Whole life insurance, as the name implies, is designed to provide protection over the insured’s entire lifetime. Although coverage continues throughout life, insurers offer policies that allow the owner to pay for the coverage over virtually any duration. At one extreme is the ordinary level premium whole life policy where the owner pays level premiums each year for as long as the insured lives (or generally to a maximum age of one hundred). At the other extreme is the single premium life policy where just one large premium payment is sufficient to purchase lifetime coverage.
The principal characteristics of ordinary limited pay whole life are:
- level or fixed periodic premiums payable for a specified number of years;
- a level or fixed death benefit; and
- a fixed schedule of minimum cash surrender values that increase over time.
The policy owner agrees to pay a fixed or level premium at regular intervals for the specified period, or until the insured dies, if sooner. Once the policy owner has paid premiums for the stipulated number of years, the policy is “paid up” for its full face amount. In other words, the owner needs to pay no more premiums past that point to keep the policy in force for as long as the client lives. In return, the insurance company agrees to pay a fixed death benefit when the insured dies even if the death occurs after the premium paying period.
As the length of the premium payment period increases, limited pay policies more closely resemble ordinary level premium whole life policies. However, because limited pay policies require premium payments for a term that is less than the term of the contract, the insurer must charge larger annual premiums than for ordinary level premium whole life. The annual premiums insurers charge become increasingly larger as the specified premium paying period grows shorter. Correspondingly, policy cash values grow more quickly for policies with shorter premium payment periods than for policies with longer payment periods.
Limited pay policies are commonly offered with ten, fifteen, twenty, thirty years, or longer premium payment periods. Most companies also offer policies where the set payment period is based on the insured’s age. The most common form is the life-paid-up-at-age-sixty-five (LP65) policy which allows the insured to discontinue premium payments at retirement (age sixty-five) while the policy remains in force for the rest of the insured’s life.
In almost all respects other than the premium paying period, limited pay policies have the contract features and characteristics of ordinary level premium whole life insurance policies. All limited pay policies contain the same nonforfeiture, settlement, dividend options, rider availability, loan provisions, mortality, expense, interest guarantees, and other features as ordinary life policies. However, limited pay policies with short premium payment periods (generally seven years, or less) may be classified as Modified Endowment Contracts (MECs). MECs are subject to less favorable tax treatment than ordinary life policies, if they fail the seven-pay test.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM