Our Analysis:
Whole or "Traditional" Life Policy Gone Bad

Due to the simplicity of whole life, it is not an easy policy to misrepresent. However, over the years, the imaginative minds of greedy salespeople have contrived some doozies.

The Vanishing Premium: The agent highly exaggerates the earning potential of the policy. A potential policy owner is "sold" on the company's financial strength and ability to earn sizable profits for its policy owners. Based on these "illusions of grandeur", policies are sold under the premise that they will be self-sufficient or "paid-up" much sooner than possible. Thus, policy owners are often wrongfully led to believe the premium will "vanish".

Premium "Re-direction": Very seldom will a whole life policy survive without its dividends or accumulations. Dividends are the policy's "life blood" in later years. Agents may sell additional policies to the policy owner or members of the family by representing that; since the older policy is now self-sufficient, you can use its dividends to finance a new product -- basically, robbing Peter to pay Paul. In most cases, both policies will eventually lapse with no value.

The Christmas Club: This particular "scam" has been called by several different names, "The Christmas Club" stands out as the most flamboyant. Here, agents contact senior policy holders with large cash values in their permanent policies representing that, because the insured has been such a loyal policy owner for so many years, they are eligible for membership in the "Christmas Club". As a member of this prestigious club, they have a choice between a "free" paid-up life insurance policy or cash. The agent (who was secretly given the amount of the policy's cash value by the company) will try very hard to "sell" the policy owner on the value of "free" insurance. Because the policy's face value is usually very small, a medical examination is seldom required.

When the "victim" selects the new policy, the agent has them unknowingly sign the appropriate forms to withdraw money from their policy's own cash value and secretly uses this money to pay several years' premiums on the new policy in advance. If the policy owner decides on the cash, which is very seldom the case, the money is given back to them in a check from the company. In just a few years, the old policy lapses because its cash value was taken and the new policy lapses because the premiums paid in advance have "run out". As you may expect, we have not yet seen an agent who's sold policies like this stay with the same company very long.

Whole or "Traditional" Life Insurance

Whole or "Traditional" Life, is the kind of policy your parents or grandparents may have had. These policies cover you for your entire life, not just a specific period. Both your premium and death benefit, or face value, remain the same for the life of the contract. (With term insurance, your premium increases as you age to account for the fact that you're a bigger health risk.) Insurance companies keep both the premium and the death benefit constant during the life of a whole life policy by charging you a premium that's higher than the actual cost of the insurance when you're young and using some of the profit to pay for the higher cost of your insurance when you're older.

As required by law, the insurance company invests the premiums in low-risk instruments, mostly bonds and mortgages. The policyholder has no say in how the company manages these funds; long-range returns are comparable to bond funds'. Over and above the guaranteed rate of return, some companies offer policyholders the opportunity to share in the company's profit, just like shareholders do. The company pays policyholders dividends, based on the success of the company in the previous year. Policies with this benefit are called "participating policies" as opposed to "non-participating policies" - that is, ones that do not pay dividends. Think of it as,"participating or not-participating in the profitability of the company."

Life Insurance Policy

Please note that amount of the annual dividend is based on many different factors and most companies will never guarantee them.

One of the more attractive features of any permanent life insurance is that earnings are tax deferred until they're withdrawn, and then only to the extent that they exceed the amount paid as premiums (capital gains). The invention of tax-deferred retirement plans, like 401(k)s and IRAs, and the phenomenal growth of mutual funds have made traditional whole life less popular as a means of college or retirement saving.

Another great feature of participating whole life policies is: it is also possible to offset premium payments in later years. With this option, annual dividends are put back into the policy and used to purchase additional amounts of paid-up insurance called paid-up additions. Once these additions or "paid-up adds" are sufficient to cover the premium, they are surrendered each year to make the premium payment. However, if the policy does not perform well you may have to make premium payments again.

Another significant benefit of the whole life policy is the fact that you can borrow against your cash value, usually at interest rates significantly lower than market rates (usually 8 percent). The rates are low because the lender is assuming little or no risk. If you don't repay the loan (plus interest), the company will take the money from your account. When you borrow against a policy, you don't have to pay any fees, and you can usually get a check in just a few days. If you die before the loan is repaid, the outstanding amount is deducted from the death benefit.

Some companies will pay a "terminal dividend"-- a type of bonus, if you will -- upon the death of the insured. Of course, a company makes no guaranty that it will pay this dividend (or any dividend, for that matter). However, most annual and terminal dividends are, indeed, paid.