Permanent Life Insurance Explained

Permanent life insurance comes in a variety of types but essentially they all do the same thing, and that is cover a person from date of purchase to date of death with death benefit. The reason you purchase thse policies- in the pureset sense- is to make a higher premium now, in an effort to make a lower premium later in life.

There are two types of permanent life insurance, one is called ‘whole life’ and the other is called ‘universal life’. True Whole Life can be purchased only from a mutual insurance company. This is a policy where the policy owner receives equity in the policy in the form of cash value. The cash value portion has two elements, a guaranteed amount and an additional amount based on company dividends. These dividends are a reflection of how well the company performs both with its investment practices and its actuarial claims experience. At the end of the year, the company assesses its gains against its losses and determines the dividends payable the next year. The dividend is actually a return of premium paid- since mutual companies offer and sell no stock, its stockholders are the policyholders themselves, and thus the whole life policies reflect ownership of that company.

A second type of permanent insurance is called ‘universal life’; the majority of permanent insurance sold on the marketplace is this type. A universal life policy is actually a term policy with a cash value component to it designed to mimic a true whole life policy. Essentially, internally you have an increasing cost term policy and the excess cash of the premium is invested by the insurance company and a rate of return is posted to the policy (typically about 4-6%). Since the company is using safe investments, these policies rates of return are usually linked to interest rates, rather than equities. A policyholder must make sure to monitor the policy yearly to make sure they are paying enough premium to both cover the internal cost of insurance and accumulate enough cash to offset the high internal costs later in life. This is primary reason most professional planners and pundits say universal life is such a bad deal- because you can do the same thing on your own by buying a term policy and investing the difference- without paying higher commissions and insurance company fees.

Insurance companies are now offering ‘variable universal life’ policies to counter these complaints. These are policies where the policyholder chooses their own investments from a selection of unit investment trusts designed to mimic mutual funds and thereby perform better than a traditional universal life. The policyholder in this manner assumes the investment risk and, hopefully, gets a better rate of return with an equity based product rather than a fixed interest product.

As always, read the fine print and consult with a professional before purchasing any permanent insurance product.

Good Luck!