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Permanent life insurance policies are designed to provide lifelong protection. The basis for permanent insurance contracts is whole life insurance.
Whole life insurance ensures a death benefit or face amount is paid upon the insured's death, no matter when it happens. This policy offers lifelong protection, covering the insured from its start date until their passing. Whole life policies are also known as straight life, continuous premium life, permanent life, or ordinary life insurance.
A whole life policy is generally described as a fixed death benefit, fixed premium life insurance contract. In other words, it's characterized by a level death benefit, a cash savings value (i.e., equity build-up), permanent protection, and a fixed, level, or predetermined premium. The death benefit, premium payment, and the interest rate paid on the cash value are all predetermined for the insured's "whole life." Also, a whole life policy protects an insured permanently for the remainder of their life. This life insurance policy never needs to be converted or renewed, since it remains in force as long as all premiums are paid on time.
All types of whole life insurance share certain features. A traditional whole life insurance policy combines pure death protection with a cash value feature. Additionally, the policy's death benefit (face amount) remains constant or level throughout the policy's life. Premiums are set at the time of policy issuance and remain fixed for the policy's life. Whole life policies are based on the assumption that premiums will be paid by the policy owner throughout the insured's lifetime or to age 100, whichever occurs first. This means that whole-life policies are designed to "mature" or "endow" at age 100. Many newer whole life policies now endow at older ages (105 or 110). "Mature" or "endow" means that the cash value accumulations equal the face amount. Cash value and endowment (or maturity) are the main features that distinguish whole life insurance from term life insurance, and they combine to produce additional living benefits for the policy owner.
While term life is designed to provide temporary protection IF the insured dies too soon, whole life insurance is designed to provide permanent protection WHEN the insured dies.
Unlike term insurance, which only provides death protection, permanent life insurance combines insurance protection with a savings element. This accumulation of funds or equity, commonly referred to as the policy's cash value, builds over the life of the policy. Although it is an essential part of funding the policy, the cash value is often considered a living benefit because it represents the amount the policy owner will receive if the policy is ever surrendered or voluntarily terminated.
When a policy owner pays the premium for a whole life insurance policy, a portion of that premium is used to pay for the death benefit. This portion of the premium is referred to as the "term" insurance cost or the mortality cost of insurance. Another portion of the premium is used to cover the costs associated with the insurance company that issued the policy — commissions, underwriting, medical exams, etc. — and the costs of maintaining the policy. After the contract has been in effect for an initial period, the insurer begins depositing a portion of the premium into the policy's cash value. Some states may have specific requirements as to when the accumulation begins. Still, in most traditional whole life policies, the cash value begins two to three years after the policy is issued. Once the cash value begins to accumulate, it increases with each subsequent premium payment and continues to build during the life of the contract. The cash value accumulates from the premiums paid plus a guaranteed fixed interest rate. This interest is added annually and allows the cash value to grow each policy year.
In the policy's early years, more of the premium money goes toward providing the actual insurance protection, but as the cash value grows and begins to offset the death benefit, the funds needed to purchase the actual insurance protection decrease. With less money being used for actual insurance protection, more of the premium can go toward growing the cash value during the later policy years. Whole life insurance policies were traditionally designed so that their cash value buildup would equal the policy's face amount by the time the insured reaches the age of 100. Therefore, if a person purchases a whole life policy today and lives to age 100, they will receive all their premiums back, plus some interest. Over the past few decades, many insurers have modified the mortality tables used to determine premiums and maturity. Although some continue to base maturity on age 100, many are using age 115 or 120.
It is important to understand that, traditionally, the cash value buildup is not paid to a beneficiary in addition to the death benefit when the insured dies. The policy's cash value is available to the policy owner at any time. Policy owners always have the right to a policy's cash value. The policy owner can surrender the policy, cancel coverage, and receive the cash value. This is why the cash value is also referred to as the cash surrender value.
For example, at age 30, John buys a $100,000 whole life policy for $1,200/year. It takes about three years to start building cash value. By year 10, the policy has $9,000 in cash value, reducing the insurer's risk to $91,000. After 35 years, the cash value grows to $40,000, lowering the insurer's risk to $60,000. At age 100, the policy matures with a full $100,000 cash value, and no further protection is needed. The cash value of a policy is influenced by several factors: a higher face amount leads to larger cash values, shorter and higher premium payments accelerate cash value growth, and the longer the policy is active, the quicker the cash values accumulate.
There's a specific "return of cash value" benefit rider that can be added to a whole life policy. If an exam question doesn't explicitly mention an insurance policy having a return of cash value rider or endorsement, it should be assumed that the policy in question doesn't include that rider.
Whole life insurance was originally designed to mature at the age of 100. From an actuarial standpoint, it's assumed that every insured will be deceased by the time they would have reached the age of 100. Although some individuals live beyond the age of 100, the number who do is statistically insignificant in the population.
Consequently, the premium rate for whole life insurance is based on the assumption that the policy owner (usually the insured) will be paying premiums for the insured's whole life. The policy is designed so that when the insured attains the age of 100, the cash value of the policy is equal to the face amount of the policy. At that point, the policy has matured or endowed, and no more premiums are owed. In turn, the insurance company issues a check for the policy's face value, minus any outstanding policy loans. Practically speaking, very few individuals live to the age of 100. In fact, it's far more likely that a whole life policy will be cashed in for its surrender value or that its face amount will be paid out as a death benefit before the policy matures.
As noted earlier, whole life is designed with the belief that the insured will live to the age of 100. Accordingly, the amount of premium for a whole life policy is calculated, in part, based on the number of years between the insured's age at issue and the age of 100. The shorter the payment period, the higher the premium. This span of years represents the full premium-paying period, with the amount of the premium spread equally over that period. This is referred to as the level premium approach. As with level premium term insurance, the level premium whole life approach keeps premiums level rather than increasing each year with the insured's age.
Whole life premiums are referred to as "bundled premiums." Bundled premiums mean the insurer is not required to explain to the policy owner how the premium paid is ultimately distributed (i.e., for death protection, commissions, and other expenses). Premium rates are based on a per-$1,000-of-coverage rate and are typically expressed annually. For example, an insurance producer might explain to a potential applicant that a whole life insurance policy costs $9 per $1,000 of coverage. If the applicant wants a policy with a $100,000 face value, the annual cost would be $900 ($9 × 100).