Whole Life Insurance

Which one of the following statements about variable life insurance is correct?

Variable life's policy values can be invested in subaccounts, which are unsecured and nonguaranteed.

current assumption and interest sensitive whole life insurance

Current assumption whole life (CAWL) and the closely related interest-sensitive whole life are characterized by premium rates that can change over time in response to the insurer's actual mortality, interest, and expense experience. If the insurer's actual experience is good, then premium rates are lowered. If the insurer's actual experience is bad, then premium rates are increased. At the time the insurer issues a policy, it sets a minimum interest rate to be credited to the policy and a maximum premium rate. After a few years, both the interest and premium rates can change based on a review and revaluation of the insurer's assumptions. The process insurers use to evaluate their actual experience and to apply the changes to their premium rates is called redetermination. The length of the period before redetermination varies among insurers. Some current assumption and interest-sensitive life insurance products redetermine their variable elements every two years. Others make a redetermination every seven years. Most make a redetermination every five years. Once the insurer identifies the new premium, it stays fixed until the next redetermination. While they share many of the same policy features, there are some notable differences between interest-sensitive whole life insurance and current assumption whole life insurance. Both types of policies credit interest to the policy's cash value at a rate based on the rise and fall of the stock or bond index linked to the policy. However, only the current assumption policy guarantees a minimum cash value level. With interest-sensitive whole life, the interest credited to the policy is not guaranteed, and thus the cash value is not guaranteed. Control over the premium and face amount also differs between the two products. With current assumption whole life, the policyowner has no control over how or when the premium changes, and the death benefit (face amount) does not vary. By contrast, interest-sensitive life policyowners do have some control over the premium and face amount. If the insurer's redetermined assumptions result in a higher premium, then the policyowner can choose to accept the higher premium. Or, the policyowner can choose to reduce the face amount of the policy and keep the same premium level.

two features

It provides guaranteed death benefit protection for the insured's whole life. No matter when the insured dies, the policy pays the face amount stated in the policy. Under most whole life policies, the covered lifespan extends to age 120. It includes a guaranteed cash value that gradually builds inside the policy. The cash value forms part of the death benefit, but it is also accessible while the insured is alive. The cash value is covered more thoroughly later in this lesson.

ordinary (straight) life insurance

The most basic type of whole life insurance is called either ordinary whole life or straight whole life policy. With whole life, benefits and premiums remain level straight through the insured's whole life. Death benefits remain level, and level premiums are paid until the insured dies or until he or she reaches age 120, whichever comes first. Premiums never increase despite the insured's increased likelihood of death with older age.

various types differ

While all forms of whole life have these two guaranteed features, the various types of whole life differ in the length of time over which premiums are paid and/or how the policy's cash values are invested and grown.

What are variable life insurance policies considered?

securities

When is a whole life insurance policy designed to mature or endow?

when the policy's cash value equals its face amount

Bill owns an indeterminate premium whole life insurance policy. Which one of the following statements about his policy is most correct?

Bill's premium will never be higher than the maximum level that the insurer guaranteed when it issued his policy. Bill will pay a lower fixed rate for a certain number of years (such as the first five or ten). At the end of that period, his premium rate will increase or decrease depending on the insurer's investment earnings. If earnings are good, premiums will be lower. If the investment experience is poor, premiums will be higher. However, Bill's premium will never be higher than the maximum level that was guaranteed when his policy was issued.

variable life

Consumer pressure on insurers to develop a product that truly reflects the investment performance of its underlying assets in the early 1980s led to the development of a new class of whole life insurance: variable life insurance. Unlike traditional whole life, variable life insurance includes an investment feature. Because of this feature, variable life policies are considered a security (like stocks, bonds, and mutual funds).

Regulation of VLI

Because of their investment nature and the inherent risk to principal, VLI policies are considered securities as well as life insurance. As securities, they are regulated by the Securities and Exchange Commission (SEC), the Financial Industry Regulatory Agency (FINRA), and state securities agencies. As with many other types of investment product sales, all variable life sales must be accompanied by a prospectus that provides details of the product and its investment characteristics. Producers who sell variable life insurance products must hold both a life insurance license and a FINRA Series 6 or 7 registration.

indeterminate premium whole life

Indeterminate premium whole life insurance is issued with two premium rates: lower fixed rate guaranteed maximum rate The policyowner pays the lower fixed rate for a specified number of years (such as the first five or ten). At the end of that period, the premium rate then moves up or down based on the investment earnings the insurer experiences. If earnings are good, then the premium will be lower. If the insurer's investment experience is not so good, then the premium will be higher. However, the premium due for any one year is never higher than the maximum level that was guaranteed when the policy was issued.

non-fixed whole life products

Straight, limited pay, modified, and graded premium whole life products all share a common trait: they offer fixed, "known in advance" premium amounts. That fixed amount may increase over time, as is the case with modified and graded premium policies, but in all cases the policyowner knows from the outset what the future premium requirements will be. These long-term fixed premiums are possible because insurers make long-term guarantees of the interest they will credit to the policy and the mortality and expense charges they will charge against it. Of necessity, these long-term interest rate guarantees are conservative. Beginning in the 1970s, when market interest rates were at historically high levels, consumers began demanding a whole life insurance product that was based on current interest assumptions. Insurers responded with a variety of new products. The first products to feature something other than fixed guaranteed assumptions and benefits were whole life policies that allowed flexibility in the premiums (based on current interest experience). They are called indeterminate premium whole life, current assumption whole life, and interest-sensitive whole life.

Indexed whole life

Indexed whole life insurance is a fairly new product that ties its death benefit and premiums to a specified index, most commonly the consumer price index (CPI). Over time, the policy's face amount increases automatically with CPI increases. Insurers offer two pricing methods for the premiums associated with a face amount that increases over time: The premium increases every year to a new fixed amount to provide for the increased coverage. A premium is set at policy inception and is based on assumptions about expected increases. This premium is higher at the front end but averages out over time. With an indexed policy, the policyowner knows the face amount will increase over time. However, he or she does not need to prove insurability each time it increases.

VLI contract charges and fees

Because of the additional administrative expenses and costs associated with separate account investing, VLI policies carry charges and fees that traditional whole life policies do not. In addition to the premium that covers the policy's death benefit, VLI policies may also charge a policy administrative expense or operational charge and a charge to cover separate investment accounts investment advisory fees. These fees may be charged monthly or annually, and they may be either a charge that is a percent of the policy's face amount or a fee that is a percent of the cash value. Potential other fees that may be charged include a fixed rate charged for loans; a charge for processing withdrawals or cash surrenders; and account transfer fees. The variable life product prospectus covers more specific details about fees and charges.

whole life insurance

In contrast to term insurance, with its three basic forms, there are many different types of permanent life insurance. The oldest and most traditional form of permanent life insurance is whole life insurance. Whole life insurance features more guarantees than any other form of permanent life insurance available today. Whole life insurance includes the following products: traditional straight (ordinary) whole life limited payment life modified premium whole life graded premium whole life changing premium whole life indexed life variable life

Fixed premium and guaranteed death benefit

Like traditional whole life, standard VLI policies require a fixed premium on a scheduled basis. As a whole life product, variable life also guarantees a minimum death benefit. However, unlike traditional whole life, there is a real possibility that the death benefit will increase above the guaranteed face amount. It all depends on the investment performance of the subaccounts selected by the VLI policyowner. If they perform well, the cash value will increase. If the increase exceeds the interest rate supporting the guaranteed face amount, the result may be a death benefit that also rises above the face amount. The death benefit will fluctuate up and down but will never be less than the guaranteed face amount.

single premium life

The most extreme example of limited pay life is the single premium life insurance policy, which is paid up with one premium payment at the time the policy is bought. Such a policy is often called a Modified Endowment Contract, or MEC. Tax law changes in 1988 diminished the appeal of single premium life by removing from it some of the tax advantages normally enjoyed by life insurance.

Guaranteed cash value

A crucial part of every permanent insurance policy is its cash value. With whole life insurance the cash value grows at a contractually guaranteed rate. This is necessary to support the guaranteed level death benefit and premiums. The cash value is funded by the policyowner, as part of the premium. Permanent life premiums are generally higher than term premiums at any issue age, which is due in part to funding the cash value. From each premium payment, the insurer withdraws the cost of the pure insurance protection at that point in time. After deducting a modest amount to cover expenses, the remainder is placed into the policy's cash value, where it accumulates at interest. The cash value continues to grow throughout the life of the policy. The policyowner owns the cash value and may borrow against it while the policy is in force (though doing so will result in a reduced death benefit if not repaid). At policy maturity (age 120 for policies issued since 2009) the policy face amount is paid to the policyowner since it equals the cash value and there is no more pure insurance protection.

modified and graded premium whole life insurance

Two similar variations on the whole life theme are modified premium whole life insurance and graded premium whole life insurance. Both of these products feature a lower initial premium than straight whole life of the same face amount, but premiums increase to a higher level after a designated period of time. The difference between the two products lies in the manner in which premiums increase over time. With modified premium whole life there is a single increase (typically five years after policy issue) with premiums remaining level thereafter. Graded premium whole life starts with an even lower premium, but premiums increase in a series of steps until they, too, become level for the remainder of the premium period. The grade-in period during which premiums increase may range anywhere from 10 to 15 years. Like all whole life policies, modified and graded premium policies issued since 2009 mature at age 120. (Policies issued before 2009 may continue to mature at age 100.) Cash values grow more slowly in the early years, due to the lower premium, but accelerate when premiums increase until they eventually equal the face amount at age 120. Modified and graded premium whole life policies appeal to consumers who want the guarantees of whole life insurance and lower premiums in the early years (with a willingness to pay more later on). They are ideally suited for younger people who are just beginning their careers and who expect their incomes to increase in the future.

limited payment life

Like ordinary whole life, limited payment whole life insurance provides level death benefit protection for the insured's whole life. Also like ordinary life, limited payment life has level premiums. The main difference between ordinary life and limited payment life is the time period over which premiums are paid. As the name suggests, the premiums for limited payment life insurance policies are payable for a shorter time than ordinary life premiums. The tradeoff to the shorter premium period is the fact that premiums are higher than they would be with a straight life policy. In most other respects, these two forms of whole life insurance are the same. Limited payment whole life policies appeal to customers who want permanent coverage but wish to pay for it within a finite period of time (not one's entire life). Limited payment life insurance premiums can be paid for 10, 15, or 20 years or, as is common, to a specified age, such as age 65. A policy with a ten-year premium period would be called a ten-pay life policy. One that requires premiums to age 65 would be called a life-paid-up-at-65 policy. At the end of the selected payment period, the policy is paid up. No more premium payments are necessary or possible. However, the insurance remains in force. In fact, the cash value continues to grow (albeit at a slower rate) until policy maturity at age 120 (for policies issued since 2009).

Level premium concept

Ordinary whole life policy owners pay the same (level) premium over the life of the policy. The purpose for this level premium concept is simple. The older one gets, the greater the risk of death, which would normally mean higher premiums. If an insured were to pay a premium that directly reflected the current chance of death, then the premium would be very low when the insured was young and prohibitively expensive in old age. "Leveling" the premium avoids such extremes in premium cost. There are a variety of factors behind the level premium concept, but the simplest explanation lies with the cash value and its effect on the policy's net amount at risk (i.e., the pure insurance component of the policy). As the policy's cash value increases, the net amount at risk decreases at the same rate so that the death benefit remains level. (The reducing net amount at risk offsets the cost of pure insurance that increases every year with age: As the cost of pure insurance increases, the amount of pure insurance decreases.)

non-guaranteed cash value

Unlike the VLI death benefit, the cash value is not guaranteed. If values decline due to poor investment results, the cash value will decrease. A variable life policy's cash value at any time is equal to the value of the policy's shares in its chosen subaccounts plus the value of funds allocated to the guaranteed fixed account. If the VLI insured dies with a diminished cash value, the insurer effectively makes up the difference so that the minimum guaranteed death benefit can be paid.

the nature of variable life insurance

With traditional whole life policies, insurers invest the premiums in safe, secure, and conservative investments that are managed in the insurer's general account. This, in turn, lets the insurer credit safe, secure, and conservative rates of return to the cash values. Variable life insurance (VLI) differs from traditional whole life insurance in the way its values are invested. VLI policy values are invested in investment accounts, known as subaccounts, which are managed in a separate account that keeps them apart from the insurer's general account. Subaccounts consist of a variety of stocks, bonds, and related securities. In this way, a VLI owner can participate in the growth of the contract's underlying securities. Like all securities, separate account investments are not guaranteed, which means VLI cash values are subject to declines as well as increases. VLI policyowners fully assume the investment risk of policy values allocated to the separate subaccounts. VLI policyowners choose how they want to invest their policies' premiums and cash values. They can fully invest in the nonguaranteed investment subaccounts. Or, they can allocate their premiums and cash values between the subaccounts that comprise the insurer's separate account and the insurer's general account. In early VLI policies, the policyowner had only three variable subaccounts to choose from: stock fund bond fund money market fund Today, VLI policies offer a wide variety of subaccount options, in some cases 20 or more. VLI policyowners can transfer funds between each subaccount. They can also transfer funds between subaccounts and the insurer's general account, although insurers may place modest restrictions limiting the frequency of some transfers.