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."
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.