Ordinary life insurance provides insurance protection for the "whole life" of the insured, that is, from the time of the policy's purchase until the death of the insured. It is called “ordinary” because the premiums remain “level,” unchanged for the life of the insured. In contrast, term life insurance policies provide protection for a specified term of one or more years. Other whole life policies can have flexible premium payment options different from ordinary life policies.
Whole Life vs. Term Policies
Term life policies pay only the fixed face value of the contract at the time of death. Whole life policies pay both a fixed death benefit and a “living benefit.” The living benefit is the cash value or savings component of the policy that grows over time as interest income accumulates. The policyowner has access to the cash value component by way of loans at any time.
Ordinary Life vs. Other Whole Life Policies
Ordinary whole life policies have level premium payments that remain the same for the life of the insured. Other whole life policies come with flexible premium payment scenarios. An example is the universal life policy. This policy allows for flexibility in the premium payments. Premiums are linked to the policy's cash value. A basic dollar amount is set to cover the cost of the death benefit. Premiums go directly into the cash value account, which generates interest. The charge for the death benefit is automatically deducted from the cash value each month. As long as there is a balance in the account to cover the charge, the policyowner can forego premium payments.
Cash Value Guarantee
The cash value in ordinary life policies is known because insurance companies typically guarantee that the cash value will grow at a specified rate. This guarantee is made independent of the company’s overall financial performance. Universal life policies make no such guarantee. Performance is tied to market and investment factors, which can negatively impact cash value.
Cost of Whole Life Policies vs. Term Policies
Whole life policies are considerably more expensive than term life policies. In the latter, premium payments fund only the cost of the death benefit plus insurance company commissions and fees. Whole life premiums fund the death benefit and the cash value component, plus the commissions and fees. Since commissions and fees are front-loaded in whole life policies, the cash value will not show any significant growth for several years. In the early years of the whole life policy, the policyowner is betting the insured will live long enough for the cash value to actually have value.
Selecting Insurance Coverage
Life insurance is one of life’s basic necessities. Policy selection depends on many variables. The first level of the decision process is whether to go with a term or a whole life policy. There are pros and cons to each type of coverage beyond the scope of this article. However, if a whole life type of policy with the cash value component (a kind of “forced savings”) seems attractive, one must decide between ordinary, level premium coverage and flexible payment universal life coverage. Risk-averse individuals would seem more inclined to the guaranteed cash values of ordinary life policies. The entire selection process begins by first deciding how much insurance is needed, then how long is the coverage needed and finally, how much money is available to pay for the insurance.
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