Ordinary life insurance (also called continuous premium whole life) is a type of whole life insurance for which premiums are based on the assumption that they will be paid until the insured�s death. It is desirable to define ordinary life insurance this way since, in an increasing number of cases, life insurance is purchased with no intention on the policyowner�s part to pay premiums as long as the insured lives. In many cases the insurance is purchased as part of a program that contemplates the use of dividends to pay up the insurance by the end of a period shorter than the life expectancy of the insured. In other cases the plan may be to eventually surrender insurance for an annuity or for a reduced amount of insurance. The point is that ordinary life should not be envisioned as a type of insurance on which the policyowner is irrevocably committed to pay premiums as long as the insured lives or even into the insured�s extreme old age. Rather, it should be viewed as a type of policy that provides permanent protection for the lowest total premium outlay and some degree of flexibility to meet changing needs and circumstances for both long-lived persons and those with average-duration lifetimes. It is the most basic lifelong policy offered by any life insurance company, and it enjoys the widest sale. Ordinary life insurance

is an appropriate foundation for any insurance program, and in an adequate amount it could well serve as the entire program. Its distinctive features are discussed below.

The protection afforded by the ordinary life contract is permanent�the term never expires, and the policy never has to be renewed or converted. If insureds continue to pay premiums or pay up their policy, they have protection for as long as they live, regardless of their health; eventually, the face amount of the policy will be paid. This is a valuable right because virtually all people need some insurance as long as they live, if for nothing more than to pay last-illness and funeral expenses. In most cases the need is much greater than that.

In one sense ordinary life can be regarded as an endowment. As discussed in chapter 5 an endowment insurance contract pays the face amount of the policy, whether the insured dies prior to the endowment maturity date or survives to the end of the period. If age 100 is considered to be the end of the endowment period�as well as the end of the mortality table�then an ordinary life policy is equivalent to an endowment contract that pays the face amount as a death claim if the insured dies before age 100 or as a matured endowment if he or she survives to age 100.

During the years when the American Experience Table of Mortality (which has a terminal age of 96) was being used for new insurance, many insurers labeled their ordinary life contract as an "endowment at 96." For that matter, many companies today offer an "endowment at 95" in lieu of an ordinary life contract. Ironically, many prospects will buy an "endowment at 95" when they will not buy an ordinary life policy. Of course, the ordinary life policy could just as aptly be described as a "level premium term to 100" if it were to be assumed that all individuals who survive to age 99 die before their 100th birthday.

Inasmuch as the premium rate for an ordinary life contract is calculated on the assumption that premiums will be payable throughout the whole of life, the lowest rate is produced. As will be noted later, the net single premium for a whole life policy is computed without reference to the manner in which the periodic premiums will be paid and, at any particular age, is the same for ordinary life insurance and any form of limited-payment life insurance. Naturally, the longer the period over which the single-sum payment is spread, the lower each periodic payment will be.

Thus the net annual level premium per $1,000 of ordinary life insurance, issued at age 25 and calculated on the basis of the 1980 CSO Male Table and 4.5 percent interest is only $7.49, while the comparable net annual level premium for a 20-payment life policy is $11.07. The gross annual premiums per $1,000 charged by two life insurance companies for the same two contracts at ages 25 and 35 are shown in table 4-1.

Limited-payment insurance contracts provide benefits that justify the higher premium rates. If, however, the insured�s objective is to secure the maximum amount of permanent insurance protection per dollar of premium outlay, then his or her purposes will be best served by the ordinary life contract. Its moderate cost brings the policy within reach of all people except those in the older age brackets.

As level premium permanent insurance, ordinary life accumulates a reserve that gradually reaches a substantial level and eventually equals the face amount of the policy. As is to be expected, however, the reserve at all durations is lower than that of the other forms of permanent insurance. In other words, the protection element tends to be relatively high. Nevertheless, it is the opinion of many that the ordinary life contract offers the optimal combination of protection and savings. The contract emphasizes protection, but it also accumulates a cash value that can be used to accomplish a variety of purposes.

The cash values that accumulate under an ordinary life contract can be utilized as surrender values, paid-up insurance, or extended term insurance (whose significance will be explained in the next section of this chapter). Cash values are not generally available during the first year or two of the insurance because of the cost to the company of putting the business on the books. Common exceptions are single-premium policies and some durations of limited-payment whole life policies whose first-year premiums are large enough to exceed all first-year expenses incurred to create the policy and maintain policy reserves. (The interdependence of expenses and cash values is described in chapter 19.)

Policy Loans. All level premium life insurance policies that develop cash values (for example, whole life, universal life, adjustable life, variable life, variable universal life, and current assumption whole life) have provisions for policy loans. These policy loans give the policyowner access to the cash value that accumulates inside the policy without having to terminate the policy.

The policyowner merely requests a loan and the life insurer will lend the funds confidentially. The loan provisions in the policy specify what portion of the cash value is available for loans and how interest will be determined on the loan. In most policies over 90 percent of the cash value is available for loans�some policies may restrict the amount of loanable funds to 92 percent of the cash value in recognition of an 8 percent policy loan interest rate�and any portion of the cash value can be borrowed. Policyowners indicate in their requests the amount desired, and they can take out more than one policy loan as long as the aggregate amount of all outstanding loans and accrued interest applicable to those loans does not exceed the policy cash value.

Policy loans do involve interest charged on the borrowed funds. There are two different approaches to setting the policy loan interest rate. The policy will stipulate either (1) a fixed rate as specified in the policy (commonly 8 percent) or (2) a variable interest rate tied by formula to some specified index. One variable approach is to use Moody�s composite yield on seasoned corporate bonds or some index that is regularly published in the financial press, such as The Wall Street Journal or The Journal of Commerce. Another index may be the interest rate being credited to the cash value plus a specified spread.

State laws impose changing upper limits on variable policy loan interest rates. These laws require that the rate be lowered whenever the upper limit drops to more than half of 1 percent below the rate being charged. The rate charged can be changed up to four times each year.

The policyowner has the option of paying the policy loan interest in cash or having the unpaid interest charge added to the balance of the outstanding loan(s) so that additional interest charges will be applied to the unpaid interest amount. The policyowner may choose to pay any part of the interest charge he or she desires since there is no repayment schedule or requirement.

The policyowner is not required to pay the interest or repay the policy loan in cash. If any repayments are made, they are totally at the discretion of the policyowner as to both timing and amount.

If the policy loan and accrued interest are not paid in cash, the life insurer can recover the outstanding balance of the loans and accrued interest in the following ways: (1) from the death benefits if the insured dies or (2) from the cash surrender value if the policy is terminated. In fact, the policy will automatically terminate if the policy loan balance plus unpaid interest ever exceeds the policy cash value.

Some whole life policies give policyowners an automatic premium loan option. When this option is selected, a delinquent premium will be paid automatically by a new policy loan. This will keep the policy in force as long as there is adequate cash value to cover each delinquent premium. However, the policy will terminate if the cash value is exhausted.

The automatic premium loan provision does not apply to flexible premium policies because the insurer usually deducts mortality charges and other expenses directly from the cash value. Hence no interest charges are incurred for skipped premium payments.

The creation of a policy loan does have negative consequences on benefits and may reduce the amount credited to the cash value and/or the level of policyowner dividends. The death benefit payable to the beneficiary is reduced by the full amount of outstanding policy loans and accrued interest under most types of policies. Therefore an irrevocable beneficiary�s consent may be required to obtain a policy loan. A policy loan is really an advance against the death benefit; thus the death benefit is adjusted to reflect the prior disbursement.

Policy loans result in the life insurer�s release of funds it would otherwise invest to earn investment income. If the rate of investment return on the insurer�s portfolio is greater than the rate being applied to the policy loan, the insurer experiences a reduction in earnings. Therefore the insurance company usually takes steps to offset such loan-induced losses in order to preserve a rough equity between policyowners who leave their cash values invested and those who preclude the insurer from reaping the higher yield. In traditional participating whole life policies, policyowner dividends were not affected by policy loans, but most participating whole life policies being sold today use what is called "direct recognition" to reduce dividends on policies with outstanding loans. This not only adjusts for the differential in earnings but also discourages policy loans. For universal life policies and other non-participating designs, there are no dividends to adjust; insurers compensate for lost earnings by reducing the earnings rate being credited directly to the cash value. If there are no policy loans, the insurer credits its normal crediting rate to the full cash value. However, if there are policy loans, the insurer typically credits the normal rate to the unloaned portion of the cash value and a lower rate (often 2 percent or 200 basis points lower) to the portion of the cash value equal to the loan indebtedness. Once the loan is repaid, the insurer resumes crediting the higher rate to the full cash value. There is no retroactive payment to eliminate the past differential.

Outstanding policy loans reduce both death benefits and nonforfeiture benefits. The net cash value available to provide either extended term insurance or reduced paid-up insurance is lessened by the loan indebtedness. In the case of extended term insurance, the amount of term insurance is reduced from the original amount of coverage by the amount of loan indebtedness as well.

State statutes allow life insurers to delay lending funds for up to 6 months after requested. This is a form of emergency protection in case policyowners� demand for loans accelerates to the point that the insurer is forced to liquidate other assets at significant losses to satisfy the loan demands. In actuality, delaying access to funds is an indication of financial weakness or lack of policyowner confidence that insurers wish to avoid. Those life insurers that have failed in recent years chose not to invoke their right to delay policy loan disbursements. Quick access to cash values was terminated only after the insurance commissioner seized control of the company.

Nonforfeiture or Surrender Options. Ordinary life, in common with other forms of whole life insurance, provides a limited degree of flexibility. This flexibility is derived from several different contract provisions, but one of the most significant is the set of provisions referred to as nonforfeiture or surrender options. Designed originally to preserve the policyowner�s equity in the policy reserve, surrender provisions are increasingly being used to adapt policy coverage to changing circumstances and needs. Most policies stipulate that the surrender value may be taken in one of three forms: cash, a reduced amount of paid-up whole life insurance, or paid-up term insurance.

Cash Value. The policy may be surrendered at any time for its cash value in that event the protection terminates and the company has no further obligation under the policy. While this privilege provides a ready source of cash to meet a financial emergency or to take advantage of a business opportunity, it should be exercised with restraint since it diminishes the further usefulness of the policy. A policy that has been surrendered for cash cannot be reinstated except by special permission of the company, which is usually withheld unless the insured can provide evidence of insurability that would satisfy the criteria for issuing a new policy to a first-time applicant.

Reduced Amount of Paid-Up Whole Life. The second option permits the insured to take a reduced amount of paid-up whole life insurance, payable upon the same conditions as the original policy. The amount of the paid-up insurance is the amount that can be purchased at the insured�s attained age by the net cash value (cash value, less any policy indebtedness [policyowner loans plus accrued interest], plus any dividend accumulations) applied as a net single premium. Note that the paid-up insurance is purchased at net rates, which constitutes a sizable saving to the purchaser. According to the 1980 CSO Table and a 4.5 percent interest assumption, the cash value at the end of 20 years on an ordinary life contract issued at age 30 is $220, which is sufficient, as a net single premium, to purchase $615 of paid-up whole life insurance. The protection continues in the reduced amount until the insured�s death unless the reduced policy is surrendered for cash, and no further premiums are called for under this plan.

Paid-Up Term. The third option provides paid-up term insurance in an amount equal to the original face amount of the policy, increased by any dividend additions or deposits and decreased by any policy indebtedness. The length of the term is that which can be purchased at the insured�s attained age with the net cash value applied as a net single premium. At age 50 the aforementioned cash value of $220 would purchase $1,000 of term insurance for about 16.5 years. If the insured fails to elect an option within a specified period after default of premiums, this option automatically goes into effect.

If the financial status of the policyowner makes it impracticable to continue premium payments, or if the need for insurance protection undergoes a change, the policyowner may wish to elect one of the surrender options. After his or her dependents have become self-supporting, for example, the policyowner may elect to discontinue premium payments and continue the protection on a reduced scale for the remainder of the insured�s life. If, on the other hand, the need for insurance continues, he or she may elect to eliminate premium payments but continue the full amount of protection for a definite period of time. The elimination of fixed payments may be particularly attractive as the insured approaches retirement and anticipates a reduction in income.

Annuity or Retirement Income. Another use of surrender values that is growing in popularity is applying them to the purchase of an annuity or retirement income. If the life insurance policy does not specifically give the insured the right to take the cash value in the form of a life income (purchased at net rates), the insurer will grant the privilege upon request. More and more insureds are purchasing ordinary life insurance to protect their families during the child-raising period with the specific objective of eventually using the cash values for their own retirement. The cash value of an ordinary life policy purchased at age 25 will usually be in the range of 50 percent to 60 percent of the face amount at age 65. The comparable percentage range for an ordinary life policy purchased at age 35 is 40 percent to 55 percent, and even a policy issued as late as age 40 will accumulate a cash value at age 65 only slightly less than one-half of the face amount (35 percent to 50 percent). Therefore if an individual procures $50,000 of ordinary life insurance at age 35, for example, he or she would have approximately $24,000 in cash value at 65, which at net rates would provide a life income somewhere in the range of $140 to $165 per month. Supplemented by federal OASDI (Old-Age, Survivors, and Disability Insurance) benefits, private retirement plan benefits, and income from other savings, this could provide the insured with an adequate retirement income.

Some people might feel that the interruption of premium payments on an ordinary life policy would in some way amount to failure to complete the program. There are, of course, situations where this might be the case. However, if the ordinary life plan is deliberately selected with the idea of discontinuing premiums at an advanced age, there can be no suggestion of failure to complete the undertaking. Neither should an insured be reluctant to convert ordinary life insurance to reduced paid-up insurance if a change of circumstance makes the reduced amount adequate for his or her needs, particularly if retirement status makes paying life insurance premiums an unjustified burden. Life insurance is designed to provide protection where the need exists. If it becomes a burden and represents a very real sacrifice on the part of the insured, the burden can be lightened when the need for protection ceases. This is an advantage of the ordinary life contract that should be recognized at the outset and utilized as the occasion arises.

Conversion. A final source of flexibility is the right to convert to other forms of insurance. It is customary to include a provision in all whole life policies giving the insured the right to exchange the policy for another type of contract, sometimes subject to certain conditions. Whether this privilege is specifically granted or not, an exchange can usually be negotiated. Virtually all companies will permit any form of permanent insurance to be converted to another form without evidence of insurability, as long as the new contract calls for a larger premium.

Most companies, however, will not permit a higher-premium contract to be exchanged for a lower-premium contract without evidence of insurability. Such an exchange not only reduces future premiums but also requires the company to return a portion of the reserve to the insured, thereby increasing the actual amount at risk. Moreover, insurers always suspect an impairment of health under such circumstances. If the insured is converting to a higher-premium form, however, the net amount at risk will be reduced more rapidly, and the company does not have to fear adverse selection.

The ordinary life contract has a unique advantage in this regard because it is the lowest-premium form of fixed-premium permanent insurance and hence can be converted to any other form of permanent insurance without evidence of insurability. Therefore the insured, whose savings objective may entail substantial amounts of limited-payment insurance but whose current financial situation limits the funds available for insurance, might well inaugurate his or her insurance program with ordinary life, with the idea of converting it later to higher-premium forms. If feasible, ordinary life is preferable to term insurance under such circumstances since, if the more ambitious program is never realized, the insured will still have permanent protection and a modest cash surrender value. Moreover, if conversion is ultimately effected, the financial adjustment involved�whether it be the lump-sum payment of the difference in reserves or merely a shift to the higher-premium basis�will not be so drastic.

Whole life policies can be issued on a nonparticipating basis with fixed and guaranteed premiums. This version of whole life does not pay any policyowner dividends. The insurance company retains all gains from favorable experience. Historically, nonparticipating policies were associated with stock life insurance companies (owned by stock holders).

Whole life policies issued on a participating basis anticipate charging a small extra margin in the fixed premium with the intent to return part of the premium in the form of policyowner dividends. This approach allows the insurer to maintain a stronger contingency margin and still adjust the cost downward after periods of coverage have been evaluated. Policyowner dividends are based on favorable experience such as higher than expected investment returns or lower than expected expenses for operations and/or mortality.

Although participating policies were originally offered by mutual life insurers (owned by policyowners), the appeal of policyowner dividends prompted stock life insurance companies to offer participating policies. Most stock life insurance companies offer a choice of both participating and nonparticipating policies. Almost all policies sold by mutual companies are participating policies.

Policyowner dividends are generally declared annually based on the insurance company experience. Investment results usually account for the largest portion of dividends. The amount of dividends cannot be guaranteed and it is illegal for an agent to present projections of future dividends as if they were guaranteed or certain. If insurance company experience turns unfavorable, policyowner dividends may decline or even cease altogether. Dividend reductions have been common during the 1990s.

The policyowner chooses the dividend option to which actual dividends are applied. In addition to direct payment, dividends can be (1) used to reduce premium payment, (2) used to purchase additional fully paid-up insurance (often called paid-up additions), (3) accumulated by the insurance companies to earn interest on behalf of the policyowner (similar to a savings account), (4) used to purchase term insurance, and (5) used to increase premiums and make the policy paid up at an earlier age than originally anticipated.

Limited-payment life insurance is a type of whole life insurance for which premiums are limited by contract to a specified number of years. The extreme end of the limited-payment policies spectrum is the single-premium whole life policy. However, few people can afford the premium or are willing to pay that much in advance.

The limitation in limited-payment policies may be expressed in terms of the number of annual premiums or of the age beyond which premiums will not be required. Policies whose premiums are limited by number usually stipulate 1, 5, 7, 10, 15, 20, 25, or 30 annual payments, although some companies are willing to issue policies calling for any desired number of premiums. The greater the number of premiums payable, naturally, the more closely the contract approaches the ordinary life design. For those who prefer to limit their premium payments to a period measured by a terminal age, companies make policies available that are paid up at a specified age�typically, 60, 65, or 70. The objective is to enable the insured to pay for the policy during his or her working lifetime. Many companies issue contracts for which premiums are payable to an advanced age, such as 85, but for all practical purposes, these contracts can be regarded as the equivalent of ordinary life contracts.

Since the value of a limited-payment whole life contract at the date of issue is precisely the same as that of a contract purchased on the ordinary life basis, and since it is presumed that there will be fewer premium payments under the limited-payment policy, it follows that each premium must be larger than the comparable premium under an ordinary life contract. Moreover, the fewer the guaranteed premiums specified or the shorter the premium-paying period, the higher each premium will be. However, the higher premiums are offset by greater cash and other surrender values. Thus the limited-payment policy will provide a larger fund for use in an emergency and will accumulate a larger fund for retirement purposes than will an ordinary life contract issued at the same age. On the other hand, if death takes place within the first several years after issue of the contract, the total premiums paid under the limited-payment policy will exceed those payable under an ordinary life policy. The comparatively long-lived policyowner, however, will pay considerably less in premiums under the limited-payment plan than on the ordinary life basis.

There is no presumptive financial advantage between forms. The choice depends on circumstances and personal preference. The limited-payment policy offers the assurance that premium payments will be confined to the insured�s productive years, while the ordinary life contract provides maximum permanent protection for any given annual outlay. The limited-payment policy contains the same surrender options, dividend options, settlement options, and other features that make for significant flexibility.

An extreme form of limited-payment contract is the single-premium life insurance policy. Under this plan the number of premiums is limited to one. The effective amount of insurance protection is, of course, substantially less than the face amount of the policy, and the investment element is correspondingly greater. Such contracts therefore are purchased largely for accumulation purposes. They offer a high degree of security, a satisfactory interest yield, and ready convertibility into cash on a basis guaranteed by the insurer for the entire duration of the contract. Since the single premium represents a substantial amount of money and since it is computed on the basis that there will be no return of any part of it in the event of the insured�s early death, it has only limited appeal for protection purposes.

The limited-payment principle is applicable to any type of contract and is frequently used in connection with endowment contracts. However, it is important to differentiate between a limited-payment policy (in which paid-up status is guaranteed at the end of the premium-paying period) and a vanishing-premium approach (which uses policyowner dividends to pay all of the premiums after they are adequate to do so). Vanishing-premium approaches have been sold much more frequently than limited-payment policies over the last decade. The notable difference between the two is that under the vanishing-premium approach dividends are not guaranteed and may decline in the future. If dividends turn out to be inadequate to pay the premiums, the policyowner will have to resume actual premium payments out of pocket or let the policy lapse. There is no guarantee that so-called vanishing premiums will actually vanish or that if they do vanish, they will never reappear.