How to Examine a Whole Life Insurance Policy Illustration

By Jim Sloan on April 14th, 2010

When you're shopping for a whole life insurance policy, your agent prepares what's called a life insurance illustration.

A whole life insurance illustration is a complex table of numbers showing the hypothetical benefits for every year your policy is in force. The illustration is put together by the insurance company's actuaries and attempts to predict the return on your investment. The illustration is based on a wide range of factors: How well the company's investments may perform, the company's projected expenses, and assumptions about your lifespan.

Although the whole life insurance illustration includes guaranteed minimum cash values and guaranteed death benefits, many of the projections in an illustration are speculative. For that reason, many consumer advocates, and even insurance company representatives, caution customers to take illustrations with a grain of salt.

Term Life Illustrations

Term insurance provides life insurance coverage for a set period of time. As a result, a term life insurance illustration is fairly simple. It shows current and maximum premiums for each year, total premiums paid up to that year, and each year's death benefit. Term life insurance illustrations run about three pages.

Whole Life Insurance Illustrations

A whole life policy includes a death benefit as well as a savings component called cash value. Because whole life insurance is a more complicated life policy than term life, the illustration is more complex and runs up to 10 pages.

Aside from the guaranteed payouts listed, the projections in a whole life insurance illustration are not likely to be what you get in your policy -- your cash value account may perform better, or not as well -- as the illustration forecasts. The illustration is trying to project dozens of years into the future, which is difficult to accurately predict.

"Policy illustrations work well to educate clients on how policies work, but they are not an adequate tool for comparing the cost of policies from different insurers," Glenn Stevick wrote recently for the National Association of Insurance and Financial Advisors Web site. "Illustrations do not create accurate projections of future performance for comparison purposes because of the differences in assumptions between insurers and the problems of estimating future performance of the company and the economy."

James Hunt of the Consumer Federation of America and an expert on policy illustrations, says illustrations reflect the complexity of whole life insurance policies. Hunt says that if consumers are unable to spend the time to understand whole life insurance illustrations, term life insurance may be a better option for them.

What to Look for in a Whole Life Insurance Illustration

Whole life insurance illustrations can be misleading because many figures are not "guaranteed," but they do have value. Here's what to look for:

  • Cash Value. You should examine the projected cash value in the first few years of the policy. Hunt says that if your premium payments in the first few years of a whole life insurance policy far exceed the cash surrender value -- the money paid to the policyholder if the policy is voluntarily terminated before its maturity -- then too much of your money might be going to commissions and other up-front costs. "If you paid $3,000 in premiums the first three years and the cash value of your policy is only $400 after three years, term insurance might be a better deal for you," he said.
  • Surrender Fees. Surrender charges are levied against a policyholder for termination of the insurance policy and withdrawal of funds within it. The amounts vary, so Hunt recommends you review them carefully.
  • Guaranteed Cash Value. The guaranteed cash value of a whole life insurance policy is separate from the predictions of what the savings component, or cash value, of your investment may return. Many consider the guaranteed values to be an important tool for evaluating a whole life insurance policy, but Hunt says that's a good way to become confused. "Keep your eye on the early surrender charges," he said, "Agents are prone to say, 'Don't look at surrender charges,' but this is because companies want enough time to recoup their high sales costs."
  • Premiums. How much does the whole life insurance policy cost you each month, and is it something you can afford?

Meaningless or Misleading Illustration Features

Here are elements of an illustration that many experts say aren't helpful when making a decision on the best policy to purchase:

  • Interest Adjusted Net Cost Indexes. These "box scores," for a whole life insurance policy illustration, take into account the premiums paid and the time value of money. Some experts say they are useful in comparing different policy illustrations. However, Hunt believes they are meaningless.
  • Dividend Rates. Dividend rates at the start of a whole life insurance policy may be termed "guaranteed," but the rate is only guaranteed for three to 12 months.
  • Large Variations in Premiums. A lower premium for the same death benefit as another policy with a higher cost may look like you're getting more for your money. But that appearance may be based on unrealistic projections by the actuaries who put the illustration together. To get an accurate comparison between whole life policies, make sure you are comparing policies that have the same interest rate -- and be sure the rate is realistic.

How to Find the Best Deal

Here are several steps you should take before purchasing a whole life insurance, universal life, or variable universal life policy based on a complex illustration:

  1. Have a consultant review the policy's illustration and evaluate it for you. For instance, the Consumer Federation of America's "Rate of Return" service estimates the "true" investment returns on any cash value life insurance policy. The service compares the whole life insurance policy to lower-premium term insurance, combined with investing the premium savings to an alternative investment. The cost is $80 for the first illustration and $60 for each additional illustration (when submitted at the same time).
  2. Have the policy "reverse engineered" by an expert who is able to review a company's data, examine the assumptions made in the illustration, and recommend the best companies and products. These experts are usually paid a flat fee, and say they help reduce commissions by an amount much higher than the expert's fee, which may save you money
  3. Shop around for term life insurance. Term life insurers are highly competitive and online quotes allow you to easily compare prices.
  4. Compare cash value policies to what's available at TIAA-CREF, a Fortune 100 financial services company that is the leading retirement system for people who work in the academic, research, medical, and cultural fields. Although it charges some sales fees, TIAA-CREF sells commission-free life insurance, and according to Hunt, "virtually all your money stays in the policy the first year."
  5. When comparing whole life insurance illustrations, ask each company for projections based on an interest rate that is 2 points lower than current projections. The policy that looks best at the lowest rate is probably the more conservative company, and might make a better choice for you

Take Time for Reflection before Committing to Life Insurance

Before purchasing life insurance, here are several questions to ask to yourself or your agent:

  • Am I prepared to hold on to the investment? Nearly half of all whole life insurance policies are surrendered after 10 years. How will my investment look after 10 years, and are there other investments that would have a better return in that timeframe?
  • Does the classification used for the illustration accurately reflect who I am? For instance, does the illustration provide projections for a 40-year-old male nonsmoker?
  • What happens if I miss a premium payment?
  • What if I become disabled? Does my insurance company offer riders to cover me if I become disabled?

Remember, it's best to use a whole life policy illustration as a way to understand how your investment may work in a hypothetical way. The numbers you see in your illustration are not necessarily something you can take to the bank.

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