It’s time to have a discussion on cash value

I see a lot of misunderstanding in this sub about cash value and whole life insurance in general. This is coming both from opponents of whole life insurance and even some from proponents. I would like to take a step back and discuss cash value, what it is, and what whole life insurance more generally is.

Unlike term insurance, whole life insurance is guaranteed to pay out. That death benefit is a real liability for the insurance company. However, it is not a present liability. It is a future liability. Mathematicians (actuaries) know the likelihood of you dying in a given year. Say it's a 1% chance of death. This means that for a 100k death benefit the insurance company must have 1k in reserves that year to cover the chance that you die and they have to pay out the death benefit. The present value (the insurance company's liability) of the death benefit is thus $1k.

Now since the insurance company must pay out that death benefit, that present value of the death benefit is an asset that you own since you own the policy. However, you as a policy owner also have a liability and that is future premium payments. These are payments that you have promised to make to the insurance company. There's a risk, however, that you will die before making all of those premium payments, so there is a present value of all future premium payments. Using actuarial calculations we can determine the present value (the insurance company's assets) of your future premium payments.

So for the insurance company, they're interested in staying solvent. They're strictly looking at assets and liabilities. The assets are your premium payments and the liabilities are death benefits. But these are potential figures. Insurance companies use the present value of those assets and liabilities. Assets must be greater than liabilities to remain solvent.

Thus we come to the concept of cash value. It is the present value of the future death benefit net of the present value of future premium payments. This is how much the insurance company must have in reserves to pay out the death benefits. Your particular cash value represents how much the insurance company must have in reserves for your particular contract. Cash value is NOT a savings account. It is NOT a portion of your premium payments. You are not overpaying for insurance to fund a side account. Cash value simply represents how much the insurance company must have in reserves to fund the death benefit.

Finally, the insurance company is necessarily going to overestimate mortality rates in order to ensure that they stay solvent. What this means is that while you may in reality have a 0.2% chance of death in a year, they will act as though you have a 1% chance. That is, they will have greater reserves than is actually necessary to stay solvent. They do this every year. This leaves them with profit. Where do the profits go? In a stock company they go to shareholders. In a mutual company they go to the owners, who are the policy holders. So this means that even though the insurance company models fairly conservatively to stay solvent, they will redirect the difference that they experience every year between their models and actual mortality figures to you, the policy holders.

In summary, cash value is not a savings account. While this can be a useful analogy, it betrays a fundamental misunderstanding of the concept of whole life insurance. Whole life insurance is an endowment contract, and a participating whole life insurance contract from a mutual company is an endowment contract with profit sharing. What you pay in premium every month isn't an overpayment. It is the modeled level cost of insurance to fund the death benefit, and the cash value represents the reserve retirement for the insurance company to stay solvent.

submitted by /u/Icy_Director_5419
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