Unlike term life insurance, permanent life provides protection for the entire life of the insured. As long as you make the premium payments, the policy will pay a death benefit. If the policy lapses, the residual benefit could be less than the total amount of premium paid or there could be no benefit depending on the type of policy and when it lapses.
Premiums for permanent life are higher than term in the early years of the policy. If you do not plan to keep a policy for at least 15 years or more, term insurance may be a better choice.
Cash values develop from the premiums you pay. Premiums are generally higher than the amount needed to cover the risk of your death and the expenses for the insurer to acquire and maintain your policy. The excess premium is accumulated with interest. Interest earnings are generally based on your insurer's investment experience.
Most policies will have little or no cash value in the first few years due to the large expenses involved in acquiring and setting up your policy.
Most permanent life insurance policies build cash value and can:
If payments are not made and cash values run out, your policy will terminate with no death benefit.
Here are some common types of permanent life policies.
Whole life policies have fixed level premiums and level death benefits for the life of the insured.
This type of policy generally provides no flexibility for adjusting the premiums or amount of death benefit. If premiums are not paid, the policy terminates.
Cash values are predetermined and will not vary over the life of the policy. Whole life is often referred to as ordinary life or straight life.
Participating whole life insurance policies have fixed level premiums, level death benefit, and predetermined cash values like a regular whole life policy.
However, participating whole life provides a return of some portion of the premium, called a dividend, if the insurance company's investment, mortality or expense experience is better than expected. These dividends provide flexibility to the policy, since they can be used for a number of purposes.
Dividends could be used to purchase additional insurance, pay premiums, or just accumulate with interest. Note that there is no guarantee that you will actually receive a dividend.
Variable life policies have a fixed level premium with a death benefit that varies based on the experience of a selected set of investments. You may specify which investments your cash value is to be invested in.
Most insurance companies offer several investment options, including money market funds, common stock funds, and bond funds. These policies provide a guaranteed minimum death benefit, but no guarantee of cash value. Variable life is riskier than other types of permanent life insurance because it is an investment-type product.
Variable life policies are subject to federal securities laws.
Universal life or flexible premium life insurance policies allow you to pay premiums at any time, in any amount, subject to certain maximums and minimums. These policies also allow you to adjust the death benefit.
With a universal life policy you will be able to actually see the interaction of premiums, death benefit, interest credits, mortality charges, expenses, and cash values.
A presentation will generally be given to you at the time you purchase the policy and at least annually showing how the cash values and death benefits develop.
In general, a universal life policy will develop cash values as follows:
Cash value = cash value from prior period + premiums paid - expense charges - mortality charges + interest
In a universal life policy, the insurance company generally guarantees that it will not charge you more than the stated maximum mortality charges. Most insurance companies charge less than the stated maximum mortality charges.
Universal life policies provide a guarantee that not less than a stated minimum interest rate will be credited. These rates are low.
Insurance companies generally credit a higher rate based on their investment experience or sometimes on the performance of a stock market index such as the S&P 500.
It is important to remember that in most cases the higher interest rate is not guaranteed to be credited in the future.
As long as the cash value is large enough to cover the mortality charges and expenses, no premium payment is required. However, you may still make premium payments which will be added to the cash value.
Federal law includes some restrictions on how high your cash value may be in relation to the death benefit before your policy will become subject to certain federal taxes.
Your insurance company will generally verify that your cash value is within the federal standards and if it is not they will adjust the death benefit automatically.
Under a universal life policy you are able to choose between two primary death benefit options.
One option is a level death benefit and the other is a death benefit that increases with the increase in cash value.
Regardless of the death benefit chosen, you will be allowed to adjust the death benefit at a later date. If you decide you want to increase the death benefit at a later date, you will likely be required to provide evidence of insurability.
If you decide to surrender (cancel) your universal life insurance policy, your cash value may be reduced by surrender charges.
Surrender charges are specified in the insurance policy and will vary significantly from one policy to the next depending on what expense charges were already assessed on your policy.
You will generally pay for the flexibility provided by universal life policies. When you are comparing interest crediting rates among policies, also compare mortality and expense charges since they can easily offset any additional interest credits.
Universal Variable Life is a variable life policy with the flexible premium structure of a universal life policy.
Unlike a universal life policy that provides a guaranteed death benefit if premiums are paid, a universal variable life insurance policy pays a death benefit that varies with the experience on the selected fund.
Universal variable life may be appropriate if you are looking for a life insurance policy that treats cash values more as an investment than a savings account.