Life Insurance: Coverage for you and your family

Posted: Wed Dec 09, 2009 11:51 am Post Subject:

zhl . . .

You are asking all the right questions -- and some that should have been asked 12-13 years ago.

IF the policy is Whole Life (it's a dividend-paying policy so it probably is), the agent lied when he said the policy will pay for itself after any number of years. That's a concept known as "vanishing premium" and the use of that phrase has been outlawed in almost every state for about 15 years or so. But let's leave that one aside.

Read the contract. It should say on the very first page, or very near the front, that "Premiums are payable to the insured's age 100" (or words to that effect). So yes, the premiums will need to be paid to keep the policy in force. Dividends are either paid in cash, used to purchase paid up additional insurance, or left with the insurer to accumulate at interest (which causes a taxable event). There may be a couple of other "dividend options" in your parent's contract.

Not sure exactly what "annual distributions" is supposed to mean, but it probably refers to receiving the "dividends" in cash. But understand that dividends are nothing more than a refund of excess premiums paid. The insurer didn't need them to make its profit, so it gives some of the "divisible surplus" back to its current policyholders in proportion to the premiums they have paid compared to every other policyholder's premiums.

The cash value in a Whole Life policy is not YOUR MONEY. It's their money (the insurer). They credit the "inside buildup" toward the eventual payment of the death claim. As the cash value accumulates, it means they have to come up with less of their money at the moment of death. Here's an example I use to help illustrate the point:

Inflate a balloon. What's inside? Air -- nothing. But the inflated balloon represents the death benefit. If the insured dies tomorrow, the balloon pops and money rains down on the beneficiary. But since there isn't any inside the balloon yet, it will all be the insurance company's money.

OK . . . you pay your premiums and the contract says that if the insured is still alive at age 100 (new policies today say age 120/121), the policy matures or endows, and a check equal to the face amount of insurance is paid to the owner of the policy (presumably the insured) because it's all inside the balloon by then.

Your question "But what happens to the cash value?" is directed to all the other years between the first day of the policy and age 100.

So let's go back to the balloon. Every year as premiums are paid, some of the air in the balloon is replaced with cash. You can pop the balloon at any time, without dying, and some of the cash will be returned to you. But the policy is dead. So we're not going to kill the balloon.

Year after year, premiums are paid and more cash is accumulating inside the balloon. Funny thing is, the balloon is still the same size as it was on Day 1. That's because the cash is only replacing the air, not adding to the volume of the balloon. At any point in time, if the insured dies, the balloon pops and money rains down on the beneficiary, as previously stated.

People think of the money inside the balloon/policy as theirs, but it's not. If you have a savings account at a bank, when you make a withdrawal how much interest do they charge? None. It's your money. But borrow the money from a life insurance policy and the insurer makes you pay interest, because, technically, it's their money, they just earmark it for you for the future.

Because the money in the balloon is in the insurer's "policy reserves" as it accumulates, it reduces the amount of "present" money needed to pay a death claim in addition to the reserves to equal the death benefit.

So here's the bottom line. When you have a Whole Life policy, the cash value belongs to the insurer. When a death occurs -- we hope for one due to old age, but dead is dead, and the company pays (except suicide in the first one or two years, or one of the few exclusions that may be in the policy, such as war or act of war, military service, flying an airplane, or certain hazardous occupations or hobbies -- many policies only have the suicide exclusion), you can think of the death benefit in one of two ways.

If you like to think of the cash value as "your money," the insurer gives you all of your money and just enough of theirs to equal the death benefit. No one gets the cash accumulation PLUS the full death benefit in Whole Life (if you want both, then you have to get a form of Universal Life with "Option 2").

The only other way to view it is they keep the savings and pay the whole death benefit. It's not stealing, because it's really their own money. And the contract tells you that this is what they will do. So they are honoring the contract.

The cash value in the policy, although not yours, is available to you in at least four ways: you can borrow any amount up to the available "loan limit" listed in the contract. The values are for the END of any policy year ($0 in years 1 and 2, probably a few thousand at this point in your parent's policy depending on the face amount and premium). So you could borrow most of it for as long as you want. Never have to repay the loan (but interest will accrue and be added to the loan if you don't at least pay the interest each year), and because the loan amount will be less than the total premiums that have been paid, even if the policy dies, it will not cause a taxable event. But borrowed money plus the interest on it will be deducted from the death benefit if the insured dies. The loan is considered an advance payment of the death benefit.

#2: You could simply "cash in" the policy and receive the surrender value, which will be less than the total premiums paid. The surrender value may be the same or higher than the loan limit. It is not normally less. But this terminates the policy. It can be reinstated usually up to three years into the future, but all past due premiums have to be paid, and the cash value received will now be treated as a loan and begin bearing interest if not repaid. And the insured must prove insurability.

#3: You could use the cash value to buy an extended term policy. Same face amount as the original Whole Life policy, but only for a certain number of years and days into the future. The insured's age and the amount of cash value will determine the length of the new term policy. You will see the values listed on the Table of Guaranteed Values in the policy.

#4: You could take the available cash value and use it to buy a new policy fully paid up to age 100 or 121. But the insurance amount will be reduced from the original face amount -- probably by at least 50% or more. That, too, is in the same Table of Guaranteed Values.

You don't say what the insurance amount is, or what your parent's current age is, so it's difficult to be more specific. But this is the nuts and bolts of how a cash value policy works.

Do you have any other questions?

If your parent is thinking about cancelling the insurance, but still needs life insurance, they need to apply for and be approved for a new policy BEFORE they cancel the existing policy. Not the other way around. Once the new policy is approved, then your parent would write a letter to the first company and request that the policy be terminated and the surrender value sent to them.

If you are in California, I can give you more information in person or by mail/email. If you're not in California, you'll need to find another agent who you can trust to give you good information.

Posted: Wed Dec 09, 2009 12:18 pm Post Subject:

If on the other hand, the sales representative said, "based upon the current dividend scale, you can stop making out of pocket premium payments in approximately 12 years", no lie was told.

Premiums never vanish, but the need for out of pocket payments can.

Posted: Wed Dec 09, 2009 07:01 pm Post Subject:

MaxHerr,

First off, thanks so much for your detailed explanation. My parents bought the life insurance when they were new immigrants into the U.S.A. Because they didn’t have any financial knowledge, they bought the insurance based on what the representative said to them: they only need to make premium payments for approximately 12 years. At that time, I was only a small kid. As I graduated from college and entered into the financial industry, I began to understand these things a little better, but not very clear. This is why I posted my question here. When I called the insurance company, they confirmed that it’s a whole-life insurance policy. They also told me the face amount also grew due to dividend reinvestment.

1. So you’re saying the cash value is not insured’s money, but the dividend is, correct?
2. Could it be that the representative implied by the year 12, my parents would have accumulated a lot of dividends in the account, which could be sufficient to cover the annual premium payments for the rest of the term?
3. Is the annual dividend to my parent fixed and predetermined?
4. The policy says “life-paid-up at age 98.” Does that mean my parent has to continue to premium until age 98? So if the insured is still alive at age 98, the insured will get the face amount and the policy terminates? If the insured dies (even if it’s due to old age), then the beneficiary gets the face amount upon insured’s death and the policy terminates?
5. My parent can apply for a new life insurance policy. Upon approval, they can surrender the current policy and get the cash value?
6. Borrowing against the cash value typically bears lower interest rates than other loans?
7. At certain point in time, the accumulated cash value may exceed the face amount, then what happens?

Posted: Wed Dec 09, 2009 09:47 pm Post Subject:

As to your questions, we'll take them in order:

1. So you’re saying the cash value is not insured’s money, but the dividend is, correct?
2. Could it be that the representative implied by the year 12, my parents would have accumulated a lot of dividends in the account, which could be sufficient to cover the annual premium payments for the rest of the term?
3. Is the annual dividend to my parent fixed and predetermined?
4. The policy says “life-paid-up at age 98.” Does that mean my parent has to continue to premium until age 98? So if the insured is still alive at age 98, the insured will get the face amount and the policy terminates? If the insured dies (even if it’s due to old age), then the beneficiary gets the face amount upon insured’s death and the policy terminates?
5. My parent can apply for a new life insurance policy. Upon approval, they can surrender the current policy and get the cash value?
6. Borrowing against the cash value typically bears lower interest rates than other loans?
7. At certain point in time, the accumulated cash value may exceed the face amount, then what happens?

Posted: Wed Dec 09, 2009 10:50 pm Post Subject:

InsTeacher has given you in essence the same answers I would. As to Q5, there may also be a conversion provision in the existing policy allowing for an exchange into a different contract, such as Universal Life, with the same company and no new underwriting if not asking for more coverage -- have to read the contract to know for sure.

It might be possible to give up the cash accumulation in exchange for a so-called "no lapse" guarantee. As long as all payments are made on time -- missing just one payment by one day could result in the loss of the guarantee, and make the policy much more expensive instantly (which is why I don't favor them for middle income families -- too much to risk) -- the policy will always provide a death benefit. This could mitigate some of the increased cost of insurance at your parent's age, the exchange of cash value into the contract will lower the "Net Amount at Risk" in turn lowering the premium requirement. Again, this is a risky strategy that could easily backfire, putting your parents in a much worse position than they are today.

The best solution might be to keep what they have, continue to pay the premiums, and supplement any additional life insurance need with 20- or 30-year term. The longer term will be more expensive, and may not be available at your parent's current age. But it's an option worth looking into. Same would be true of starting another whole life policy as a supplement to the existing WL policy. More expensive than term, but premiums guaranteed for the life of the contract. A non-participating policy (no dividends) will be a bit less expensive.

Neither of these policy options are required to be purchased from the existing insurance company, but the existing insurance amount will need to be disclosed in the application as "not being replaced or surrendered" if that will be the case. The existing $100,000 policy should not raise the eyebrows of the underwriter.

As to Q7, the primary cause of a taxable event in such a case is when the original policy is terminated before the death of the insured. The excess over cost basis (the premiums paid, less dividends received in cash) is the taxable portion. Highly unlikely to occur in a "straight whole life" policy until the last few years of the contract. The only other time such accumulation might be taxable is upon payment of the death benefit, and for the same reasons -- the distribution exceeds cost basis (or interest paid on the death benefit from the actual date of death to the time of the death claim payment). [In 2007, I processed a claim for the death of one of our corporate clients' insured executives in which the date of death was 6 years prior to discovering the death in the Social Security Death Index and filing the claim. The $250,000 policy paid several thousand dollars in accrued, taxable interest.][/quote]

Posted: Thu Dec 10, 2009 02:36 pm Post Subject:

Thanks to you both.

Posted: Thu Dec 10, 2009 03:08 pm Post Subject:

Sorry, may I have one more question? When I wrote to the insurance company, they said the following:"your policy has the Variable Additional Rider. This rider allows the owner to direct dividends into a separate account and purchase amounts of single premium variable life insurance.”

Can you translate the above into layman’s term? What is a single premium variable life insurance? Thanks.

Posted: Thu Dec 10, 2009 11:28 pm Post Subject:

It must mean that the dividends are being directed into a tax-deferred account which uses the money to buy what are known as "paid up additions" instead of accumulating in the cash value of the policy which could result in a tax liability.

But these additions are apparently "variable" life insurance, and the additional value will rise or fall according to the value of the underlying investments. You should receive a prospectus annually that describes each of the subaccounts in the separate account along with information about how to reallocate values among the subaccounts. Do you have any statements indicating how many additional policies and what the face amounts are?

If possible, can you reply with the title of the policy your parent bought? It could be something like "Golden Years Wealth Builder Whole Life Insurance" or "Flexible Premium Life Insurance" or "Universal Life Insurance" or "Modified Premium Variable Life Insurance." It would be a big help, because the rider you describe is not commonly associated with a Whole Life policy.

Posted: Fri Dec 11, 2009 12:40 am Post Subject: life insurance

My 'Dear MAX'..LOL I'm just looking at the different threads, concerning Life Insurance. BOY!!...you sure explain things that I can understand!! I recently took out a Life (Whole) Insurance policy on my son...he's 16 now. This policy will build 'Cash Value'. Now...if I wanted to 'barrow' aqainst the policy, when it builds Cash Value' (and I was told I can), would that amount of money go to me or my son?

Posted: Fri Dec 11, 2009 05:49 pm Post Subject:

Wendy . . .

The owner of the policy has exclusive access to the cash value. If and when the policy has sufficient CV form which to borrow, you would be the borrower, and you can do with the money as you please. You could give it to your son, or you could drive inland to Barona and place a wager on black or red or green on the roolette table (I know I spelled it wrong, the filters on this site won't let anyone use "gaming" terms including "CA SEEN OH"-- pathetic). (Personally, I would spend some of it at the buffet first! And Barona is a much nicer stop than Harrah's.)

The only thing that must be understood is that any use of the cash value, whether as a loan to you, or an "Automatic Premium Loan" to the insurer (if you forgot to or stopped making premium payments), disrupts the death benefit payable to the beneficiary. All unpaid loan principal and interest will be deducted from the proceeds before they are paid in the event, God forbid, your son were to die.

I presume that at some point in your son's adult phase, you are going to assign ownership of the policy (and probably the remaining premium payments) to him. When he becomes the owner, he'll have the right to take you off as beneficiary, and do whatever he wants with the CV or the policy. You won't be able to dictate what he does with "his property," even if you bought it for him. Just like a mom can't tell her son how to cut his hair or to pull his jeans up over his butt so that his boxers aren't visible to the whole world (hopefully yours doesn't do that!) LOL :oops: