Demystifying Whole Life Premiums

Critics of whole life insurance point to the higher premiums these plans require and the inflexibility of the payment schedule, however, when the structure and features of whole life insurance are fully understood, a fair-minded person would see that it offers affordability and flexibility along with unmatched long term security.  When whole life premiums are clearly explained, it becomes clear why whole life still remains the most popular permanent life insurance plan on the market.

Start with Assumptions

When you consider that the core proposition of whole life insurance is to guarantee lifetime protection that can never be revoked, then there must be a way for the life insurance company to ensure that it can deliver on that promise.  At the same time, they ask that you offset their risk by paying a small fraction of that future benefit in fixed installments over the life of the policy. 

To do this, they rely upon assumptions about the cost of money and the current rate of mortality.  It begins with a calculation of the cost of covering the risk. For any one policyholder, the risk of death increases each year and so does the cost of insuring against that risk.  This is more easily illustrated when looking at a yearly renewable term policy where each year the premium increases proportionately to the risk.

This is the reason why yearly renewable term insurance is not an ideal long term solution. While the premiums for a 25 year old person are very low when the policy is issued, by the time the insured reaches the later stages of life the insurance coverage can become prohibitively expensive.

Leveling the Premium

The value of a whole life plan is that the premiums will never increase.  This is accomplished by having the insured “pre-fund” the higher, future cost of insurance with current, cheaper, premium dollars. By paying a higher premium amount today that exceeds the cost of insurance, there will be excess funds that are available to accumulate.  These excess funds, or cash values, will accumulate each year through additional excess premium payments and a guaranteed interest credit.  The life company has calculated how much of the future insurance cost can be covered by the future growth of the cash values and, at the point where their annual cost of insurance exceeds the amount of premium, they draw the balance needed from the cash values.

The Magic of Dividends

Some whole life plans are “participating” policies that participate in the profits of the life insurance companies. When the life company outperforms its assumptions by experiencing better returns on their investments or lower than anticipated costs of insurance (this is achieved than lower than expected mortality), it pays a portion of its profits to the policyholders in the form of dividends.

Dividends can be used in a number of ways. They can be applied to premium payments which will reduce the annual outlay. They can be used to purchase additional blocks of paid up insurance which will also add to the growth of cash values. Or, they can be left to accumulate in a separate dividend account available for cash withdrawals. 

Dividends are not guaranteed, however, well managed, financially stable life companies have been known to pay dividends without interruption. 

A properly managed whole life policy, held over time, can generate enough cash value growth to eventually eliminate the need for future premium payments.  This is called a “paid up” policy and it provides the policyholder with continued lifetime protection and cash value growth with no additional outlay. 

Through the combination of cash value accumulation, dividends and favorable loan provisions, whole life insurance truly offers an optimum life insurance plan that can be both affordable and flexible while providing the ultimate in financial security.

The cost and availability of life insurance depend on factors such as age, health, and the type and amount of insurance purchased. Before implementing a strategy involving life insurance, it would be prudent to make sure that you are insurable by having the policy approved. As with most financial decisions, there are expenses associated with the purchase of life insurance. Policies commonly have mortality and expense charges. In addition, if a policy is surrendered prematurely, there may be surrender charges and income tax implications.

*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2020 Advisor Websites.