One of the reasons life insurance as a subject seems confusing is because the terminology used when talking about it is fairly incomprehensible to a layman. It’s unfortunate, because basic life insurance concepts really aren’t that difficult to understand. I’ll start with some definitions in the article and I guarantee that 500 words from now you will ‘get’ the basics, and have whole life insurance explained to you. That’s right, a guarantee. And we hardly know each other. Anyway, after that you can determine if whole life insurance policies are something that you want to examine more closely.
First we need to look at whole life in the context of other forms of insurance available to you. Now, the most basic insurance, term life, is simply coverage for a specific period, for which a policyholder pays a monthly premium. If the insured person outlives the policy, nothing is paid out. If he dies, there is a payout. Because people most do outlive their term policies, they are relatively inexpensive.
Inexpensive relative to what? Glad you asked. Relative to so-called permanent life insurance. There are many sub-types of permanent life insurance, but as the name indicates, they are all ‘permanent’ insurance policies that are designed to have a payout, or ‘death benefit’ (you’ve never used those two words together before, have you?), no matter how far in the future the policy holder dies. So, no fixed term. Will pay out. You can see why permanent insurance is more expensive than term.
So what is whole life insurance, and what does it have to do with all this? Whole life is the simplest form of permanent life, and it can be seen as a middle ground between straightforward term life, and other forms of permanent insurance, like variable life insurance or universal life insurance, which involve more flexibility, but often demand greater financial sophistication and involve increased financial risks as well. Whole life insurance rates will be higher than those for term, but at least they are constant over the duration of the policy.
With whole life (and all permanent insurance actually), the concept of ‘cash value’ was introduced, where the policy over time would build up a reserve amount that would eventually cover the death benefit. So maintaining that cash value is the reason for the higher premiums you will pay with whole life. The good news is that (unlike term life) you are actually paid interest on the cash value, so that the premiums you have paid over are actually working for you. Also, you usually can borrow against the cash value your policy has built up.
I won’t cover the more complicated forms of permanent life insurance in this article, but suffice it to say that it is possible to buy policies that allow much more flexibility in what you can do with the cash value, that have variable premium payments, and that actually have some risk associated with them. But you at least have a handle on whole life insurance now, I hope.