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term vs whole life insurance

Life Insurance Types – Whole Life and Term to 100

by Glenn on June 30, 2008

This is part 2 in a 3 part article intended to make the types of life insurance less confusing.

These three articles should be read in order.

  1. Life Insurance Types – Term life insurance
  2. Life Insurance Types – Whole Life and Term To 100
  3. Life Insurance Types – Universal Life Insurance

(Continued from previous article)

Enter permanent life insurance. There are three basic types of permanent life insurance but they share one common feature. They all have level premiums for life.

Effectively what the insurance companies do is average the premiums for the 1 year term product, but over your entire lifetime. We end up with one premium, that while substantially higher than the 1 year term, will never go up. Later in life when the term premiums increase to the point of unaffordability, permanent life insurance purchasers will still be paying the same premium they were paying when they first bought the policy – eventually permanent premiums become less expensive than term.

What you’re really doing (and I’m being conceptual here) is overpaying your premiums above the true cost of insurance, or the 1 year term. The insurance company then reserves that overpayment in premiums you make in the early years. Eventually when the actual cost of insurance and the claims they’re paying out exceed what you’re paying for permanent insurance, they can make up that difference in premiums out of their reserves they’ve built up – using your overpayment in premiums from the early years. This concept works well for those needing permanent insurance.

Now what happens if you cancel your policy early? You’ve overpayed your premiums for future use, which now you’re not going to use. The insurance company will refund you a percentage of your overpayment in premiums. This refund is called a Cash Value. And this product – level premiums for life, with cash values if you cancel your policy early – is called Whole Life Insurance.

Unfortunately through the years the insurance industry has decided to sell this refund of overpayment of premiums as a great savings vehicle when it really isn’t. Consumer advocates realized this was a crappy deal for consumers (who for the most part just needed some cheap term life insurance). So Whole Life Insurance got a deservedly bad rap.

The insurance companies had a response to this. They took a permanent insurance policy and removed the cash values. This allowed them to lower the premiums. This product – level premiums for life with no cash values if you cancel early – is called Term to 100 Life Insurance.