University of Sarajevo

School of Economics and Business

WHOLE LIFE INSURANCE

1.4.2013. | Sarajevo, BiH

Main page
Name, surname and index number: Faruk Hodi (71209), Miran Pezer
(71251)
Essay topic: Whole life insurance
Name of the subject: Quantitative Models in Finance
Mentor: Jasmina Selimovi, PhD
Name of the university: School of Economics and Business, University
of Sarajevo
Place and date of submission: Sarajevo, 1.4.2014.

Table of Contents
Main page............................................................................................................. 1
1. Introduction................................................................................................... 3
2. Whole Life Insurance................................................................................... 5
3. Types of Whole Life Insurance....................................................................7
3.1. Limited Payment Whole Life Insurance................................................7
3.2 Indeterminate premium Whole Life Insurance.....................................7
3.3 Participating Whole Life Insurance........................................................7
3.4. Level Premium Whole Life Insurance...................................................8
3.5. Single Premium Whole Life Insurance..................................................8
4. Conclusion..................................................................................................... 9
Sources and references................................................................................... 10
List of tables...................................................................................................... 11

1 Introduction
In order to have a better understanding of the whole life insurance, one
should also be familiar with the term life insurance.
Life insurance1 can be defined as a contract between the person who owns
the policy, and the life insurance company (insurer). In the contract,
insurer agrees to pay a certain sum of money (death benefit) to an already
chosen beneficiary when the insured person dies, or the insurer has a
terminal illness.
The insurer agrees to pay a premium 2 at regular intervals, or eventually in
lump sums. It's important to note that the insurer doesn't have to be
insured.
The main purpose of life insurance is to ensure the economic existence of
the insurer's family, individual or multiple individuals who have the right to
claim the death benefit.
There are two basic types3 of life insurance policy: temporary (term) and
whole life insurance. Whole life insurance is the sub-group of permanent
life insurance policies.

1 Risk Management Society. Insurance Risk Management Handbook. Risk

Management

Society.

Nanyang

Technological

University.

Web.

<http://clubs.ntu.edu.sg/rms/researchreports/Insurance%20Risk
%20Management%20Handbook%20%28Complete%29.pdf>. p. 2
2 Premium amount of insurance coverage.
3 "Types of Life Insurance Policies." Types of Life Insurance Policies. Cable
News

Network,

26

July

2012.

Web.

29

Mar.

2014.

<http://money.cnn.com/magazines/moneymag/money101/lesson20/index2
.htm>.
3

Term insurance4 is regarded to be the simplest type of life insurance. It

provides insurance for a specified period of time, and pays benefit only if
the insurer dies during the specified period of time. The price of the
premium depends on the insurer's age, health and the duration of the
term. As the person gets older, the premium will be more expensive. Also,
if the duration of the term is longer, the premium price will be greater.
These factors are directly correlated because of the risk; the older the
person is it's more likely that the person will die during the specified
period, also, the longer the term it's a greater chance that the person will
die during the specified period, and logically, the premium paid will be
higher.
Whole life5 insurance is the product for the situation when there is a strict
need for insuring the lifetime period, so that the insurance will actually last
for the same period as the life of insured. This is the main difference in
between whole life insurance and term insurance. Whole life insurance is
customized to the degree that it has implemented a system of flowing and
continuing saving funds, because of the continuous incoming payments
into the fund made by the insurer. Also, it is denoted as a future plan for
redistributing the money after the rules of gathering have been fulfilled.
Differences between the insurance policies can be seen in the following
Table 1.1:

4 Risk Management Society. Insurance Risk Management Handbook. Risk

Management

Society.

Nanyang

Technological

University.

Web.

<http://clubs.ntu.edu.sg/rms/researchreports/Insurance%20Risk
%20Management%20Handbook%20%28Complete%29.pdf>. p. 2
5 "Whole Life Insurance -- How Does It Work?" Whole Life Insurance -- How
Does It Work? | Military.com. Military, Web. 27 Mar. 2014.
4

Table 2.1 Insurance comparison

Source: http://www.inheritancenetwork.org/life-insurance/life-insurance-comparison.php

2 Whole Life Insurance

As it has been mentioned, whole life insurance policy 6 is within the
permanent insurance policy sub-group. Death benefit is valid during the
client's whole life. Whole life insurance has a more expensive premium
than other insurance plans due to its continuing and well rewarding
process at the end. Most of the whole life insurance plans are actually less
costly than the same renewable insurance for fixed period of time.
However, as the time passes, premium becomes smaller during the later
years of whole life insurance. Aforementioned cash fund is developed
during the time, and it's available for the policy owner. Accumulated
money (at the policy specified rate) on the cash fund can be withdrawn,
but, the death benefit can't be realized in that case. It's interesting to
point out that, for example, if the permanent life insurance matures at age
100 and insured client is still alive, the client will receive the full value of
the whole life insurance policy.
This type of insurance proves its usefulness in the case of the need for
insuring during the whole life, doing it easiest way which is, simply put,
using the money you have, paying regularly and building up the plan for
estate and/or retirement plan.
The main and most important difference lies in the flow of time. Whole life
insurance is using premium payments for unlimited time that are dictated
by the rules of created policy. On the other hand, the term life insurance
defines the fixed period which has been determined in the contract.

6 Risk Management Society. Insurance Risk Management Handbook. Risk

Management

Society.

Nanyang

Technological

University.

Web.

<http://clubs.ntu.edu.sg/rms/researchreports/Insurance%20Risk
%20Management%20Handbook%20%28Complete%29.pdf>. p. 3
6

Its important to note that the whole life insurance beneficiaries are
exempt7 (income and estate tax) from the tax, but also the eventual cash
growth in the fund is also exempt from the tax. Interest that make the
cash value grow are not being subject to taxes calculated yearly. The case
for dividends, which are denoted as premium returns, are not being the
object of taxation appliances, unless they extend their value above the
initial value of paid premium. Death benefits are commonly not obliged to
be taxed they might become the target in special cases due to changing
regulations8. If the value of the money users receive after the death of the
insured person, is being treated as estate or gift, then this value can
become the taxation base.
Its also important to mention that its possible to borrow money but to the
limit that there should be enough resources in the cash value to provide
backup for the loan. If borrowing occurs to the amount of the money
taken, it shall be treated as a loan with interest rates on it, prescribed by
the policy settings. Whatever is left unpaid in form of taken loan is later on
reducing the value of cash the user receives in case of death or forfeiting.
The terms cash value and face amount should be clarified, since those two
terms are often mixed up by the insurers. The main amount that will be
paid out if the event of death occurs is the face amount that insurer will
receive. The amount of cash that is correlating with the policy is the cash
value. The minimum of cash amount is set to be what insurer paid in the
past premium payments after the expenses and when claims of the insurer
are paid out. The cash value increases as the time passes, so the actual
user of the policy can be allowed to withdraw the cash amount that has
7 Lambert, George D. "Cut Your Tax Bill With Permanent Life Insurance."
Cut Your Tax Bill With Permanent Life Insurance. Investopedia, 28 Feb.
2010.

Web.

25

Mar.

2014.

<http://www.investopedia.com/articles/pf/07/permanent_life_insurance_tax
es.asp>.
8 "Whole Life Insurance -- How Does It Work?" Whole Life Insurance -- How
Does It Work? | Military.com. Military, Web. 27 Mar. 2014.
7

gathered on his account. The face amount of the contract is set to be

larger than, taking into account all things, the cash value in the situation
of viewing the begging years of the contract. If the policy is being forfeited
the user is left to get cash value of the policy, but if the contract is fulfilled,
the beneficiaries are to get the whole and unique face value of cash
amount.
Another

important

thing

is

the

questionability

of

the

premiums

consistency in terms of equal payable values of the premium. In most

cases, the scheduled premium prices are equal to the predefined prices in
the contract. The very same amount of premiums are seen for the rest of
the contract-fixed life of the contract. However, premium isnt always
equal from the beginning to the end. There are cases that the premium is
being lowered at the begging of the contract, to be increased in later
period, after which it remains constant.

3 Types of Whole Life Insurance

There are several types of whole life insurance:
1
2
3
4
5

Limited payment whole life insurance

Indeterminate premium whole life insurance
Participating whole life insurance
Level premium whole life insurance
Single premium whole life insurance

3.1. Limited Payment Whole Life Insurance

The situation may occur to be ever-changing so the insurer might want to
limit the payments of premium to a fixed period of time 9. User then
receives full life protection, but the inflow of cash to the fund is being
active only for the limited number of payments. This leads to a jump in the
price of payments since of the reduced number of aforementioned. Models
that existed until now are presented as 10, 15, 20, etc. years of payments,
as well as payments made up to some expected end age of the insurer,
lets say 70.

3.2 Indeterminate premium Whole Life Insurance

This kind of insurance is similar with limited payment whole life insurance.
The main difference is that it provides option for changeable premium. 10
The insurance company is making the level of premium coexist with the
estimated amount of earnings on the investments, costs and level of death
cases for researched area or time period. The premium required to be paid

9 Northwestern Mutual. Northwestern Mutual. LimitedPay Life. The

Northwestern Mutual Life Insurance Company. Web. 27 Mar. 2014.
<http://www.northwesternmutual.com/products-and-services/personal/lifeinsurance/Documents/29433125.pdf?win_type=pdfform>.
10 "Life Insurance - Top Ten Questions." Whole Life Insurance. Department
of

Financial

Services,

New

York.

Web.

25

Mar.

2014.

<http://www.dfs.ny.gov/consumer/que_top10/que_life_who.htm>.
9

can be changed as the company wants but to the limit of maximum

prescribed premium set by the policy contract.

3.3 Participating Whole Life Insurance

In participating whole life insurance11, we are talking about the model of
contract where the user is actively engaged in the process. Insurer is being
paid the amount of dividends that in this case represent the positive
outcomes from the companys additional investments and the return on
those investments as well as cost reduction in some fields and savings
built on the lowering of the expenses. Programs used to pay out dividends
are varying on the amount that dividends can be contributed to the user in
form of cash, or they can be simply added to accumulation fund that has a
prescribed interest rate. Another way of dealing with dividends is using
them to reduce initial premium costs of the insurer, as well as buying off
finished insurance that in return provides greater base value of insurers
own investment. Payments of dividends are not obliged to happen, they
are very volatile and depend on the will of insurance company and its
financial results.

3.4. Level Premium Whole Life Insurance

This type of insurance states that the payments in the shape of the
premium are set on a certain level that requires their payments to be done
for the time of insured persons life 12. The amount of payments in the
starting period of the contract is sufficient to provide for the current
expenses of the contract protection. Additional money, which is left to be
paid, adds the revenue from interest that is covering the lack of premium
in the period of time when the premium which is being paid yearly is not
consistent to the amount it should provide. The plus premiums are being
11 "Whole Life Insurance -- How Does It Work?" Whole Life Insurance -How Does It Work? | Military.com. Military, Web. 27 Mar. 2014.
12 "Life Insurance - Top Ten Questions." Whole Life Insurance. Department
of

Financial

Services,

New

York.

Web.

25

Mar.

2014.

<http://www.dfs.ny.gov/consumer/que_top10/que_life_who.htm>.
10

taken and re-supplied by the contractor which will provide cast return and
cash value of the contract or the policy.

3.5. Single Premium Whole Life Insurance

Single premium whole life insurance13 is self-explanatory. It consists of one
extra large premium that is being paid out at fixed, predetermined date of
time. When this kind of payment happens, there is no more premium
obligation left to be fulfilled. The value of the cash and loan is important
for the insurance company due to its increased amount. Because there is
only one payment, some call this kind of payment a regular investment,
based on insurers life span.

4 Conclusion
There are several positive things, but also several negative things
regarding the whole life insurance policy. The main positive factors are
related to the safety, predictability, and ultimately, the profitability of the
whole life insurance at the end. Negative factors are mainly related to the
cost and short-term expenses of whole life insurance policy.
According to the New York Financial Services Department14, pros and cons
are summed below.
Pros:
13 "Single Premium Life Insurance A Lifetime of Benefits, Just One
Payment." Single Premium Life Insurance A Lifetime of Benefits, Just
One

Payment.

State

Farm.

Web.

26

Mar.

2014.

<https://www.statefarm.com/insurance/life/whole-life/single-premiumlife>.
14 "Life Insurance - Top Ten Questions." Whole Life Insurance. Department
of

Financial

Services,

New

York.

Web.

25

Mar.

2014.

<http://www.dfs.ny.gov/consumer/que_top10/que_life_who.htm>.
11

Whole life insurance is mostly predictable, in the cases where

premiums are set to be fixed for the period of insured life.

The beneficiaries are to get the amount set in the contract, wheter
taking or not into concern the time of death of the insured person,

but as long as the inflow of premium is being active.

Policy or the contract can make the cash value grow.
If the policy is forfeited in some future period of time, whatever

amount of money that was generated will be sent to the user.

Premiums not being paid up anymore can lead to return of the cash

value. That money can be invested further.

It's possible to borrow money from the whole life policy, if needed.

Cons:

Whole life insurance is a lot more complex by its nature than the

simple life insurance term.

The amount paid, premiums, are higher for whole life insurance in

short term period than in other policies during the short term period.
Whole life insurance can be quite costly if lapses

Sources and references

Risk Management Society. Insurance Risk Management Handbook.

Risk Management Society. Nanyang Technological University. Web.
<http://clubs.ntu.edu.sg/rms/researchreports/Insurance%20Risk
%20Management%20Handbook%20%28Complete%29.pdf>.

"Types of Life Insurance Policies." Types of Life Insurance Policies.

Cable News Network, 26 July 2012. Web. 29 Mar. 2014.
<http://money.cnn.com/magazines/moneymag/money101/lesson20/i
ndex2.htm>.

3 "Whole Life Insurance -- How Does It Work?" Whole Life Insurance -How Does It Work? | Military.com. Military, Web. 27 Mar. 2014.
4 Lambert, George D. "Cut Your Tax Bill With Permanent Life
Insurance." Cut Your Tax Bill With Permanent Life Insurance.
Investopedia, 28 Feb. 2010. Web. 25 Mar. 2014.
<http://www.investopedia.com/articles/pf/07/permanent_life_insuran
12

ce_taxes.asp>
5

"Single Premium Life Insurance A Lifetime of Benefits, Just One

Payment." Single Premium Life Insurance A Lifetime of Benefits,
Just One Payment. State Farm. Web. 26 Mar. 2014.
<https://www.statefarm.com/insurance/life/whole-life/singlepremium-life>.

"Life Insurance - Top Ten Questions." Whole Life Insurance.

Department of Financial Services, New York. Web. 25 Mar. 2014.
<http://www.dfs.ny.gov/consumer/que_top10/que_life_who.htm>.

13

List of tables

Table no.
1.1

Table title
Insurance comparison

Page no.
4

14