Whole Life Policy
From Financial Literacy Wiki
Whole life policy provide lifelong insurance protection. A basic whole life pays the sum assured in a lump sum on death of the assured. Depending on the clauses, they pay either a lump sum or by installments on total & permanent disability when it occurs. Most whole life policies are participating – meaning that the policy will accumulate bonuses. Premiums collected are used by the insurance company to:
- Pool money in a fund and invest according to their asset allocation strategy stated in the benefit illustration & product summary on application
- Pay out claims
- Pay out commissions (limited to usually a max of 5 years on a decreasing scale)
Contents |
Evolution of Main purpose of Whole Life
Whole life insurance originally was used for legacy planning as it is the only instrument that guarantees a payout with the absolute certainty of death (with the exception of the folding of an insurance company). Due to advances in medical technology, diagnosis and treatment of critical illnesses became widespread which then led to the creation of a critical illness rider in the 90s that can be attached to the basic whole life policy. This meant that a policy with such a rider pays out the sum assured when the insured person is diagnosed with a critical illness as defined in the rider, resulting in whole life coverage of death and critical illnesses. Thus, the availability of this critical illness rider and term insurance meant that whole life insurance policies core purpose has evolved to providing life time cover against critical illnesses. Since 2010, early critical illness policies have surfaced but only as a term insurance with the exception of one company that offers whole life insurance that includes early critical illnesses coverage for life. In this example, the scope of critical illness cover becomes broad and also quite notable, for life.
Premiums
In the past before the turn of the century, whole life insurance policies collect premiums for life which created financial stress for retirees, which discouraged them from continuing their policies by surrendering them. Modern whole life policies have a limited-pay feature, meaning premiums are collected over a fixed term that the policyholder chooses but coverage remains for life. For example, someone who buys a 25 year premium term will pay 25 times of annual premiums but enjoy coverage for life. However, this applies to only the basic whole life plan and the critical illness rider, not other riders attached to the plan.
Cash Value & Row over Policy Breakeven
As a whole life policy accumulates bonuses, there is a cash value (also known as surrender value) to the policy. Should the policy be surrendered, the cash value becomes payable to the policyholder. The cash value table is commonly used to estimate when the policy breakeven or in other words, the cash value is equal or marginally greater than the premiums paid so far. In the past, some insurance companies encouraged insurance agents to pitch their whole life policies (which were life-long premium terms then) to consumers that the premiums of the policy can be paid for via bonuses declared by the insurance companies and still have leftover bonuses credited into the policy. As limited-pay whole life didn’t exist then, many consumers bought the plans on the basis that the plan will be financially self-sufficient at say, 15 years. However, as these were sold in a high interest rate period (when the US Federal Reserve imposed high interest rates to curb inflation), the insurance companies were able to project relatively high bonuses. However, when interest rates came down, insurance companies could not achieve returns high enough to maintain these bonus rates to credit into whole life policies without investing into high risk instruments which may jeopardize the entire fund. Thus, the insurance industry on a whole had to reduce bonuses to policyholders. As lesser bonuses were credited into whole life policies, consumers had no choice but to pay more premiums before the policy was able to be financially self-sufficient. This caused great dissatisfaction among consumers as they felt cheated into a financial product that did not deliver up to expectations. The life insurance industry then introduced limited pay whole life policies that is available presently and MAS passed regulations to stop insurance agents from selling to consumers based on the number of years to breakeven.
Other Financial Options
Because whole life policies accumulate cash value over time, policyholders have options apart from surrendering the policy.
- Policy loan: policyholders can borrow up to typically 90% of the cash value. The interest charged by insurers usually ranges around 5-6% per annum.
- Convert to fully paid up: the insurance company will calculate a new sum assured based on total amount of premiums paid so far and the policy becomes fully paid up. Policyholders of the old type of whole life policy may want to utilize this option upon retirement to retain some coverage. Riders remain attached to the basic policy.
- Convert to term: the policy will be converted to a term insurance with the same amount of cover but the coverage will terminate after the term expires. Riders will no longer be attached.
