurance

AKA Continuous premium whole life - premiums are based on the assumption that they will be paid until the insured's death. Purchased with no intention on the policyowner's part to pay premiums as long as the insured lives The point is that ordinary life should not be envisioned as a type of insurance on which the policyowner is irrevocably committed to pay premiums as long as the insured lives or even into the insured's extreme old age. Rather, it should be viewed as a type of policy that provides permanent protection for the lowest total premium outlay and some degree of flexibility to meet changing needs and circumstances for both long-lived persons and those with average-duration lifetimes. The most basic lifelong policy offered by any life insurance company, and it enjoys the widest sale

Misnamed vanishing premium policy designs

Apply dividends and post dividend accumulations to ongoing premium payments. This is entirely different from a limited-payment policy, which has higher premiums payable for a specified and guaranteed period of time so the policy becomes fully paid up.

"direct recognition" to reduce dividends on policies with outstanding loans

This not only adjusts for the differential in earnings but also discourages policy loans there are policy loans, the insurer typically credits the normal rate to the unloaned portion of the cash value and a lower rate (often 2 percent or 200 basis points lower) to the portion of the cash value equal to the loan indebtedness. Once the loan is repaid, the insurer resumes crediting the higher rate to the full cash value. There is no retroactive payment to eliminate the past differential State statutes allow life insurers to delay lending funds for up to 6 months after requested.

Creating a separate preferred-risk class results in higher costs of insurance for smaller policies sold in the future and for insureds not eligible for the preferred class.

True - Placing larger policies or superior risks in a separate class with a lower premium rate inevitably results in a higher cost of insurance for smaller policies and insureds who cannot qualify as preferred risks.

two principal types of whole life contracts

• ordinary life insurance • limited-payment life insurance

Cash Value or Accumulation Element

Ordinary life accumulates a reserve that gradually reaches a substantial level and eventually equals the face amount of the policy. As is to be expected, however, the reserve at all durations is lower than that of the other forms of permanent insurance. In other words, the protection element tends to be relatively high Cash values that accumulate under an ordinary life contract can be utilized as surrender values, paid-up insurance, or extended term insurance.

Limited-Payment Life Insurance

Whole life insurance - premiums are limited by contract to a specified number of years Each premium must be larger than the comparable premium under an ordinary life contract. Moreover, the fewer the guaranteed premiums specified or the shorter the premium-paying period, the higher each premium will be. However, the higher premiums are offset by greater cash and other surrender values. Thus the limited-payment policy will provide a larger fund for use in an emergency and will accumulate a larger fund for retirement purposes than will an ordinary life contract issued at the same age. On the other hand, if death takes place within the first several years after issue of the contract, the total premiums paid under the limited-payment policy will exceed those payable under an ordinary life policy There is no presumptive financial advantage between forms. The choice depends on circumstances and personal preference

Participating versus Nonparticipating

Whole life policies can be issued on a nonparticipating basis with fixed and guaranteed premiums. This version of whole life does not pay any policyowner dividends Whole life policies issued on a participating basis anticipate charging a small extra margin in the fixed premium with the intent to return part of the premium in the form of policyowner dividends. This approach allows the insurer to maintain a stronger contingency margin and still adjust the cost downward after periods of coverage have been evaluated. Policyowner dividends are based on favorable experience such as higher than expected investment returns or lower than expected expenses for operations and/or mortality The appeal of policyowner dividends prompted stock life insurance companies to offer participating policies. Most stock life insurance companies offer a choice of both participating and nonparticipating policies. Almost all policies sold by mutual companies are participating policies.

JOINT LIFE INSURANCE

first-to-die joint life policy Strictly speaking, a joint life contract is one written on the lives of two or more persons and payable upon the death of the first person to die If the face amount is payable upon the death of the last of two or more lives insured under a single contract, it is called either a survivorship policy or a second-to-die policy Joint life policies are fairly common for funding business buy-sell agreements. May cover from two to 12 lives, but because of expense and other practical obstacles, most companies limit the number to three or four lives Contract is most often written on the whole life plan, either ordinary life, limited-payment or universal life. Seldom written on the term plan since separate term policies on each life for the same amount would cost little more than a joint policy and would offer the advantage of continued protection to the survivor or survivors Premium for a joint life policy is somewhat greater than the combined premiums on separate policies providing an equivalent amount of insurance.

Policy Loan Features

• Available on demand of policyowner • Interest charges apply • Depending on the specific contract, interest rates are either fixed or variable • Variable interest rates tied to a published index • Unpaid interest charges get added to loan balance • Repayment of loans is at discretion of policyowner • Outstanding policy loans plus unpaid interest is recovered from either death benefit or surrender value • Outstanding loans plus unpaid interest reduce nonforfeiture values • Policy terminates if loans plus unpaid interest ever exceed the policy cash value

FUNCTIONS OF WHOLE LIFE INSURANCE

• provides protection against long-range or permanent needs • accumulates a savings fund that can be used for general purposes or to meet specific objectives