General Life Insurance Topics
Misconception of Cash Value Provision in Life Insurance
Just as it took a long time for people to finally accept the truth that the world is round rather than flat, so is the issue of cash value in a life insurance product.
Every once in a while an article will be written which continues to perpetuate the concept that cash value in a whole life insurance policy is a personal savings account accessible at anyone’s beck or call.
Such is the article appearing on the internet under “Bankrate, What is cash value life insurance?” (https://www.msn.com/en-us/money/personalfinance/what-is-cash-value-life-insurance/ar-BB14dAf6?ocid=spartanntp)
The very first paragraph says, “Cash value life insurance is basically the same as a regular life insurance policy but with one important difference–a portion of the money you pay each month gets put into a savings account that you can access in various ways as you see fit.”
Explanation of “Regular” Insurance
Using the term “regular” to name a type of life insurance policy is too ambiguous because it does not give details sufficient to understand what it means. It does not give the latitude needed to describe the cash value provision available in several types of policies.
If the author intended to use “regular” to introduce the concept of life insurance, he or she should have begun with a simple explanation of an insurance policy providing a death benefit upon the death of a person insured–no whistles or bells, just a death benefit payable upon the death of the insured. It would be comprised of the following elements: a person to be insured; an owner of the policy; a premium payor; a beneficiary of the policy; a death benefit based on age, health, occupation, period of time coverage to be provided, amount of death proceeds to be paid, and premium charged to cover the exposure. If those elements are included, then those policies could be considered a regular policy. These “regular” policies carry names like yearly renewable term, 5-year, 10-, 15-, 20-year renewable term, term to age 65, term to age 100, etc.
Cash Value Life Insurance
Once one defines “regular” then the cash value life insurance policies can be discussed. These are policies where the premium deposit is divided in several ways: one, a portion set aside to assist in establishing a death benefit reserve; second, a portion to pay for administrative fees and operating expenses; third, a portion to help fund a guaranteed cash value nonforfeiture clause in the cash value life insurance policy.
These policies generally are those whose death benefit and premiums are level over the lifetime of the policy. They are intended to keep the premium level so the insured does not have to anticipate an increase in premium due to increased age, occupational change, or deteriorating health as time moves along. Once the policy is initially underwritten for age, health, and occupation, the face amount and premium will remain constant.
Here is where a clarification is warranted from the above mentioned article.
At the time the policy is issued, a death benefit reserve is established which will be paid to the beneficiary at the one death event. Since the policy is being underwritten for the life of the insured, premiums charged will be higher than required to cover the initial death benefit. As the insured grows older, the gap between what is actuarially required and actually being charged narrows. Recognizing they are charging more than your chances of dying, and in order to keep people from becoming disgruntled with these larger payments than ones charged for term insurance, the insurance companies have established in their policies a nonforfeiture clause called guaranteed cash values in which they use those excess premiums to invest.This is not a divisible savings account set aside in the insurance company general account with any particular client’s name on it. It is misleading to suggest that when you make your monthly premium payment a portion of that specific payment goes into “your savings account.” It does not. If it did, you could go to your insurance policy every month and see what was accumulating, but you can’t. It takes several years before you receive any notification of what is in the cash reserves of your policy. This is within the confines of the nonforfeiture value provision of your insurance contract referred to as guaranteed cash values.
Since calculating death benefits is not a science, actuaries use probability tables and other sophisticated statistical computations to determine what amount of money is going to be needed at any given time for death benefits, administrative and operating expenses, and funding of the cash value borrowing provision. They recognize the “guarantees” are based on the claims paying ability of the issuing company. With that being the case, companies are careful to collect adequate premiums and make their investments as risk free as possible. Those values above the amount needed to fund guarantees and other expenses become for some companies excess earnings while others refer to them as dividends.
Dividend and Cash Value Misunderstanding
Here again is a misconception in the article, “. . . there are numerous cons with cash value life insurance, but one is bigger than all others: any amount of money you’ve built up over the years doesn’t go to your family. Instead, it goes to the insurance company.”
Again, the policy does not have a provision for you to build up any amount of money over time. It is a little confusing when you see in the contract a table reflecting guaranteed cash values. These are not kept in some separate account with individual insured names but are simple tables showing cash value guarantees set aside in general revenues of the company for you to borrow against if you choose to do so. In addition to guaranteed tables found in policy, declared excess earnings and/or dividends statements should be promoted as one of the living benefits of life insurance: one doesn’t have to die to take advantage of them. Once the company has declared a dividend or excess interest and you choose the dividend option of receiving dividends in cash, you will receive a check in the mail. If you choose the option of leaving the dividends to accumulate at interest,then at a later date you may request them; if you choose to have dividends purchase paid up additions, then when they are declared a small paid up life insurance policy would be acknowledged and it would become part of your overall death benefit.
When an agent sits down to discuss with a client the need to provide a source of income in the event of death, the agent too often begins by saying, “Let’s talk about your life insurance.” What a misnomer right out of the gate. No agent can reproduce life. That is well above his or her pay scale. What he or she can do is provide a source of income which will replace the earning power of the one who dies. It would be so much more meaningful to say, “Let’s talk about what happens to the mortgage when you pass away; let’s talk about how will you handle basic daily expenses in the event you cannot provide for them anymore; let’s talk about how you are going to live after you have retirement; let’s talk about the “black out period” when your wife will no longer be eligible for social security benefits; John, what would be your most important financial concern to take care of if you weren’t here to take care of it?” etc.
It is important that both agent and client understand the terms of insurance, but it is so much more important that a policy be in place when it is needed the most. A hungry child doesn’t know if the food on his table came from a term or a cash value life insurance policy. All he knows is Daddy or Mommy cared enough to provide it.
If you are interested in more detailed commentary on types of life insurance, please visit https://www.insuranceguidelocal.com/articles/whole-life-insurance-apologetics/
Glen B. Marks, CLU, retired insurance agent of 42 years experience. The thoughts and comments in the above article are his own. Comments are welcome at email@example.com