Term, Whole Life and Endowment Policies in Practice
Term, whole life and endowment policies differ in what the insurer is at risk for, how long the promise lasts, and what the owner gets back if the insured lives. The arithmetic behind those differences shows how much the insurer is really covering in each policy year, what extra features of a term policy cost, how a renew-or-convert decision plays out in dollars, how newer whole life forms credit values, what a policy loan does to a death claim, and what an endowment pays and costs. Michigan’s loan and endowment rules apply where they change the result (MCL 500.4022, 500.4023, 500.4047 and 500.4064). Names, premiums and rates in the examples are invented, and none is a statutory figure or a rate any insurer charges.
Amount at Risk Over Time
The insurer’s amount at risk is the death benefit minus the policy’s cash value. In a term policy there is no cash value, so the amount at risk is the face amount every year. In a whole life policy it falls as cash value builds. Take a $100,000 straight life policy issued at age 35, with invented cash values.
| Policy year | Cash value | Amount at risk | Cash value as a share of face |
|---|---|---|---|
| 1 | $0 | $100,000 | 0% |
| 5 | $3,200 | $96,800 | 3.2% |
| 10 | $9,800 | $90,200 | 9.8% |
| 20 | $26,500 | $73,500 | 26.5% |
| 30 | $48,000 | $52,000 | 48.0% |
By year 30 the insurer is covering about half of what it covered in year 1, even though the premium never changed. A level term policy for the same $100,000 leaves the insurer exposed to the full $100,000 in year 30, and the insured is 30 years older. That is why level term prices climb sharply at renewal and why whole life can stay level.
The premium pattern changes the speed. A 20-pay life policy for the same $100,000 charges more each year for 20 years, so its cash value builds faster. If it shows $39,500 at year 20 (also invented), the insurer’s amount at risk is $60,500 against $73,500 on the straight life policy. Both policies mature at the same age. The limited pay policy simply has less of the face amount left to insure when its premiums stop.
When the insured dies in year 20, the beneficiary receives $100,000, not $100,000 plus the $26,500. The cash value is not paid on top of the face amount. It is the part of the face amount the insurer has already funded. That is the right way to answer when a client asks whether “the savings” are paid in addition.
Term Forms, Priced and Compared
Level Term and the Cost of Features
The base price of term is the mortality cost for a stated age, health class and period. Features raise it. Renewability costs more because the insurer is accepting the risk that the insured’s health will have changed, and convertibility costs more for the same reason. The extra premium buys a right that is worth the most to the person who becomes uninsurable, which is who is most likely to use it.
Return of Premium Term
Return of premium term refunds the premiums paid if the insured outlives the term. Suppose Garrett Lindqvist, 35, can buy a 20-year level term policy for $500,000 at $420 a year, or a return of premium version at $1,150 a year.
| Level term | Return of premium | |
|---|---|---|
| Annual premium | $420 | $1,150 |
| Premiums over 20 years | $8,400 | $23,000 |
| Paid at death in the term | $500,000 | $500,000 |
| Paid if he outlives the term | $0 | $23,000 |
| Extra premium each year | $730 | |
| Extra premium over 20 years | $14,600 |
The return of premium policy refunds $23,000, but $8,400 of that is premium he would have paid for term protection anyway. The real question is what the extra $730 a year earns. Paying $730 at the start of each of 20 years and receiving $23,000 at the end of year 20 is an annual return of about 4.2%. Investing the same $730 a year at 3% would reach about $20,204 and at 4% about $22,608. The refund is a guaranteed return of roughly 4.2% on the extra money, if he keeps the policy for the whole term.
The weak point is early lapse. Suppose the policy refunds 50% of premiums if it is dropped in year 12 (the schedule is in the policy, and 50% is an example). By then he has paid $13,800 and would receive $6,900. A level term buyer would have paid $5,040 over the same 12 years. Net of the refund, the return of premium owner has paid $6,900 for 12 years of coverage and the level term owner $5,040, a difference of $1,860. A client who may not hold a policy for 20 years should see this arithmetic before choosing the higher premium.
Decreasing Term Against a Loan
Decreasing term keeps the premium level while the face amount falls on a schedule printed in the policy. It is sold to cover a loan, but the face schedule and the loan balance are separate numbers. Sofia Brandt takes a $200,000, 30-year mortgage at 6% (monthly payment $1,199.10, with balances worked from the unrounded payment) and buys decreasing term that falls evenly from $200,000 to $0 over 30 years.
| Year-end | Loan balance | Policy face | Loan not covered |
|---|---|---|---|
| 1 | $197,543.98 | $193,333.33 | $4,210.65 |
| 5 | $186,108.71 | $166,666.67 | $19,442.04 |
| 10 | $167,371.45 | $133,333.33 | $34,038.12 |
| 15 | $142,097.69 | $100,000.00 | $42,097.69 |
| 20 | $108,007.17 | $66,666.67 | $41,340.50 |
| 25 | $62,024.17 | $33,333.33 | $28,690.84 |
| 30 | $0.00 | $0.00 | $0.00 |
The reason is that a mortgage repays slowly at first, because early payments are mostly interest, while an even schedule gives back a fixed slice of face each year. If Sofia dies at the end of year 10, the policy pays $133,333.33 and her family still owes $34,038.12 on the loan. A schedule matched to the amortization would close that gap. When a client buys decreasing term for a mortgage, compare the policy’s schedule with the loan’s balance. Decreasing term pays the beneficiary named in the policy, which differs from credit life, where the creditor is paid and the debt is extinguished.
Matching the Form to the Need
| Need | Form that fits | Why |
|---|---|---|
| A fixed income-replacement period, such as until children are independent | Level term for that period | Face stays whole while the need lasts, and the cost is the lowest |
| A loan that amortizes | Decreasing term, with the schedule checked against the loan | Face falls as the need falls |
| Duration uncertain, and a health change would end insurability | Renewable and convertible term | The right to continue or convert needs no new evidence |
| A client who wants the premiums back and can afford about 2.7 times the level term premium | Return of premium term | Refund if the policy runs its full term, with the lapse risk above |
| A need that never ends, such as final expenses or an estate | Whole life | Premium is level and coverage does not expire |
Term Versus Permanent in Dollars
Garrett’s family needs $500,000 for the next 20 years. A level term policy costs $420 a year. A $500,000 straight life policy issued at the same age costs $5,400 a year, and its cash value at year 20 is 26.5% of face, or $132,500, matching the table above. Choosing term and investing the $4,980 difference at the start of each year grows to $123,421 at 2%, $137,829 at 3% and $154,227 at 4%. At 3% the two are close, and above that the term-and-invest plan is ahead. The comparison hides two things. After year 20 the term buyer has no coverage, while the whole life owner still holds $500,000 of coverage at age 55 and the cash value. And the term buyer has to invest the difference every year. The better choice depends on whether the need ends in 20 years and whether the client will really save.
Renewal and Conversion: A Convert-or-Renew Case
Priya Nair bought a 10-year level term policy at 40 for $250,000. She paid $1.20 per $1,000, or $300 a year. At 49 she was diagnosed with a heart condition and now could not qualify for new coverage on standard terms. The term expires at 50. Her policy is renewable and convertible without evidence of insurability. The renewal premium is priced on her attained age and rises every year, so the first renewal premium of $1,150 is about 3.8 times the $300 she has been paying. She has three choices: renew all of it, convert all of it to whole life at her attained age, or convert part and renew the rest. The example rates are as follows.
| Attained age | Renewal term, per $1,000 | Annual premium for $250,000 |
|---|---|---|
| 50 | $4.60 | $1,150 |
| 51 | $5.10 | $1,275 |
| 52 | $5.70 | $1,425 |
| 53 | $6.40 | $1,600 |
| 54 | $7.20 | $1,800 |
| 55 | $8.00 | $2,000 |
| 56 | $8.90 | $2,225 |
| 57 | $9.90 | $2,475 |
| 58 | $11.00 | $2,750 |
| 59 | $12.20 | $3,050 |
Whole life conversion at 50 is priced at $24.00 per $1,000, or $6,000 a year, level for life. Over the ten years from age 50 to 59 the comparison runs:
| Renew each year | Convert all | Convert $100,000 and renew $150,000 | |
|---|---|---|---|
| First-year premium | $1,150 | $6,000 | $3,090 |
| Premiums over 10 years | $19,750 | $60,000 | $35,850 |
| Cash value at year 10 (example) | $0 | $41,500 | $16,600 |
| Premiums less cash value | $19,750 | $18,500 | $19,250 |
The split policy’s first-year premium is $2,400 (100 times $24.00) plus $690 (150 times $4.60), or $3,090. Its ten-year premiums are $24,000 for the converted part plus $11,850 for the renewed part (150 times the ten renewal rates, which sum to $79.00). The cash value of $41,500 at the end of year 10 is an invented figure for illustration, and the split policy is assumed to hold 100/250 of it, or $16,600.
The figures show a pattern that matters. Renewal is far cheaper at the start, and the cost converges when cash value is counted. After ten years the net cost of conversion is $1,250 below renewal, and conversion alone leaves a policy that keeps going without further increases. The comparison ignores what the unspent money could earn, so it is rough. What it settles is not which option is cheaper but what Priya needs. If the need is a debt that ends in five years, renewing a smaller amount is sensible. If she wants a death benefit for a spouse for life, or to leave money for final expenses, the rising renewal premiums will eventually become unaffordable, and the right to convert will be gone when the policy’s conversion deadline passes. A partial conversion preserves part of the permanent coverage at an affordable cost.
Conversion is also different from replacement. The owner stays with the same insurer, there is no new medical evidence, and the policy is usually issued as of the conversion date at the attained age. Some policies allow conversion at the original age within a limited window, with the owner paying the difference in cost. The policy states which applies.
Whole Life Forms: Interest-Sensitive and Equity-Index
Interest-Sensitive Whole Life
Traditional whole life sets its premium and its guaranteed cash values from assumptions about mortality, interest and expense, and a participating policy then pays dividends. Interest-sensitive whole life ties the policy’s results to current conditions. The insurer credits interest to the cash value at a current rate that it sets, subject to a guaranteed minimum. Some forms hold the premium level and let the cash value vary. Others let the insurer change the premium, within a stated maximum, as interest and mortality experience change. In both, the guaranteed values are the floor. The values in an illustration are not guaranteed above that floor, and a client who is shown only current values has been shown a best case.
Equity-Index Whole Life
Equity-index whole life credits its cash value with a return linked to a market index, such as a stock index, but the owner is not invested in the index. The policy uses a formula. A participation rate applies a percentage of the index’s change, and a cap limits the credit in any year. A floor, commonly zero, protects the cash value from a loss. Michigan still requires every life policy to contain nonforfeiture benefits and cash surrender values (MCL 500.4024), so the policy continues to carry guaranteed values.
Consider a policy with an 80% participation rate, an 8% cap and a 0% floor, with $20,000 of cash value at the start of the year.
| Index change | 80% of the change | Credit after the 8% cap and 0% floor | Added to $20,000 |
|---|---|---|---|
| +12% | 9.6% | 8% | $1,600 |
| +5% | 4.0% | 4% | $800 |
| -10% | -8.0% | 0% | $0 |
| +30% | 24.0% | 8% | $1,600 |
The cap holds the credit to 8% even when the index rises 30%, and the floor means a 10% drop costs the owner no cash value. Over three years of +12%, -10% and +5%, the cash value goes from $20,000 to $21,600 to $21,600 to $22,464 ($20,000 × 1.08 × 1.00 × 1.04). A fixed 3% credit would have produced $21,854.54. The three-year index return, compounded without a cap, is 5.84% ($1.12 × 0.90 × 1.05 = $1.0584), while the credited cash value rose 12.32%. The floor kept the year-2 loss out, and the cap and participation rate trimmed the gains. The same terms cost the owner in a rising market. Three years of +30%, +25% and +20% compound to a 95% gain in the index ($1.30 × 1.25 × 1.20 = $1.95), yet the cash value rises at the 8% cap each year to $25,194.24 ($20,000 × 1.08³), or 25.97%. A producer should explain that the owner receives a credit by formula and does not own shares or index units, and that an illustration of equity-index values is a projection.
A Policy Loan Outstanding at Death
A policy loan is secured by the cash value, and the policy remains in force while it is outstanding. Michigan’s loan provision applies after three full years’ premiums have been paid. The insurer must lend, on proper assignment of the policy and on its sole security, up to the loan value, and the owner may borrow less (MCL 500.4022). For a policy issued under the standard nonforfeiture law, the loan value is the cash surrender value at the end of the current policy year. The insurer may defer a loan for six months after the application, except a loan to pay premiums (MCL 500.4062(2)).
For policies issued after the rate statute took effect, Michigan lets a policy provide either a maximum fixed loan rate of not more than 8% a year, or an adjustable maximum of not more than 18% that is set at least once every 12 months and not more than once every 3 months, with notice to the owner at the initial rate and 30 days before any change (MCL 500.4023(2), (4), (5)). Unpaid interest is added to the loan and itself bears interest (MCL 500.4064).
The Death Claim
Rafael Ortega owns a $250,000 whole life policy. At policy year 15 the cash value is $38,000, and he borrows $20,000 at the policy’s fixed loan rate of 6%. He pays no interest. The insured dies four years later.
- Unpaid interest compounds annually, so the debt after four years is $20,000 × 1.06⁴, or $25,249.54.
- The insurer pays the death benefit less the loan: $250,000 minus $25,249.54.
- The beneficiary receives $224,750.46.
The loan reduced the payment by $25,249.54, which is the $20,000 borrowed plus $5,249.54 of interest. If Rafael had paid the interest each year, the debt would have stayed at $20,000 and the claim would have been $230,000.
When the Loan Grows Past the Cash Value
Left unpaid, the loan can eat the policy. Suppose the cash value stays at $38,000 (a simplification, because it normally grows) and the loan rate is 8%. The loan reaches $37,018.60 after 8 years and $39,980.09 after 9, so it overtakes the cash value during year 9. The policy does not end automatically. Michigan requires that a policy may not terminate for failure to repay a loan or pay its interest until the total debt equals or exceeds the loan value and 1 month after notice has been mailed to the insured and any assignee (MCL 500.4022, 500.4046(1)). A policy with an automatic premium loan provision behaves the same way, because each unpaid premium becomes a loan that grows the debt. If a $1,900 annual premium is left unpaid on three anniversaries and each is loaned at 6%, the debt right after the third loan is $1,900 × (1.06² + 1.06 + 1), or $6,048.84, and every later year adds interest to it.
If the policy then ends with the loan outstanding, the loan is treated as paid from the cash value, and any gain above the premiums paid can become taxable income. The producer’s job is to warn the owner before that point, not to discover it after.
Endowment Maturity and Uses
An endowment pays the face amount if the insured dies during the endowment period and pays the same amount to the owner if the insured is alive at the end. Take a 20-year endowment, $50,000, bought by Lena Fischer at 45 to give her a guaranteed lump sum at 65. The premium is $2,150 a year, and her total premiums over 20 years are $43,000.
| Result | |
|---|---|
| Total premiums | $43,000 |
| Paid at maturity | $50,000 |
| Amount above premiums | $7,000 |
| Paid on death in the period | $50,000 |
Because the endowment includes both protection and savings, the sound comparison is with term insurance plus a separate savings plan. Suppose a $50,000 20-year term policy costs $310 a year. That leaves $1,840 a year to save, or $36,800 in total. Saved at the start of each year, $1,840 grows to $45,601 at 2%, $50,925 at 3% and $56,983 at 4%. The endowment’s guaranteed return on the savings part is about 2.84% a year, because $1,840 paid at the start of each of 20 years reaches $50,000 at that rate. If she can earn more elsewhere, the endowment loses. If she values the guarantee, or would not save without it, the endowment wins. It also leaves her no flexibility, because a 20-year payment obligation is fixed.
Some uses fit. A guaranteed lump sum at a fixed date suits a person who needs cash at a particular time, such as a debt due at retirement. Parents have used the form to fund a child’s education on a schedule. The same fit explains why it is uncommon now: most buyers want flexibility, and the same cash can be invested in other ways.
Tax Treatment
At maturity, the owner is paid an amount that is not received as an annuity. The amount allocable to income is the cash value in excess of the investment in the contract, which is generally premiums paid, and only that part is included in gross income (IRC 72(e)(2), (3)). For Lena, that is the $7,000 above the $43,000 she paid.
An endowment contract must also meet the federal definition of life insurance, either the cash value accumulation test or the guideline premium and cash value corridor tests (IRC 7702(a), (h)). For testing, the maturity date is deemed to be no earlier than age 95 and no later than age 100, and an endowment benefit is deemed not to exceed the least amount payable as a death benefit at any time (IRC 7702(e)(1)(B), (D)). An endowment that pays its full face at 65 must still meet those tests, and that limits how a short endowment can be built. A contract that fails the definition is taxed on the income earned each year as ordinary income (IRC 7702(g)(1)(A)). A contract that passes can still be a modified endowment contract under a separate seven-pay test, which changes how loans and withdrawals are taxed.
A Michigan Limit on Endowment Series
The prohibition is aimed at a policy containing a “series of pure endowments,” meaning predetermined benefits maturing at specified dates if the insured is living, any one of which is less than the gross annual policy premium (MCL 500.4047(4), (5)). A policy with a $1,200 annual premium that pays $400 on each of five anniversaries has five benefits, each below the premium, and cannot be issued or delivered in Michigan. A presentation, written or oral, may not represent a policy as one of these types, and doing so also violates MCL 500.2064 (MCL 500.4047(6)).
Lesson summary
- The amount at risk is the death benefit less the cash value. It stays at the face amount in term and falls over time in whole life, and the cash value is not paid on top of the face amount.
- Return of premium term returns the premiums if the insured outlives the term. In the example the extra premium earns about 4.2% if held to the end, and a lapse before then can mean a net loss.
- Decreasing term follows a policy schedule, not the loan balance, so a mortgage can exceed the face amount for years. Compare the schedule with the amortization.
- A convert-or-renew decision turns on the length of the need, the budget and insurability. Renewal costs less at first, conversion fixes the premium for life, and a conversion deadline can end the choice.
- Interest-sensitive whole life credits current interest above guaranteed minimums. Equity-index whole life credits a formula result, limited by a participation rate, a cap and a floor.
- An unpaid policy loan compounds and is subtracted from the death benefit. In Michigan a policy cannot end for an unpaid loan until the debt reaches the loan value and 1 month after notice is mailed.
- An endowment pays its face amount at death or maturity. Compare it with term plus savings, and note the tax on the gain at maturity, the federal life insurance definition and Michigan’s ban on a series of pure endowments.