After my last column, a customer of mine asked how life insurance works. I asked what he meant and he said, “I understand term life insurance. Ninety percent of the policies never pay a benefit, so the insurance company gets to keep all those premiums and only pay the beneficiaries of the 10% who die while their policy is still in-force.

He then said, “What I don’t understand is whole life insurance. The companies always pay more than they take in in premiums.”

Whole life insurance, sometimes called permanent insurance, or ordinary life, is designed to stay in force throughout one’s lifetime. As long as the policy owner meets his or her obligations under the policy, the policy remains in force, regardless of changes in health that may occur.

Unlike term insurance, where premiums generally increase, as the insured gets older (the chance of death increases with age), premiums for most whole life policies remain level.

When my children were young, they asked how planes fly. I always said “by magic.” Here is the magic of whole life insurance.

A portion of each premium payment in a whole life insurance policy is set aside to earn interest. Over time, a whole life policy will develop cash values. The accumulated cash values form a reserve, which enables the insurer to pay a policy’s full death benefit, while keeping premiums level. Insurance companies also know some individuals will not keep their whole life insurance policies until they die. These surrendered policies relieve the insurance company of some of their future liability.

Underwriting is an other way of an insurance company can keep their promise and still make a profit. Underwriting consists of questions asked on the application, gathering of medical records, requesting medical exams and looking for adverse life styles, such as speeding and DUIs. All of this information helps a life insurance company price its products correctly so benefits can be paid years into the future.

There are many reasons for surrendering a whole life insurance policy early. The beneficiary of the policy may no longer need the money, the owner of the policy may need the money accumulated in the policy cash value. Understand that if whole life insurance policies are designed to last until the insured dies, the maximum benefit will always be paid at death.

Sometimes, numbers make a point better than words. Then I remembered putting numbers into a column is noncompliant. What is compliant is that every whole life policy requires a life insurance illustration signed by the purchaser of the policy and the licensed selling agent. This life insurance illustration provides information on the policy that is being purchased. It is the best tool used by a purchaser of life insurance to gather information about benefits of the policy.

It is usually five to 10 pages long and provides information like premiums, initial death benefit, dividend options, riders, description of coverage and definitions. It provides a spread sheet showing the premium cost, death benefit and cash values of the policy for each year the policy is in force. It will provide these numbers until the insured reaches age 121. At age 121, most insurance companies consider the policy matured and pay the maximum benefit of the policy.

These numbers are separated into guaranteed and nonguaranteed values. The guaranteed values are contractual and are the obligation of the insurance company to pay. The nonguaranteed values are projections of the company in its future operating plan. Companies known as participating companies share these values in the form of dividends that increase the benefits of the policy.

Using the life insurance illustration and asking for ratings of the companies you are working with is the best way to determine which whole life insurance policy is best for you. As always, avoid companies with no ratings and no illustrations.

Bob Hollick is a State Farm Insurance agent based in Washington.

To submit columns on financial planning, investing or business-related matters, email Rick Shrum at

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