Frequently Asked Questions about Whole Life Insurance
What is a paid-up addition (PUA)?
PUAs are like small whole life policies that are, in fact, paid-up. This means that they never require further premiums. PUAs have a cash value and a death benefit. In other words, assume a dividend is paid in the amount of $100 and used to purchase a PUA. The PUA will have a cash value of $100 and a death benefit of, for example, about $220. This means that it if it was cashed in at that time, the policyholder would receive $100. However, if the insured died at that time, the beneficiary would receive about $220. Like whole life insurance, PUAs can be seen as having two sets of values, that is a living value and a death value.
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The cash value of a PUA grows every year until it equals its death benefit (typically at age 100) and may continue to earn interest beyond that time. In addition, the $220 death benefit can also grow if it receives its own dividends which is normally the case.
Over time, PUAs can triple or quadruple the death benefit. In other words, a 35-year-old living until his or her mid-eighties could easily see a $500,000 death benefit grow to $1,500,000 or more.
If dividends are used to pay part or all of the premium, will that affect the values of the policy?
It will have no effect on the guaranteed values. However, it will cause the total cash value (i.e. the sum of the guaranteed cash value plus the cash value of PUAs) to grow more slowly. This is merely a result of fewer total dollars flowing into the policy.
What is the difference between a distribution from a whole life insurance policy and a loan from a whole life insurance policy?
A distribution is made by cashing in PUAs. This causes the death benefit to diminish more than $1 for $1 with the amount of money taken – but never less than the guaranteed death benefit of the basic policy. Remember, PUAs have a death benefit larger than their cash value, so it stands to reason that cashing them in will reduce the death benefit more rapidly.
Conversely, a loan is merely a collateralization of the policy. It does not cash in PUAs. Therefore, a loan reduces the death benefit on a $1 to $1 basis. However, loans require loan interest to be paid.
If the policyholder owns the policy, why does he or she have to pay interest on their policy loan?
The cash value is an asset of the policy. It needs to earn interest to deliver the guarantees of the policy. If it is taken out, it can not earn interest. Therefore, a loan is actually a collateralization of the policy to a loan that the insurance company makes to a policyholder. This is analogous to making a bank loan secured by a CD. The reason why the insurance company does not need to check credit is that the loan is always fully secured by the cash value. Typically, the maximum that can be borrowed is about 93% or so of the total cash value. The insurance company will not lend a policyholder unsecured funds.
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If a Will instructs that proceeds from a life insurance policy be paid to one party, and the beneficiary named in the policy is someone else, who receives the proceeds?
The beneficiary named in the policy. The Will only controls the proceeds if the beneficiary is the estate.
Can a policyholder increase the amount of insurance in the future?
With the exception of dividends purchasing PUAs and perhaps increasing term riders (purchased at the inception of the policy), the death benefit may not be increased in the future. This is to prevent anti-selection. Anti-selection is where those that become unhealthy would generally act towards increasing their death benefit if they could. This could de-stabilize an insurance company as it would then be issuing massive amounts of new insurance at Preferred or Standard rates to those who otherwise could not qualify for it.
Can a policyholder decrease the amount of insurance in the future?
Generally speaking, the answer is yes. A whole life policy may be reduced in the future with a corresponding decrease in premium. The total death benefit might also be reduced by cashing in PUAs or canceling term riders, if any.
What is the difference between a stock insurance company and a mutual insurance company?
A stock company is a public company that has shares that generally trade on a stock exchange. Earnings of a stock company are generally shared between stockholders (owners) as dividends and as excess credits to the policyholders. Technically, the policyholders as a class are the owners of a mutual company. Earnings of a mutual company are not diluted and are distributed solely to policyholders in the form of dividends. We believe that this gives the policyholders of a mutual company an advantage.
How can dividends be used?
- Received in cash
- Reduce out of pocket premiums
- Pay entire premiums
- Purchase term riders
- Purchase paid-up additions (PUAs)
- Pay interest on policy loans, if any
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