Whole life insurance

What whole life insurance is

Whole life is the oldest and simplest form of permanent life insurance. You pay a level premium, the insurer promises a stated death benefit whenever you die, and the contract remains in force for your entire life provided the premium is paid. There is no expiry date and no renewal at a higher rate. The policy that was issued at 55 is the same policy, at the same price, at 95.

The reason a fixed premium can cover a rising risk is that whole life is deliberately overpriced in the early years and underpriced in the later ones. The insurer takes more than the true cost of insuring you at 40 and holds the surplus in reserve, which is why the same payment still works at 85 when the true cost of insuring you has multiplied. That reserve is also where cash value comes from.

Whole life is issued at almost any size, from a $5,000 funeral policy to a multi million dollar estate planning contract. The size decides how it is underwritten. Large policies are fully underwritten with an exam. Small ones are simplified issue, which is a page of health questions and no exam at all.

The three guarantees

A traditional whole life contract makes three guarantees, and everything else in the product is commentary on them.

• The premium never changes. It is set on the day the policy is issued, based on your age and health then, and it stays there for life. Nothing you do later, and nothing that happens to your health later, can raise it.
• The death benefit never shrinks. The face amount is contractual. It does not reduce as you age and it does not disappear at 80 or 90.
• The cash value grows on a guaranteed schedule. The contract contains a table of guaranteed cash values by policy year, so you can see the floor before you buy.

Those three are the entire case for whole life. They are also the reason it costs more than term for the same face amount, because a promise that has no end date is worth more than one that stops after twenty years.

How cash value actually works

Cash value is the savings component inside the policy. It grows slowly at first, since early premiums cover the cost of insurance and the cost of putting the policy on the books, then compounds. On a small burial policy it is genuinely small, often nothing meaningful for the first two or three years, and it should never be the reason you buy one.

You can reach it in three ways, and each has a real consequence.

The most common misunderstanding is the relationship between the cash value and the death benefit. On a traditional whole life policy the beneficiary receives the face amount, not the face amount plus the cash value. The cash value is an asset you can use while you are alive, and it collapses into the death benefit when you die. Borrowing against it and never repaying reduces what your family receives, which matters a great deal on a policy bought to pay for a funeral.

Most policies also carry a set of nonforfeiture options, which are what happens if you stop paying. Typically you can take the cash surrender value, convert to a smaller paid up policy that needs no further premiums, or use the cash value to keep the full death benefit in force for a limited period. Those options are listed in the contract and they are the reason a lapsed whole life policy is not always a total loss.

Dividends and participating policies

Policies issued by mutual insurers, meaning companies owned by their policyholders rather than by shareholders, are often participating. A participating policy may pay an annual dividend, which represents the insurer returning part of the difference between what it assumed about mortality, expenses and investment returns and what actually happened.

Dividends are not guaranteed. That sentence is in every contract and it should be in every sales conversation. When a dividend is paid you generally choose whether to take it in cash, use it to reduce your premium, leave it to accumulate at interest, or buy paid up additional insurance, which increases both the death benefit and the cash value. Buying paid up additions is the option that most improves a policy over decades, and it is the one that makes long dated illustrations look impressive.

For a funeral sized policy this is a footnote rather than a feature. Judge a $10,000 policy on its guaranteed premium and guaranteed death benefit, not on a dividend projection that may or may not happen.

Whole life compared with term and universal

The comparison people should actually make is not which product is better in the abstract. It is whether the need has an end date. A mortgage ends. Children grow up. A funeral does not have an end date, which is why term life is usually the wrong tool for it.

Why burial insurance is small whole life

Burial insurance, final expense insurance and funeral insurance are marketing names for a small whole life policy. Nothing about the contract type changes. What changes is the size, which is typically $5,000 to $25,000, and the underwriting, which is simplified issue rather than a medical exam.

That combination fits the problem precisely. A funeral is a bill of a fairly known size, $6,280 for a cremation with a service and around $15,395 for a burial once the cemetery has billed, arriving at an unknown date, most likely in old age, at a moment when the family needs cash within days rather than weeks. Permanent coverage answers the unknown date. A small face amount keeps the premium affordable on a fixed income. Simplified issue means it is available to people in ordinary rather than perfect health.

How burial insurance works covers the buying side, and the funeral cost breakdown is where the face amount should come from. If you want to see the underwriting outcomes rather than the contract mechanics, read which policies pay from day one.

When whole life is worth it, and when it is oversold

Whole life earns its higher price when the need is permanent. Final expenses are the clearest case, because everyone has a funeral and nobody knows the date. It also does real work for a lifelong dependent such as an adult child with a disability, for estate liquidity where heirs would otherwise have to sell something quickly, for a business buy sell agreement, and as a way to leave a specific legacy that does not depend on market timing.

It is oversold in two situations. The first is when someone with a large temporary need buys a small permanent policy because that is what fitted the budget. A parent of young children who needs several hundred thousand dollars of coverage and buys $25,000 of whole life has bought the wrong thing, however good the contract. The second is when whole life is presented primarily as an investment. It is a poor investment and an excellent guarantee, and the honest way to sell it is on the guarantee.

There is a straightforward test. Write down what the money is for and when it would be needed. If the answer has an end date, look at term. If it does not, look at permanent coverage sized to the actual bill.

Reading an illustration without being sold to

Whole life is usually sold with an illustration, a multi page projection of premiums, cash values and death benefits over decades. Illustrations are regulated, and they contain both a guaranteed column and a non guaranteed column. Almost every impressive number in a sales presentation comes from the non guaranteed column.

• Read the guaranteed columns first and decide whether the policy is acceptable on those numbers alone.
• Check the guaranteed premium and how long it must be paid, since some policies are designed to be paid up after a set number of years and others are paid for life.
• Look at the guaranteed cash value in years one to five. On a small policy it is often close to nothing, which is normal and should be stated plainly rather than glossed over.
• Ask whether any illustrated premium reduction depends on dividends, because dividends are not guaranteed.
• Ask for the free look period in writing. Every state gives you a window after delivery, commonly ten to thirty days, to return the policy for a full refund.
• Check the contestability and suicide provisions, normally two years, so the family is not surprised by a delayed claim review.