Comprehensive Guide to Whole Life Insurance
14th September 2022
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Life is unpredictable, but a good insurance plan can provide protection for you and your family. This article will explain the ins and outs of whole life insurance, covering everything from premiums, death benefits, beneficiaries, cash value, and dividends.
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What is whole life insurance?
Whole life insurance provides the insured person with lifetime coverage (or coverage until you are 100 years old), as well as a long-term savings component. Premiums for whole life policies are level, so they don’t change over time.
In exchange for you paying your premiums on time, whole life insurance offers:
- A guaranteed death benefit, usually paid out in a lump sum to designated beneficiaries when you pass away
- A guaranteed cash value, which grows over time and allows you to make withdrawals or take out loans from your policy
- Non-guaranteed dividends, which are paid out depending on your insurance provider’s investment strategy and performance (only for participating policies)
How does whole life insurance work?
After taking out a whole life insurance policy, the policyholder pays their premiums. Premiums are usually paid in annual installments, but you can also pay at semi-annual, quarterly or monthly intervals. These premiums are paid either over a set premium term (for example, 5, 10, 20, or 25 years) or for the rest of the insured person’s life.
In most cases, the policyholder is the insured person under the policy, but the policyholder can also take out a life insurance policy for a spouse, child or parent. In Hong Kong, it is not possible to buy a life insurance policy for a sibling or friend.
For each policy, the policyholder designates a beneficiary or multiple beneficiaries. If the insured person dies, then their beneficiaries will be paid the death benefit.
Aside from the death benefit, another advantage of whole life insurance is the cash value it can accumulate over time. At any point, the policyholder or insured person can access the cash value, either by making withdrawals, taking out loans, or surrendering the policy altogether.
What is the death benefit?
The death benefit is the core protection component of a whole life insurance policy. It is paid as a lump sum to the beneficiary, usually by cheque, when the insured person passes away. Like all insurance benefits in Hong Kong, the death benefit is tax-free, so the beneficiary will not have to pay any tax if they receive it.
The death benefit is calculated as follows:
Death Benefit = (Sum Insured + Guaranteed Cash Value + Non-guaranteed Dividends and Bonuses) - Loans
The sum insured (sometimes called the sum assured or face amount) is the amount the policy promises to pay upon the death of the insured person. It is specified on the first page of a life insurance policy. Guaranteed cash value, non-guaranteed dividends, and loans are explained below.
Using the death benefit
Beneficiaries are free to use the funds as they choose. In many cases, the death benefit is used to pay for after-death arrangements such as funerals, memorial services, cremations and burials. Depending on the size, scale and style of such rituals, expenses can range from HK$10,000 to over HK$1,000,000.
Some beneficiaries also use the death benefit to pay for living expenses, especially if the deceased was the sole provider for their family. In this case, the death benefit can help cover expenses like rent, food, clothing, entertainment, childcare, education and medical care.
Claiming the death benefit
Only a named beneficiary can claim the benefit. To claim the death benefit, the beneficiary must present certain documents, such as the original death certificate of the insured person, the original life insurance policy document, the completed claim form, identification documents, and proof of relationship with the deceased (such as a marriage certificate or birth certificate).
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What is a beneficiary?
A beneficiary is a person who receives the death benefit when the insured person dies.
Typically, the policyholder will designate their spouse, children, or parents as their beneficiaries. A sibling or friend cannot be named the beneficiary of a policy. The beneficiary can also be a trust, charity, or organization. If the beneficiary is a minor, it’s a good idea to make arrangements for a guardian or trustee to manage funds received from insurance payouts until the child is old enough to receive them directly.
Classes of beneficiaries
In general, each policy allows you to designate three classes of beneficiaries: primary, secondary, and tertiary.
- Primary beneficiary: Receives the death benefit if the insured person passes away.
- Secondary beneficiary: Receives the death benefit if the insured person dies and the primary beneficiary/ies have passed away.
- Tertiary beneficiary: Receives the death benefit the insured person dies and the primary and secondary beneficiary/ies have passed away.
Distributing the death benefit to your beneficiaries
When you set up your policy, you can designate what share of the death benefit each beneficiary will receive among each beneficiary class (namely, primary and secondary; few insurers allow this for tertiary beneficiaries).
How you allocate the death benefit is up to you, but the distribution must add up to 100% of the benefit for each class.
- Primary beneficiaries: Spouse (50%) + Child #1 (25%) + Child #2 (25%)
If the insured person dies, then their spouse will receive half of the death benefit, and their children will each receive a quarter.
- Primary beneficiary: Spouse (100%)
- Secondary beneficiaries: Child #1 (50%) + Child #2 (50%)
If the spouse passes away before the insured person dies, then when the insured person passes away, each of their children will receive half of the death benefit. If the spouse is still living when the insured person dies, then the spouse will receive the entire death benefit, and the children will receive nothing.
- Primary beneficiary: Spouse (100%)
- Secondary beneficiary: Child #1 (100%)
- Tertiary beneficiary: Child #2 (100%)
If the spouse and first child both pass away before the insured person does, then when the insured person dies, the second child will receive all of the death benefit.
You can change the beneficiaries of your whole life insurance policy at any time. Just contact your insurance broker or provider, and they will provide you with a form to fill out with the details about the new beneficiaries. If the beneficiary is below 18, no consent is required to designate them as your beneficiary. If the beneficiary is 18 or above, you will need their signature to confirm the change.
What is cash value?
Cash value is a key feature for whole life policies, offering a financial planning component in addition to the death benefit. When you pay your premiums, a portion goes towards your death benefit, while another portion goes to building your policy’s cash value. The cash value is the amount you receive from the insurance provider upon policy surrender.
Cash value is the savings that accumulate in your policy starting from the policy issue date. It is made up of guaranteed cash value and non-guaranteed dividends and bonuses. These funds can be surrendered, withdrawn or taken out as a loan against the guaranteed cash value in the policy.
Guaranteed cash value
Guaranteed cash value is the minimum amount you receive from the insurance company upon policy surrender. Your cash value is guaranteed to earn interest as long as the policy is active. This interest rate is fixed; in Hong Kong, the average rate of interest is 3.5-4.5%.
If you have a participating policy (also known as a with-profits policy), then you will be able to participate in the insurance company’s profit sharing. This means you can receive dividends or bonuses from the insurer. Note that these dividends are not guaranteed and depend on a number of factors.
To generate dividends, the insurance company pools together the premiums from all policyholders and invests them in government bonds. The dividend amount depends on the insurance company’s profits, investment performance, and premiums received from all policyholders. At the end of the year, the insurance company does an accounting of death claims paid, earnings, operating expenses, and premiums collected. If their performance was better than their worst-case projection (their pessimistic scenario), then they will pay dividends to policyholders. Your share of the profits earned will then be added to the cash value savings of your policy.
Note that the dividends you receive may be higher or lower than those shown in the benefits illustration, which is a projection.
In a non-participating policy, no profits are shared, and no dividends are paid to policyholders.
How do I access the cash value?
Either the policyholder or the insured person (if 18 or above) can access the cash value of the policy by withdrawing funds, taking out a loan or surrendering it.
All you would need to do is fill out a form, which you can get from your insurance broker or provider. Forms are required as originals with wet signatures. If the insured person is trying to access the funds, then the signatures of both the policyholder and the insured are required.
It’s a good idea to talk to an insurance advisor before you access the cash value of your policy so you can understand all the facts and make an informed decision.
Withdrawing from cash value savings
Why you might do it: You might wish to withdraw from your cash value savings to pay for your premiums or for personal use.
What happens when you do it: If you withdraw from your cash value savings, your policy will stay active. Once withdrawn, cash value can be accumulated on the remaining value. After some time, you will be able to withdraw funds from the policy again.
Taking out a loan
Why you might do it: If you miss a premium payment, some insurance policies have a provision for an automatic premium loan (APL) to be taken out against your policy to pay for your premium. This way, you don’t lose coverage if you don’t have sufficient personal funds to pay for the premium.
What happens when you do it: The insurance company uses your policy’s guaranteed cash value as collateral for your loan. For the automatic premium loan to be taken out, there needs to be enough guaranteed cash value in your policy to cover the outstanding premium.
You can also take out a loan for any other purpose. Your insurance provider will have set a percentage limit of the cash value that you are allowed to borrow. If you take out a loan against your policy, the loan compound interest rate will be as high as 8%. You will need to pay back the loan with interest to get your policy on track. Not paying back your loan will reduce the death benefit paid out to beneficiaries if you pass away before the loan is paid off.
If the unpaid loan total with interest exceeds your policy’s cash value, then your policy will lapse. You can get it reinstated by undergoing a new medical declaration or health examinations according to the sum insured by the policy.
Surrendering your policy
Why you might do it: You might surrender your policy if you want to use the available surrender value for personal use.
What happens if you do it: If you surrender your policy, your policy will end. You will no longer be protected by life insurance. You will lose the death benefit and receive a payment of the cash value (guaranteed surrender value plus dividends or bonuses) minus any outstanding premiums and loan amounts (with interest).
Note that you will likely suffer a loss if you surrender your policy too early. Once you have surrendered your policy, you will not be able to get it reinstated.
It’s a good idea to wait until the annual dividends have been paid out before you surrender your policy so you can get a bit of extra cash.
Whole life insurance: Pros and cons
- Guaranteed death benefit
- Guaranteed cash value
- Non-guaranteed dividends
- Level premiums
- Whole life protection
- Access to funds: You can withdraw money from your plan or take out a loan against your policy at any time
- Your sum insured remains the same throughout your life. Increasing the sum insured would subject you to a new medical underwriting.
- It takes time for a life insurance policy to build up cash value.
- Whole life premiums are much more expensive than for term life (due to whole life insurance’s ability to accumulate cash value).
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Do I need whole life insurance?
Whether you need whole life insurance depends on your protection needs. If you are looking for a plan with lifelong coverage, a death benefit, and a savings component, then you might want to consider whole life. Speaking with an insurance provider will help you get clarity on the most suitable life insurance plans for you.
I have term life insurance. Can I convert it to whole life insurance?
Yes, you can convert your term life insurance policy into whole life. Converting your policy is subject to a new medical underwriting, and your premiums will change (how much depends on your age).
How much coverage do I need?
The amount of coverage you need depends on your family’s needs. Generally, this might be 10-15 times your annual income, or the amount that would be enough to financially support your family when you are gone until your children can provide for themselves.
The Insurance Authority’s calculator provides this basic formula:
Coverage Required = Protection Needs - Financial Resources
To estimate the amount of cover you need, you’ll want to factor in your family’s living expenses, education costs and medical fees against your savings. In general, the younger you are, and the more vulnerable your dependents are, the higher your protection needs will be.
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This article was independently written by Alea and is not sponsored. It is informative only and not intended to be a substitute for professional advice and should never be relied upon for specific advice.