Understanding the basics of Whole Life Insurance is relatively simple. As the original permanent life insurance, Whole Life insurance is designed to be maintained until death, or 100 years, whichever comes first. For example, if you are the person getting a Whole Life Insurance policy on yourself, it means that as long as you pay your premiums, you are guaranteed to have life insurance in place until you die. If you happen to live past age 100, your life insurance policy will be paid out.
There are two main components to Whole Life Insurance, the death benefit and the living benefit (or policy cash values). The cash values make up part of the death benefit and are guaranteed to be equal to the death benefit at age 100. It is the cash values that will be paid out if you were to live past age 100.
Unique and often ignored values of Whole Life Insurance are the living benefits that have evolved along side the insurance industry since its inception. Whole Life Insurance was once used as a primary savings vehicle in the early 20th century because of its built-in guarantees, liquidity in the form of cash values, and the stability the insurance sector was built upon.
For a detailed history of Life Insurance please go here.
However, it is important to know that not all Whole Life Insurance policies are created equal. There are two different types of Whole Life Insurance:
- Participating Whole Life
- Non-Participating Whole Life
Participating Whole Life Insurance
Owners of a Participating Whole Life Insurance Policy contribute to and share in both the expenses and benefits of the Participating Account. When the Participating Account does better than expected, Policy Owners participate in the earnings of the account through Annual Non-Guaranteed Dividends. When the Participating Account does worse than expected, Policy Owners can see their Dividend reduced or not paid at all.
The Participating Account and Premiums
The participating account is a pooled account where premiums, investment returns, and policy loan repayments from all participating policy owners go into. The pool is designed to pay any death benefit experiences, cash value guarantees, taxes and administrative expenses, investments, and dividends for policy holders. Premiums above the cost of insurance and other expenses go into the participating account to be invested for the purpose of meeting policy guarantees, paying claims, and other expenses.
Investments can be managed by the insurance company’s asset management group who may practice different investment strategies including diversification, asset allocation, buy and hold, and more. Alternatively, the premiums set aside for investing can be used by individual policy owners through policy loans instead. Policy loan repayments contribute to the investment returns through the interest rate set on policy loans at the time.
When calculating premiums, Permanent Life Insurance considers both the cost of insurance and investments required for the lifetime of the insured person and averages this cost over the insured persons elected pay period. For example, the pay period may be 10, 20, 90, or 100 years, where, at the end of the period the policy will be fully paid up. That means the premiums for this product have a guaranteed level cost.
The death benefit of a Participating Whole Life Insurance policy is guaranteed to be paid out according to the individual owner’s contract. The insurance company is responsible for paying the amount in full and at any time its needed. The death benefit is paid out on a tax-free basis.
If the insured person were to die while there is a policy loan outstanding, the death benefit would be reduced by the loan amount.
Cash Values are guaranteed every year and will be equal to the amount of the guaranteed Death Benefit at the time the insured person turns 100 years old. Cash Values make up part of the death benefit though its important to note that they are not paid out in addition to it. A good way to think of Cash Values is that they are the insurance company’s way of saving money on your behalf.
The whole idea behind providing Cash Values is so the insurance company can reduce the death benefit amount they are responsible for paying. The company credits individual policy owners Cash Values from the Participating Account (premiums, investment returns and policy loan repayments), effectively saving money on the insured persons behalf and reducing their own ‘out of pocket’ liability.
Policy Loans can be requested at any time by the policy owner who can borrow against up to 90% of the Cash Values inside the policy. Again, premiums above the cost of insurance and other expenses go into the participating account to be invested or can be elected by policy owners to be used for these policy loans. So, while policy loans may reduce the overall Death Benefit until they are repaid, they do not reduce the Cash Values inside the policy.
Dividends are paid based on the experience of the Participating Account each year. If expenses are low and investment returns are high, the dividend payment will reflect this with a higher dividend scale. The inverse will also happen. The good news is that in years where investment returns, policy loan repayments, claims and other expenses are better than expected, the insurance company withholds a certain amount inside a contingency fund. The contingency fund is drawn upon in down years to smooth the experience of the company. This helps ensure there is a dividend paid every year, even in economic down years.
Depending on the insurance company, dividends can be paid out in the following ways:
- On Deposit
- Investment in a Segregated Fund
- Reducing or offsetting premiums
- Purchasing additional insurance
- Term Additions (one-year term insurance option)
- Paid Up Additions (permanent insurance option)
Non-Participating Whole Life Insurance
This is a basic Whole Life Insurance policy. While it does offer tax-advantaged investments and the ability to borrow against cash values, it does not participate in the experience or earnings of the Participating Account and is generally less flexible.
Different insurance companies offer different insurance riders. Riders are optional benefits you can add on to a basic insurance policy. While some insurance companies offer more riders and some less, here is a list of the basic riders available in Canada:
- Term Insurance
- Critical Illness Insurance
- Long Term Care Or Terminal Illness
- Accidental Death and Dismemberment
- Death Or Disability Waiver Of Premiums
- Future Guaranteed Insurability
- Child Rider
- Spousal Rider
- Paid Up Additions
Part of the special design of an Infinite Banking policy is purchasing Paid Up Additions (or as I like to call them, additional fully paid up ‘mini’ policies). These new ‘mini’ policies come with their own guaranteed cash values, guaranteed death benefit, and opportunity for non-guaranteed annual dividends as described above. The effect is an ever-growing death benefit with ever growing cash values that we can borrow against at any time and for any purpose we may need it for. When we take out a policy loan against our cash values, they will continue growing uninterrupted inside our policy the whole time!
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