Whole life insurance: How is it different?

By Insurance.com Posted : 01/01/2011

Anyone who shops for life insurance soon learns that whole life insurance - a form of permanent insurance, or cash-value insurance - is more costly than term life insurance. But why is that?

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"The simple answer to the question of why whole life insurance is more expensive is that permanent policies like whole life have a cash value buildup and term life insurance policies don't," says Alan S. Lurty, senior vice president for ING

Whole life insurance allows a policyholder to accumulate cash savings. The savings can be withdrawn, used to pay future insurance premiums or borrowed against, depending on the policy.

"Whole life in general can be more costly because it provides lifelong protection and it comes with a savings component," says Jack Dolan, vice president of media relations for the American Council of Life Insurers (ACLI). "When you pay premiums for whole life, you are not only securing death benefit protection, you are saving for the future."

By contrast, term life simply provides money to beneficiaries if the policyholder dies during the policy's term. Policyholders do not build cash savings in these plans.

"Term life insurance is straight death benefit protection for a particular period of time," Dolan says.

Life insurance cost differences

Whole life policies also are more expensive because there is a greater likelihood insurers will to have to pay out on a whole life policy than a term life policy, Lurty says.

"Given the nature of the policies, the chances of someone dying with a [whole life] policy in force are somewhat greater than with a term life insurance policy," he says.

Many people choose whole life policies when looking to hold a policy over a long period of time, Lurty says. On the other hand, people typically buy a term policy for a specific period of time, such as 10, 20 or 30 years.

"Many term policy owners have given up their policies before they are likely to die from age-related illnesses," he says.

Age and life insurance

Dolan says the gap in cost between whole life insurance and term insurance is widest for young people and narrows as people age.

Term life can be inexpensive for people in good health who purchase the policy before age 50. After that, premiums start to rise rapidly each year you wait to buy a policy.

Few insurance companies offer new term life policies for individuals over 65, so people who want to purchase life insurance after that age usually are forced to buy whole life insurance -- even though it, too, is much more costly for older individuals -- or a simplified-issue policy, which tends to have lower available payouts than whole life does.

Whole life insurance - also called permanent or cash value life insurance - differs from term life insurance because the coverage lasts as long as you pay the premiums. Because of this, however, the insurance company assumes more risk and consequently charges you higher premiums.

Whole life insurance premiums offset the higher cost associated with the increasing likelihood of mortality in the policy's later years by "overcharging" for insurance in the earlier years. The amount you "overpay" in premiums goes into a cash value portion of the account that is legally required to become available to you after a certain period of time. You can often take out a loan against this cash value, or use it to pay premiums if money is tight. The loan is not subject to credit checks, but must be repaid with interest - and reduces the death benefit payment until paid back.

Types of whole life insurance

  1. Universal (or adjustable) life adds flexibility because it allows you to vary your premium payments in amount and frequency after the cash value account becomes available. If you pay less in the beginning, you'll probably have to pay far more later - to prevent your policy from lapsing, death benefit being reduced or your cash value from evaporating.
  2. Variable life adds a savings account investment element that allows you to invest your paid premiums in a variety of stocks and bonds. This option is risky, because it reduces or raises the death benefit depending on the performance of the investments. Some policies prevent the death benefit from dropping below a certain amount, but their premiums are higher.
  3. Variable universal life provides the features of both variable and universal: you can vary your premium payments in amount and frequency after a certain period, and you can invest the paid premiums to affect the death benefit amount.

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