Demystifying Whole Life Premiums
by Keith A. Rhodus on Dec 19, 2017
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.
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