554 Chapter 13 Insurance and Risk Management
Example 13.3.4 Suppose that the nonforfeiture table shown above is for a
$150,000 death benefi t policy. If the policyowner decides to surrender the policy at the
end of the 8th contract year, what would he receive if he chose to surrender the policy
for (a) cash, (b) RPU, or (c) extended term.(a) The cash value at the end of year 8 is $80 per thousand. So the cash value is (150)($80)
$12,000.(b) The RPU at the end of year 8 is $195 per thousand. So the policy could be surrendered
for a paid-up policy with a (150)($195) $29,250 death benefi t.(c) The $150,000 death benefi t could be continued with extended term for 18 years and
21 days.The insurer does not have the opportunity to change whole life insurance premiums once
a policy is issued. When setting rates, the actuary must make predictions about investment
rate of return and life expectancies far into the future. If the assumed rate of return or of
claims proves overly optimistic, the insurer has no opportunity to adjust the premiums to
reflect this. Thus, insurers have to be fairly conservative about the assumptions they use in
calculating whole life premiums.
But this conservatism makes it likely that the rates of return and of claims will actu-
ally turn out to be quite a bit better than the assumed ones. With a participating whole
life policy, the policy owner may be paid dividends based on the insurer’s actual experi-
ence with policies of a given type. The dividends may be paid in cash, may be used to
reduce premiums, or may be used to purchase additional chunks of paid-up death benefit
(known as paid-up additions). Not all life insurance policies are participating, though.
With a nonparticipating policy, the policy owner does not receive any such dividends.
A participating policy may carry a higher up-front premium than a nonparticipating one,
but in the long run the ability to earn dividends may more than make up for the higher
premium.
Rates for whole life insurance are usually calculated from a rate table in much the same
way as term insurance rates are. If a substandard rating is applied, however, it may not
result in a simple percent increase as it did with a term policy.
A third type of life insurance is also quite popular; in addition to being important in its
own right, it can provide some insight into how whole life insurance works.Universal Life Insurance
Traditional whole life insurance does not offer much flexibility in how the premiums are
paid, and the whole process of determining the cash values and dividends is not at all trans-
parent. Universal life insurance provides an alternative to traditional whole life. Universal
life insurance functions much like an investment account with a term insurance policy
attached to it. When a premium is paid on a universal life policy, the funds are deposited
to an investment account (often less a percent charge called a load, and, in some states,
premium taxes). Each month interest is credited to the account and a deduction called a
mortality charge or term cost is made for the cost of the insurance coverage (comparable
to the cost of a term insurance policy).
For example, suppose that you have a newly purchased universal life insurance policy.
The death benefit is $100,000, and you pay a $2,000 premium up front. The policy charges
a 3% load on all premiums, and pays 6% interest compounded monthly. The monthly insur-
ance charge is given as $0.043 per thousand, plus a $2.50 monthly service charge. We can
illustrate the first few months of this policy by means of a table:MonthPremium
(Less Load)Mortality
Charge Fees Interest End Balance
1 $1,940.00 $4.22 $2.50 $0.00 $1,933.28
2 $0.00 $4.22 $2.50 $9.67 $1,936.23