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A lot of people buy whole life insurance policies with the intention of one day stopping the premium payment. In some cases, these are guaranteed paid-up policies like a 10-Pay whole life product. In other cases, the policyholder uses non-guaranteed features of the policy to cover the premium. In others, a nonforfeiture option comes into play and creates a paid-up policy.
All of these features of whole life insurance have a place and exist to uniquely accommodate an array of needs. But one of these features–the ability to use non-guaranteed features of a whole life policy to cover the premium–was sold aggressively for years. It still is in many insurance marketing circles. In fact, the excitement that once encircled this concept of whole life insurance got so red hot, that it led to a regulatory change that sought to temper both expectations as well as marketing hoorah around the idea.
Despite that change, many people continue to buy into the idea and many agents often embellish just how well it works. Perhaps these agents don't necessarily act intentionally. Since we're talking non-guaranteed elements of a whole life policy, we are at the mercy of whole life dividends. If they change in the downward direction, it certainly changes the assumptions one might have made about the what and when regarding future premium payments.
The Dividend Option to Pay Premiums
Participating whole life insurance policies all come with four basic dividend options. Some companies may offer others, but there are four that exist all of the time. These options include:
- Cash payment
- Reduce/Pay Premium
- Accumulate at Interest
- Purchase Paid-up Additions
Number two on our list is the option at the center of today's discussion. This dividend option allows the policyholder to use the dividend to pay part or all of his/her premium. Let's look at an example.
Let's say that you own a whole life insurance policy that has a $10,000 annual premium. This year, the insurance company will pay you a dividend of $6,000. You can elect to use all of the dividend to cover $6,000 of your premium, and you will need to cover the remaining $4,000. The dividend has decreased the annual cost of the insurance policy.
Now let's move forward a few years. This year, the insurance company will pay you $12,000 in dividends. You can still elect to direct this dividend payment towards your premium. Now the dividend covers the entire payment, and you'll have $2,000 leftover. You'll then have to decide what to do with the remaining money. In this case, your out-of-pocket cost for the life insurance policy is zero. It's like getting free insurance! Sidebar, regulators really hate it when insurance companies and/or agents/brokers make claims about free insurance. I'm not really suggesting that you have free insurance. This is an example of what we in the internet content creator business call…sarcasm.
Whole Life Insurance and the Vanishing Premium
Years ago, interest rates were really high and, as a result, dividends on whole life insurance policies were also really high. These lofty dividends of the time created policy projections that appeared somewhat magical. You could buy a policy and, with relatively little money, do things with that policy that we'd laugh at today if you thought we were going to take your projections seriously.
But back then it seemed reasonable to believe the projection. Insurance marketers and agents quickly caught on to just how fantastic the dividend option to reduce/pay premiums looked. You could buy a policy, make maybe a dozen payments, and then poof your premiums magically went away because the all-mighty dividend was more than capable of covering your policy premium for you…for the rest of your life.
Only fools laid out extra money for guaranteed paid-up policies. Dividends would allow you to spend way less money than outrageous premiums those 10 Pays said you had to pay. And who wouldn't be attracted to a policy whose premium would be not your responsibility in about a decade?
The problem is the dividends of yesteryear didn't hold, and those policies purchased with a critical dependency on them to cover the premium involved some really uncomfortable conversations about what non-guaranteed means. In other words, the policies weren't paid up contractually speaking, but a non-guaranteed feature of the policy was instead paying the premium due…or not paying the premium due.
So we all learned a lesson about making projections based on non-guaranteed elements and the world is a better place where never again did people have to worry about missed expectations again. The end.
Yeah…that's not at all how it worked out.
Insurance agents continued to pitch whole life under the idea that dividends could cover premiums and that would effectively make owning that whole life death benefit free one day. In fact, it still goes on today.
Now, I'm not saying that it's completely bad. It can and is being done by several whole life policies purchased years ago. But there are many whole life policies that had certain expectations that sadly fell well short. The good news is, these people may be in a position to achieve the results they desire, just with a different approach.
Why are you Still Paying your Premium Case Study
I want to talk about a couple we recently met. We'll call them John and Jane. The couple bought whole life policies in their 30's because they needed death benefit and they were attracted to the various features whole life offered. They liked the idea of having cash value just in case. And they also liked the idea of one day being able to stop making premium payments because the dividend could cover it.
The decision to buy those policies took place a little over 20 years ago. They purchased the following policies.
John bought a $1.6 million death benefit participating whole life insurance policy with a $24,000 annual premium.
Jane bought a $1.5 million death benefit participating whole life insurance policy with a $16,000 annual premium.
They have each paid their premiums when due for a little more than 20 years. Here are their most recent policy summary reports.
John has accumulated about $723,000 in cash value. His current annual dividend is $14,080. The death benefit on his policy is a little over $1,650,000.
Jane has accumulated about $499,000 in cash value. Her current annual dividend is $8,511. The death benefit on her policy is about $1,550,000.
These policies were issued at preferred rates from a well-known mutual life insurer that still holds a revered position on the whole life insurance market.
Doing the math on internal rate of return, John has achieved a 1.78% IRR while Jane has achieved a 2.20% IRR. Jane is younger and women do tend to benefit from cheaper life insurance rates.
The one major point of contention this couple had was the fact that their current dividends were nowhere close to covering their premiums. Despite the two decades that had passed since they bought the policies.
Our Recommended Solution
The good news for John and Jane was that their policies built value that could go a long way in helping them accomplish the goal of no longer paying the premiums on their life insurance policies. This was done by using newer products with improved expense structures due to the evolution of mortality cost models that transpired in the time since they purchased their policies. We were able to set up John and Jane with the following policies–I'm taking data from the policy ledgers.
John
| Year | Age | Dividend | Premium | Cash Value | Death Benefit |
| 1 | 60 | $ 17,715 | $ 723,252 | $ 650,928 | $ 2,268,399 |
| 2 | 61 | $ 17,634 | $ – | $ 651,763 | $ 2,230,558 |
| 3 | 62 | $ 17,079 | $ – | $ 672,462 | $ 2,192,982 |
| 4 | 63 | $ 18,837 | $ – | $ 697,108 | $ 2,157,566 |
| 5 | 64 | $ 23,219 | $ – | $ 729,405 | $ 2,128,769 |
| 6 | 65 | $ 24,889 | $ – | $ 760,036 | $ 2,105,663 |
| 7 | 66 | $ 25,862 | $ – | $ 791,949 | $ 2,085,290 |
| 8 | 67 | $ 26,956 | $ – | $ 825,275 | $ 2,067,163 |
| 9 | 68 | $ 28,216 | $ – | $ 860,203 | $ 2,051,432 |
| 10 | 69 | $ 29,309 | $ – | $ 896,570 | $ 2,037,935 |
| 11 | 70 | $ 30,357 | $ – | $ 933,538 | $ 2,026,429 |
| 12 | 71 | $ 31,349 | $ – | $ 971,629 | $ 2,016,751 |
| 13 | 72 | $ 32,638 | $ – | $ 1,010,952 | $ 2,009,090 |
| 14 | 73 | $ 34,191 | $ – | $ 1,051,656 | $ 2,003,780 |
| 15 | 74 | $ 35,894 | $ – | $ 1,093,700 | $ 2,001,003 |
| 16 | 75 | $ 37,365 | $ – | $ 1,134,843 | $ 2,000,495 |
| 17 | 76 | $ 38,538 | $ – | $ 1,176,689 | $ 2,001,770 |
| 18 | 77 | $ 39,746 | $ – | $ 1,219,320 | $ 2,004,679 |
| 19 | 78 | $ 40,920 | $ – | $ 1,262,766 | $ 2,009,144 |
| 20 | 79 | $ 42,010 | $ – | $ 1,307,000 | $ 2,015,017 |
| 21 | 80 | $ 42,862 | $ – | $ 1,351,718 | $ 2,021,985 |
| 22 | 81 | $ 43,728 | $ – | $ 1,396,859 | $ 2,029,955 |
| 23 | 82 | $ 45,015 | $ – | $ 1,442,670 | $ 2,039,323 |
| 24 | 83 | $ 46,260 | $ – | $ 1,489,175 | $ 2,050,120 |
| 25 | 84 | $ 47,851 | $ – | $ 1,536,229 | $ 2,062,640 |
| 26 | 85 | $ 48,808 | $ – | $ 1,583,004 | $ 2,076,286 |
| 27 | 86 | $ 51,067 | $ – | $ 1,630,563 | $ 2,092,203 |
| 28 | 87 | $ 52,735 | $ – | $ 1,678,050 | $ 2,110,004 |
| 29 | 88 | $ 54,367 | $ – | $ 1,725,200 | $ 2,129,514 |
| 30 | 89 | $ 55,973 | $ – | $ 1,771,772 | $ 2,150,676 |
| 31 | 90 | $ 57,509 | $ – | $ 1,817,688 | $ 2,173,400 |
| 32 | 91 | $ 58,971 | $ – | $ 1,862,955 | $ 2,197,593 |
| 33 | 92 | $ 60,443 | $ – | $ 1,907,823 | $ 2,223,248 |
| 34 | 93 | $ 61,837 | $ – | $ 1,952,661 | $ 2,250,288 |
| 35 | 94 | $ 63,174 | $ – | $ 1,997,908 | $ 2,278,643 |
| 36 | 95 | $ 64,415 | $ – | $ 2,044,427 | $ 2,308,212 |
| 37 | 96 | $ 65,482 | $ – | $ 2,093,529 | $ 2,338,805 |
| 38 | 97 | $ 66,394 | $ – | $ 2,144,841 | $ 2,370,238 |
| 39 | 98 | $ 67,333 | $ – | $ 2,199,536 | $ 2,402,523 |
| 40 | 99 | $ 68,338 | $ – | $ 2,259,498 | $ 2,435,729 |
| 41 | 100 | $ 69,376 | $ – | $ 2,328,339 | $ 2,469,895 |
Jane
| Year | Age | Dividend | Premium | Cash Value | Death Benefit |
| 1 | 55 | $ 12,031.00 | $ 498,809.00 | $ 450,209.00 | $ 2,014,433.00 |
| 2 | 56 | $ 11,677.00 | $ – | $ 451,260.00 | $ 1,984,491.00 |
| 3 | 57 | $ 11,379.00 | $ – | $ 467,902.00 | $ 1,954,618.00 |
| 4 | 58 | $ 11,300.00 | $ – | $ 486,540.00 | $ 1,925,095.00 |
| 5 | 59 | $ 13,703.00 | $ – | $ 510,591.00 | $ 1,898,655.00 |
| 6 | 60 | $ 14,865.00 | $ – | $ 533,449.00 | $ 1,876,703.00 |
| 7 | 61 | $ 15,946.00 | $ – | $ 557,886.00 | $ 1,857,612.00 |
| 8 | 62 | $ 16,777.00 | $ – | $ 583,648.00 | $ 1,840,916.00 |
| 9 | 63 | $ 17,651.00 | $ – | $ 610,738.00 | $ 1,826,304.00 |
| 10 | 64 | $ 18,550.00 | $ – | $ 639,128.00 | $ 1,813,743.00 |
| 11 | 65 | $ 19,635.00 | $ – | $ 668,354.00 | $ 1,803,348.00 |
| 12 | 66 | $ 20,881.00 | $ – | $ 699,120.00 | $ 1,795,335.00 |
| 13 | 67 | $ 22,091.00 | $ – | $ 731,388.00 | $ 1,789,689.00 |
| 14 | 68 | $ 23,231.00 | $ – | $ 765,055.00 | $ 1,786,206.00 |
| 15 | 69 | $ 24,374.00 | $ – | $ 800,098.00 | $ 1,784,740.00 |
| 16 | 70 | $ 25,576.00 | $ – | $ 834,758.00 | $ 1,785,263.00 |
| 17 | 71 | $ 26,840.00 | $ – | $ 870,827.00 | $ 1,787,790.00 |
| 18 | 72 | $ 27,996.00 | $ – | $ 908,213.00 | $ 1,792,165.00 |
| 19 | 73 | $ 29,095.00 | $ – | $ 946,885.00 | $ 1,798,192.00 |
| 20 | 74 | $ 30,154.00 | $ – | $ 986,778.00 | $ 1,805,732.00 |
| 21 | 75 | $ 31,165.00 | $ – | $ 1,027,819.00 | $ 1,814,658.00 |
| 22 | 76 | $ 32,429.00 | $ – | $ 1,070,230.00 | $ 1,825,142.00 |
| 23 | 77 | $ 33,742.00 | $ – | $ 1,114,022.00 | $ 1,837,291.00 |
| 24 | 78 | $ 35,108.00 | $ – | $ 1,159,159.00 | $ 1,851,116.00 |
| 25 | 79 | $ 36,455.00 | $ – | $ 1,205,583.00 | $ 1,866,559.00 |
| 26 | 80 | $ 37,752.00 | $ – | $ 1,253,207.00 | $ 1,883,506.00 |
| 27 | 81 | $ 38,940.00 | $ – | $ 1,301,856.00 | $ 1,901,782.00 |
| 28 | 82 | $ 40,301.00 | $ – | $ 1,351,441.00 | $ 1,921,480.00 |
| 29 | 83 | $ 42,103.00 | $ – | $ 1,402,292.00 | $ 1,943,056.00 |
| 30 | 84 | $ 44,039.00 | $ – | $ 1,454,474.00 | $ 1,966,715.00 |
| 31 | 85 | $ 45,969.00 | $ – | $ 1,507,800.00 | $ 1,992,434.00 |
| 32 | 86 | $ 47,497.00 | $ – | $ 1,561,703.00 | $ 2,019,761.00 |
| 33 | 87 | $ 49,489.00 | $ – | $ 1,616,429.00 | $ 2,049,037.00 |
| 34 | 88 | $ 51,417.00 | $ – | $ 1,671,959.00 | $ 2,080,264.00 |
| 35 | 89 | $ 53,163.00 | $ – | $ 1,728,067.00 | $ 2,113,217.00 |
| 36 | 90 | $ 54,902.00 | $ – | $ 1,784,687.00 | $ 2,147,838.00 |
| 37 | 91 | $ 56,591.00 | $ – | $ 1,841,811.00 | $ 2,184,060.00 |
| 38 | 92 | $ 58,244.00 | $ – | $ 1,899,599.00 | $ 2,221,830.00 |
| 39 | 93 | $ 59,861.00 | $ – | $ 1,958,142.00 | $ 2,261,099.00 |
| 40 | 94 | $ 61,458.00 | $ – | $ 2,017,579.00 | $ 2,301,836.00 |
| 41 | 95 | $ 62,916.00 | $ – | $ 2,078,513.00 | $ 2,343,894.00 |
| 42 | 96 | $ 64,386.00 | $ – | $ 2,141,432.00 | $ 2,387,263.00 |
| 43 | 97 | $ 65,624.00 | $ – | $ 2,205,757.00 | $ 2,431,702.00 |
| 44 | 98 | $ 66,853.00 | $ – | $ 2,272,133.00 | $ 2,477,183.00 |
| 45 | 99 | $ 68,082.00 | $ – | $ 2,341,749.00 | $ 2,523,717.00 |
| 46 | 100 | $ 69,341.00 | $ – | $ 2,416,915.00 | $ 2,571,346.00 |
Key Observations
We could design and implement new policies that used the cash value built up in John and Jane's policies and allowed them to stop paying premiums after putting these policies in force. In other words, there was one effective premium, which was the transfer of their old whole life policy cash values to these new policies. After that, no new money out of their pocket is required. They both received a bump in outstanding death benefit. This wasn't a critical component of the plan, but the resulting death benefit is the lowest we could achieve without creating a Modified Endowment Contract.
The dividend payable at the end of the first year for both policies is higher than the dividend payable on the old policies, which they had owned for more than 20 years. Even when we looked at this scenario with a reduced dividend, they still do not need to pay premiums on these new policies.
We did explain to John and Jane that the mechanism that allows them to not pay premiums is a non-guaranteed component of the policy. But even if we needed to trigger other features at our disposal, we can keep the couple very close to their original death benefit amounts while ensuring that they never again have to pay whole life insurance premiums.
While it wasn't a huge consideration for them, the rate of return on cash value will be higher moving forward than would have been the case with their old whole life policies.
Moral of the Story: You May Not Need to be Paying Your Whole Life Premium
There are a lot of whole life policies in existence that are similar to John and Jane's. There are a lot of people who have options regarding their whole life policies, but they don't fully understand them.
That's where we come in. We have considerable experience with whole life insurance and other forms of permanent life insurance and know how to leverage the options policyholders have with their policies to achieve various goals.
Excellent article!
Have you seen the option to gradually reduce the base benefit so that dividends and part of the base cash value cover an adjusted premium?
It guarantees that you can stay with a planned outlay. The outlay is vanished by accepting a somewhat reduced benefit. The benefit typically able to increase later once dividends are more than enough to cover the adjusted premium.
It is a small reduction compared to RPU for those who need a higher current coverage.
We have looked at this scenario on a few occasions. It works at times. It’s important to note that not all companies allow reductions that work seamlessly with this idea.