20 April 2012 0 Comments

Permanent Life Insurance Primer

So far I’ve concentrated on Term Life Insurance, but Term doesn’t solve all needs, so here we go…a quick primer on Permanent Life Insurance followed by at least 10 situations that require Permanent Insurance.

The premium for all Permanent Life Insurance is a product of four factors:

1.  Mortality costs: percentage of people who will die each year.

2.  Earnings of the insurance company from investing your premium.

3.  Insurance company expenses: operations, sales, marketing, taxes & investment.

4.  Insurance company profit margins.

In fact, these same factors go into the pricing of term insurance, but the second factor, earnings, is less important.  That’s because Permanent Life Insurance charges more in the early years than is required to cover current mortality costs and therefore has more money to invest over a longer period of time.  The concept of Permanent Life Insurance is to charge more early in order to charge less in later years.

This pricing formula is quite transparent in some policies and with others it is a big black box that is very difficult to decipher.  Just remember though that these are the elements and in the end the insurance company must create a policy attractive enough for you to buy while returning a reasonable profit.  As I explain each type of policy I’ll identify which are transparent and which are black boxes.

Non-Participating Whole Life Insurance

This policy is quite simple, so I wouldn’t call it a black box.  That doesn’t make it good.  It has fixed premium and guaranteed cash values that build slowly equaling the death benefit at age 100. It pays no dividends, and its premium is calculated using low interest, high mortality costs and undisclosed expenses.  It does not produce a competitive premium. Non-Participating Whole Life Insurance should only be considered if no other policy type is available to the applicant.

Participating Whole Life Insurance

Now, here’s a black box. This type of policy is the same as a Non-Participating Whole Life policy except the guaranteed premium is usually higher because dividends are projected to be paid. The dividends usually do not start until the end of the second policy year and can be taken in cash or used in any of the following ways:

  • To reduce the premium.
  • To purchase units of additional insurance.
  • To purchase Term Life Insurance.

An agent selling Participating Whole Life will show an illustration that projects dividends many years into the future based on what the actuaries assume will be paid based on current factors and anticipated events.  Dividends, however, are not guaranteed. In recent years, variations that blend Participating Whole Life with Term Insurance Riders have been introduced to compete with the lower initial premium of Universal Life Insurance. The premiums for the term riders are typically not guaranteed, further compounding the black box effect.

Participating Whole Life Insurance can be a good deal, but only if you keep the policy in force for many, many years, and the dividends paid are close to those that were projected. The death benefit guarantees are not competitive. In today’s changing economy, I believe there are too many uncertainties to make this a viable product for most applicants. While it’s possible for a Participating Whole Life policy to yield sufficient dividends to cover the entire premium after 25 years or more, most people end up dropping these policies long before the dividends can make a difference.

Next I’ll be covering Interest Sensitive Whole Life and Variable Life and finally Universal Life.

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