A whole life insurance policy illustration will include details, such as the life insurance coverage amount, the annual premium requirement, the guaranteed cash value, current dividend payment, and the year-over-year increase in cash value. There are also times that you might see a column on one of the internal pages of a whole life policy illustration that displays the internal rate of return which many people who desire cash value accumulation find very useful.
The whole life insurance illustration is a detailed disclosure of a proposed whole life policy. The purpose of the illustration is to explain the policy's functionality and features. Today, we're going to explain what is in this document and how to interpret the numerous tables of values that make up a large percentage of its pages. Please keep in mind that illustrations are a part of any permanent life insurance purchase, including universal life insurance and term life insurance. What you read below pertains specifically to whole life.
Breakdown of the Whole Life Insurance Illustration
Per regulation modeled by the NAIC and adopted (for the most part) by all 50 states, all illustrations contain the same four pieces of information:
- A Cover Page
- Narrative Summary of the Proposed Insurance Policy
- Numeric Summary of the Proposed Insurance Policy
- Tabular Detail of the Proposed Insurance Policy
Some illustrations contain more information than these four basic parts. The decision to include more information is up to the life insurance company or (in some cases) the agent when proposing a policy with a hypothetical scenario that requires additional explanation or disclosure.
The Cover Page
The cover page is merely an overview page that includes all of the following information:
- The name of the Product proposed with the illustration
- The name of the proposed insurance and (if different) the proposed policy owners
- The name of the agent/broker who is proposing the life insurance sale
All of these pieces of information are important and required if the prospective buyer chooses to move forward with the life insurance purchase. The illustration becomes a part of the application process and the life insurance company will need it on file.
It's common for agents to present prospective buyers with illustrations that might not include the name of the proposed insured or the agent proposing the purchase. This is done often to save time with the understanding that the illustration is being used at this point only to convey information about a proposed policy rather than make a specific recommendation for purchase.
Narrative Summary of the Proposed Insurance Policy
The narrative summary details the policy and its many features. It often defines several terms considered important for the prospective buyer. It also discloses the fees of the policy by often detailing the net cost surrender index of the policy. This is the cost in discounted dollars to the insured based on guaranteed values and non-guaranteed (projected) values later disclosed in the Tabular Detail of the illustration.
The Narrative Summary will usually breakdown the premium of the proposed policy. This discloses what the prospective buyer will pay not just for the death benefit of the policy, but also for any riders included in the proposal for life insurance.
The breakdown of the premium will also detail any additional expenses the policy has for premium payments made at different frequencies (e.g. paying premiums monthly rather than annually). The Narrative Summary will also define and explain the specific functionality of any riders included in the proposal for life insurance.
Lastly, the Narrative Summary includes a tax disclosure noting that the proposed life insurance policy meets the definition of life insurance per U.S. Tax Code and will identify whether or not the proposed policy violates the Modified Endowment Contract or will violate the MEC in the future based off planned premium payments.
Numeric Summary of the Proposed Insurance Policy
The Numeric Summary is usually a very short section of the whole life insurance illustration. Usually just one page, the summary gives a very brief breakdown of guaranteed, current, and midpoint projected values in an abbreviated table.
The guaranteed projections represent the policy cash value and death benefit resulting from the contractually guaranteed elements of the whole life insurance policy. This effectively means what happens if the policy received no dividends ever.
The current projections represent the cash value and death benefit resulting from non-guaranteed elements of the whole life insurance policy basing those projections on the dividend currently payable by the life insurance company. The life insurer uses the current dividend scale to project all values in the future as if the dividend scale never changes.
The mid-point projections represent the cash value and death benefit resulting from non-guaranteed elements of the whole life insurance policy reduced to a point in between the current and guaranteed (i.e. no dividends) dividend scale of the policy. The original intention behind requiring life insurers to disclose a midpoint projection came from a time when dividends were at extraordinarily high levels that many doubted would sustain.
The midpoint projection was a buffer to help manage expectations should dividend comes down from unusually high levels. Today dividend rates are nowhere near those historically high levels, but the midpoint requirement remains nonetheless.
Tabular Detail of the Proposed Insurance Policy
This section of the whole life insurance illustration contains a numerical breakdown of premiums, dividends, cash value, and death benefit of the proposed life insurance policy. The disclosure comes in the form of a ledger that delineates values year-by-year beginning at inception through the insured's age 120.
These ledgers can provide significant data to the proposed buyer about the policy and can also explain certain functionality of various whole life insurance features like:
- Using the policies cash or dividends to pay premiums
- Making the policy paid-up before the paid-up year
- Taking a loan from the policy
- Using the policy to create an income stream
Additionally, the prospective buyer can use the data found in the ledgers found in this section of the illustration to compute the projected rate of return of the policy. With this data, the prospective buyer can set expectations about how this policy functions relative to other whole life policies as well as relative to other savings and/or investment options.
The ledgers often detail both the guaranteed and current projection values. Some whole life ledgers include a midpoint projection as well in the Tabular Detail, but not all. Some states also have specific requirements for a midpoint disclosure, so if you live in one, you'll see a midpoint disclosure in this section for sure.
Understanding all of the Values in a Whole Life Insurance Illustration
While the Tabular Detail section of a whole life insurance illustration is very helpful, some people feel overwhelmed by the huge volume of information contained in this section. We agree it certainly appears intimidating, especially when seeing this information for the first time. I'm going to take some time to explain the various components of ledgers. This section often contains two ledgers. The Basic Ledger and the Supplemental Ledger.
The purpose of these two ledgers is to highlight the guaranteed components of the whole life insurance contract and the versatility of the whole life insurance contract.
The Basic Ledger stresses the guaranteed components. Its chief concern is for you to realize that if you want the original death benefit to remain in force for the entire contract period (i.e. your lifetime) you must pay the initial whole life premium for the entire premium payment period (you can see the premium payment period in the Narrative Summary of the illustration).
The Supplemental Ledger shows you the versatility of the contract by depicting any hypothetical scenario your insurance agent chooses to present to you. This might include assumptions like using dividends to pay the premium, creating an income with the cash value of the policy, or using the reduced paid-up option to make the policy paid-up sooner than the original premium payment period.
All of these scenarios under the Supplemental Ledger depend on non-guaranteed elements of the contract to achieve the values depicted in the ledger. The insurance company wants you to understand that while these features are available, the results you achieve by using them can vary depending on what actually happens with the non-guaranteed components of the policy (i.e. the dividends).
Lots of Columns
Whole life insurance illustration ledgers have a lot of columns. This volume of information can cause confusion, so let's breakdown the most common columns found in this section of the whole life insurance illustration.
Year is pretty straightforward. It's the policy year, which starts at 1 and goes through the maturity of the whole life insurance policy.
Age refers to the age of the insured of the policy and you should note that age usually means the age the insured will be at the end of the policy year. Some life insurers like to be different and repot age at the beginning of the policy year. This makes comparing values when one is looking at age confusing. The illustration will disclosure if age means the end or beginning of the policy year.
You can also discern this by looking at the stated age of the insured in the Narrative Summary section of the policy (or it's often printed in the top or bottom corner of every page of the illustration) and comparing it to the age listed for year 1. If for example the insured under the policy is 34 as the illustration reports in the Narrative Summary, and the age listed under year 1 is 35, you know that the age column reports age at the end of the policy year. If on the other hand, the age listed in the ledger matches the age listed in the Narrative Summary, you know that age listed is the beginning of the policy year.
Premium shows the premium paid by the policyholder in the given policy year. The Premium Column often breaks into several columns to disclose some very important aspects of the policy. Ledgers often have a premium due and net premium (oftentimes called “net outlay”) column. You can think of this net outlay column as premiums actually paid. You might see a situation where the premium due reflects a value, but the net outlay column is zero. In this situation, the ledger is disclosing that functionally the policyholder is not paying a premium out of pocket, but a premium is due. The life insurance policy itself is paying the premium either with dividends (just one dividend option you can choose) or cash value from the policy. The Net Outlay Column also commonly reflects policy loans or cash withdrawals. You'll see this reported as a negative number reflecting the fact that it is coming out of the policy and flowing to the policyholder.
Dividend reports the dividends paid in that year. This value is a projection based on the current dividend scale at the insurance company for the specific product. Dividends payments usually occur at the end of the policy year, and most ledgers report dividends as the payment of earnings anticipated at the end of the policy year. There are, however, some life insurers that again feel the need to be different and will report dividends paid as if it occurs at the beginning of the following policy year. It's yet another way of making things difficult to compare. And always remember, dividends are only paid on participating whole life policies.
Cash Value is the current cash value of the whole life policy. Because whole life insurance does not have surrender charges, the cash value is also the net cash surrender value. Understand that cash value figures reported in the ledger are net surrender values (even if the column doesn't specifically say net cash surrender value). If a loan is outstanding, the cash value reflects the cash value net of the loan. This means if you surrendered the policy and the insurance company paid off the outstanding loan, the value you see in this column is the amount you'd receive as a check after the life insurer pays off the loan.
Increase in Cash Value reflects the increase in the cash value of the policy for the given policy year. This column shows you the year-over-year changes in how much cash value you gain in a policy year.
Death Benefit is the outstanding net death benefit on the policy. Just like the cash value column, the numbers you see here reflect net figures. If a loan is outstanding, the value reported in this column is the amount your beneficiary(ies) receive after the life insurer pays off the outstanding loan. The amount of death benefit will depend upon your premium and your risk-adjusted mortality.
Loan Balance reports the calculated loan balance (including interest accumulation) in a given year. This column usually only shows up if the illustration specifically shows loan activity. This means if the illustration shows no loans, this column will not appear.
Taxable Distribution or Tax Liability is a special column that appears if the policy design violated the Modified Endowment Contract test in any year illustrated. This column attempts to project possible tax liability to the policyholder upon distributions or full surrender of the policy. It requires the agent to specify a marginal income tax rate as part of the illustration calculation. Withdrawals to the policy cost basis and most policy loans are tax-free.
The Challenge of Early Years in a Whole Life Policy
Undoubtedly as you look at numerous whole life policy illustrations when weighing your options, you will notice the challenge of little to no cash value. With a traditional policy design, that will always be the case. However, you do not have to accept that as your reality. Proper whole life policy design is crucial to overcoming this hurdle.
The illustration will not accurately project every detail into the future. Who knows what dividend rates maybe 10 or 20 years from now but the illustration will tell you if your policy is efficient at accumulating cash. That for many is what's most important.