Learn more about Life Insurance than your Insurance Agent knows Part 7

In Part 7, we will take a look at the change spawned by infuriated policy holders (infuriated by the amount of money the insurance companies were making on the investment pools inside whole life policies!). If you like, you can access the earlier parts in the series by clicking here: Part 1, Part 2, Part 3, Part 4, Part 5, Part 6.

This is the time when people started to “buy term, invest the rest” – a strategy where people would buy Term life insurance (closer to the pure cost of insurance and much cheaper) and take the extra amount that would’ve gone to the whole life premium and invest it themselves. The concept is that these savings would grow at rates that were available in the market (and what the insurance companies were enjoying) and it would grow enough that they would become “self-insured” as they became older. They would still have the coverage early on through the term policy, but would later shed their insurance coverage (and premiums) as the investment pool grew to a sufficient amount to cover their needs.

Of course, big companies only listen to the language spoken by consumer’s wallets. So “Participating Whole Life” became more popular. (Credit to Brian Poncelet for his note below – original text suggested participating whole life was a relatively new product.) “Participating” in the sense that the policy holder would participate in the performance of the investment pool. If the investment pool grew faster than predicted then the policy holder would get the extra growth returned to them in a number of different forms. On the flip side, if the investment pool under performed, the policy holder would not be held accountable for making up the shortfall. This “participation” of the policy holders in the actual performance of the investment portfolio made whole life more popular again.

The policy holders had a few options available to them in terms of how they participated in the performance. First, a bit of terminology: when the insurance company’s investment portfolio returns more than their expectations, the extra money is returned to the policy holder in the form of “policy dividends”. This is not to be confused with dividends from common shares or preferred shares.

There are three main ways in which to use these “dividends”:

1) Purchase “Paid Up Additions” – A paid up addition is just that: an additional amount of insurance coverage that is “paid up” – which means you pay for it once and don’t have to pay for it on an ongoing basis. So over time, as you receive policy dividends over the years, your insurance coverage increases even though your premiums remain the same.

2) Receive the policy dividend in cash - this is pretty straight forward – whatever the extra return on the investment pool turns out to be will be sent to the policy holder via a cheque.

3) Reduce your premiums – the policy dividend can be used to reduce the cost of your insurance policy. In some cases people will start by using policy dividends to purchase “paid up additions” until a point where the policy dividends PLUS THE POLICY DIVIDENDS OF THE PAID UP ADDITIONAL INSURANCE is sufficient to pay the ENTIRE insurance premium. In this case, after around 10 years (give or take) your policy can pay for itself.

(Policy holders can also elect to use policy dividends to accrue with interest with the insurance company, or to buy additional temporary insurance – but I rarely see these options selected.)

In Part 8, we will talk a little bit more about whole life insurance before making the leap to “Universal Life Insurance”.

CLICK HERE TO GO TO PART 8