Question

Fantastic Life Insurance Company guarantees its policyowners a rate of return of 3.5 percent on assets underlying the reserves in its policies. However, it earns 7.5 percent on those assets. In a case such as this, more favorable earnings than those guaranteed can affect different policies in different ways. Explain the impact of these favorable earnings on the named features (e. g. cash value, face value, dividends, etc.) of the following policies:

1. Cash value of ordinary life insurance.
2. Face value of universal life insurance, Option A.  (Assume a face value of $100,000 and a cash value of $20,000.)
3. Face value of term life insurance.
4. Dividends on an ordinary life insurance policy that had been in effect for forty years.

Answer 1

ordinary life insurance - A life insurance policy that remains in force for the policyholder?s lifetime. It contrasts with term insurance, which only lasts for a specified number of years but is renewable.

Cash-value life insurance, also known as permanent life insurance, includes a death benefit in addition to cash value accumulation. While variable life, whole life, and universal life insurance all have built-in cash value, term life does not.

hare is an example of Cash Value of Ordinary insurance policy-

Let’s say you purchase a whole life policy with a $1 million death benefit when you’re 25 years old. You consistently pay your monthly premium, and every month a percentage of that payment goes toward the cash value of your policy.

Thirty years after you purchase the policy, you’re 55 years old, and your cash value account has grown to $500,000. Because the policy offers a $1 million death benefit and you already have a cash value of $500,000, the insurance costs must cover the remaining $500,000.

Ten years later, your policy’s cash value has grown to $750,000. As you are 65 years old now, the cost of insuring your life is much higher. However, when you factor in your significant cash value, the policy is really only insuring $250,000. The rest of the death benefit the policy will pay will come from the cash value.

This is a greatly simplified example: The numbers will vary significantly depending on the life insurance company, the type of policy you purchase and, in some cases, current interest rates.

Universal Life Insurance

Universal life insurance is also termed "adjustable life insurance" because it offers more flexibility compared to whole life insurance. You have the liberty to reduce or increase your death benefit and pay your premiums at any time in any amount (subject to certain limits) after your first premium payment has been made.

With a universal policy, you can increase the face value of your insurance coverage. However, you must pass a medical examination to qualify for this benefit. Similarly, you may decrease your coverage to a minimum amount without surrendering your policy.3 Keep in mind, surrender charges may be applied against the cash value of your policy.

When it comes to the death benefit, you have two options: a fixed amount of death benefit or an increasing death benefit equal to the face value of your policy plus your cash value amount.3

You also have the opportunity to change the amount and frequency of your premium payments. This means you can increase your premiums or pay a lump sum, according to the specified limit in the policy. As you know, part of your premium minus the cost of insurance is put into an investment account, and any interest accrued is credited to your account. The interest you earn grows on a tax-deferred basis, increasing your cash value.2

You can reduce or stop your premiums to use your cash value to pay premiums in case you face financial hardships. Nevertheless, there should be enough money accumulated in your cash-value account to cover the premium payments. Make sure to discuss the status of your cash-value fund with your insurance adviser or agent before stopping the premiums. Your policy may lapse if you cease to pay premiums and have insufficient cash value to cover the cost of insurance.

The ability to partially withdraw funds is an added perk of universal life insurance. You must not make repeated withdrawals from your accumulated fund as this may reduce the cash value amount and render you helpless in the time of need. Another good thing about universal life insurance is that your insurance company discloses the entire cost of insurance to you. This gives you an idea of how your policy works.

The downside of universal life insurance is the interest rate. If the policy performs well, there are chances of potential growth in a savings fund. On the other hand, the bad performance of your policy means the estimated returns are not earned. So you end up paying higher premiums to get your cash-value account going. Second, surrender charges may be levied at the time of terminating your policy or withdrawing money from the account.

Universal life insurance offers well-rounded protection to your loved ones, thanks to its security, flexibility, and variety of investment options. In times of low liquidity, you can alter your premium payments or even withdraw from your cash-value fund. You can also increase or decrease the face value of your insurance as per your circumstances.

What Is Term Life Insurance?

Term life insurance, also known as pure life insurance, is life insurance that guarantees payment of a stated death benefit during a specified term. Once the term expires, the policyholder can either renew it for another term, convert the policy to permanent coverage, or allow the policy to terminate.

Term Life Example

Thirty-year-old George wants to protect his family in the unlikely event of his early death. He buys a $500,000 10-year term life insurance policy with a premium of $50 per month. Should George die within the 10-year term, the policy will pay George’s beneficiary $500,000. Alternatively, George does not die and is now 40 years old. His term policy has expired. If he chooses not to renew and subsequently dies, his beneficiary receives no benefit. If he decides to renew the policy, the new policy will base the premium on his current 40 years of age.

What are Dividends?

Many whole life insurance policies provide dividends representing a portion of the insurance company’s profits that are paid to policyholders. In many ways, these dividends are similar to traditional investment dividends that represent a share of a public company’s profit. The dividend amount often depends on the amount of money paid into the policy. For instance, a policy worth $50,000 that offers a 3% dividend will pay a policyholder $1,500 for the year. If the policyholder contributes another $2,000 in value during the subsequent year, they will receive $60 more for a total of $1,560 next year. These amounts can increase over time to sufficient levels to offset some costs associated with the premium payments.