The best life insurance companies understand that they can expand their customer base by offering financial products designed to benefit people in a variety of situations.
Standard, tried-and-true whole life insurance is well-suited to applicants in many phases of life.
However, for people whose circumstances make standard whole life difficult to obtain, modified whole life insurance policies can provide a means of securing the protection and stability of whole life under a slightly different structure.
Modified-premium whole life insurance is a good fit for individuals who want or need to save a little on whole life insurance rates early one. Modified-benefit policies allow otherwise ineligible applicants to obtain coverage.
And a host of available riders let whole life policies provide supplemental protection. Whichever way you go, the goal is to get whole life coverage tailored to your individual circumstances.
It should be noted that modified whole life insurance is different from limited pay life insurance, where the premium is set for a specific period of years, after which time no more premiums are due.
Whole Life Insurance
“Whole life” is permanent life insurance guaranteed to retain the same death benefit for the entire life of the insured person. A whole life policy won’t expire or lapse (other than for failure to pay premiums), and, in most cases the premiums are fixed.
So, the insurance company won’t increase the premiums as the insured gets older, in contrast to when a term life policy renews or a universal life policy is underfunded.
A defining trait of whole life insurance is that it has cash value. And a whole life policy’s cash value isn’t theoretical value based on the probability that it will eventually pay out.
Whole life cash value is a financial asset that can be accessed when needed and can be used as collateral for a life insurance loan.
And if you decide you no longer require life insurance, you can surrender the policy, and the insurance company will hand you a check for the cash surrender value.
The precise policy terms of whole life insurance vary among policies and between insurers, and most life insurance companies offer a wide variety of riders that (usually in exchange for additional premium) are intended to increase a policy’s practical value and tailor it to the policyholder’s specific needs.
But the fundamentals are consistent—permanent, guaranteed life insurance with cash value.
What is “Modified” (or “Modified Premium”) Whole Life Insurance?
Modified (or “modified premium”) whole life insurance is whole life insurance with a twist.
Where a traditional whole life policy features fixed premiums throughout the duration of the policy, a modified premium policy starts out with lower premiums and adjusts the premium amount after an initial period.
Other than the revised premium structure, a modified whole life policy will otherwise look very similar to standard whole life insurance.
Now, modified premiums aren’t like a mortgage with an adjustable rate. The premium rate doesn’t float and isn’t adjusted every year.
Instead, there’s usually only one or two premium adjustments, and adjustments come at a predetermined time—usually either five or ten years after the policy is originally issued.
Policy documents will clearly identify how long the starting period lasts. And, after any applicable premium adjustment(s) has occurred, the modified policy’s premiums are fixed for the rest of the insured’s life.
During the modified-premium period after the policy is first issued, a modified whole life policy will have lower premium payments compared to a standard whole life policy with the same coverage level.
Then, after the premium payments are adjusted, the modified policy’s premiums are higher than what you would get with a comparable fixed-rate policy.
So, lower up front, higher on the back-end.
What it boils down to is that you get decreased premiums for five or ten years, and, in exchange, you agree to pay increased premiums for the duration of the policy.
Importantly, the face amount (i.e., the death benefit paid to the beneficiary upon the insured’s death) stays constant during and after the modified period. It remains the same policy with the same coverage amount. It just costs less for the first few years.
Modified Benefit Whole Life Insurance
Somewhat confusingly, the term “modified whole life insurance” is sometimes also used to describe final expense whole life insurance policies with a waiting period (usually two years or so) during which the policy’s full death benefit is not yet effective.
With these modified-benefit whole life insurance policies, the premiums are fixed, but the benefit amount changes.
They usually work in one of two ways if the insured dies during the waiting period.
Either the payout upon death is measured as a total refund of all premiums paid on the policy, with interest (“return of premium”).
Or the payout is measured as a percentage (often 25 – 50%) of the policy’s full coverage level (“graded benefit”).
And note, once the waiting period ends, the full coverage amount kicks in.
Modified-benefit policies frequently provide “guaranteed acceptance” coverage (i.e., an applicant cannot be denied), marketed as final expense insurance (or “funeral insurance” or “burial insurance”).
We’ve examined final expense insurance generally and guaranteed acceptance life insurance specifically in other articles.
So, here, we will focus primarily on modified-premium whole life insurance.
However, it’s worth noting that modified-benefit whole life policies with guaranteed acceptance can provide a path to obtaining life insurance for people who might not otherwise be able to qualify due to a preexisting medical condition.
Why a Waiting Period?
Life insurance companies are hesitant to cover applicants with certain health problems out of fear that the insured will die early and the company will have to pay out a big death benefit on a policy that hasn’t contributed much premium.
Waiting periods alleviate that concern by ensuring that at least a couple years of premiums will be paid into the policy before the total benefit amount is paid out.
This allows the insurance company to offer coverage to individuals who would otherwise be ineligible due to a significant medical condition.
In fact, most guaranteed acceptance policies don’t require any medical underwriting whatsoever—not even a health questionnaire let alone a physical.
Any time a life insurance policy is “guaranteed acceptance” and has no medical underwriting, the whole life insurance rates are going to be higher than with a medically underwritten policy.
The sooner the insurer anticipates paying out a death benefit, the higher the premiums will be.
Modified-premium life insurance works the other way—the insurer is willing to accept a reduced premium early on if it believes there is a relatively low risk of an early payout.
Comparing the Cost of Modified vs. Fixed-Premium Whole Life Insurance
The altered premium structure that comes with modified whole life insurance raises a somewhat obvious question: ‘do you end up paying more in total premiums for a standard whole life policy or for a modified policy?’
Unfortunately, it’s impossible to say for sure either way on the day a policy is issued because the answer depends on how long the insured person ends up living.
If the insured dies during the modified period—or doesn’t live much longer after the conclusion of the period—a modified policy will be considerably less expensive.
In those scenarios, the policyholder pays less premium for the same death benefit, so modified whole life was a great choice.
On the other hand, if the insured lives well past the end of the modified period and exceeds his or her life expectancy, then the classic whole life policy with fixed premiums will end up costing less in aggregate premium payments.
The longer the insured lives, the more premiums must be made at the higher post-adjustment rate.
Eventually, the higher back-end payments catch up with the early savings.
Time Value of Money
If the insured lives exactly to life expectancy, the fixed-rate policy will probably cost somewhat less in terms of actual dollars spent.
But there’s an important qualification that needs to be factored into the analysis—a concept economists call the “time value of money.”
Stated simply, the time value of money contends that a dollar in your pocket today is worth more than a dollar in your pocket ten years from now.
Cash in-hand has more value than future cash due to inflation and decreased purchasing power.
We’ve all heard how a bottle of Coke used to cost a nickel and how you could purchase a nice house for $30,000 back in the 1960’s.
People reaching retirement age today likely have fond memories of how much lower prices used to be for many items. Even ten or fifteen years ago, most goods and services cost at least a little less than they do now.
With that in mind and all other things being equal, you gain more purchasing power from saving money on life insurance premiums today than you would from saving on premiums in ten or twenty years.
Moreover, if you invest the savings during the modified premium period, there’s a decent chance that-— factoring in the return on investment—the savings will end up being worth more or the same as the additional premiums you pay after the modified period.
And it works the other way, too. If the insurance company had received higher premiums early on from a fixed-rate policy, it would have invested the money.
The nominally higher long-term premiums for a modified policy are based on the insurer’s calculation of how much investment growth it didn’t earn due to the lower early premium payments.
Ultimately, the nominal value of the early savings might be less than the additional back-end premiums, but the real value, factoring in the growth earned on the early savings, can even things out or even favor the modified policy.
Of course, the analysis in a specific situation depends on the rate of inflation and how well the invested savings actually performs.
In general, insurance companies attempt to set modified premiums so that—if the insured lives to life expectancy, invests the early premium savings, and earns average returns—the standard and modified whole life policies end up costing more-or-less the same in real terms.
In other words, it’s a wash.
Cash Value of Modified vs. Fixed Whole Life Insurance
The comparative cash value of fixed-premium versus modified-premium whole life is another factor worth considering.
Whole life policies—whether the premiums are modified or fixed–accrue cash value that steadily increases the longer the policy remains in place.
Cash value can be borrowed against for a low-interest loan, cashed in by surrendering the policy, or rolled over into an annuity at retirement.
So, cash value is a bona fide asset and definitely needs to be weighed when comparing life insurance policies.
Less Cash Value Initially
When a policy has modified premiums, cash value accrues more slowly at first than a comparable policy with fixed premiums.
Less cash is paid into the policy upfront, so there’s less available to apply toward cash value and to earn interest.
After premiums are adjusted and payments increase, the policy’s cash value will start building more quickly and may eventually even out.
Early on, though, a modified policy will have a lower surrender value.
Similarly, a modified whole life policy can still receive life insurance dividends from the insurance company. And the dividends can still be taken as cash, applied to future premiums, or put back into the policy to increase its value.
However, life insurance dividends will be smaller during the modified period compared to a fixed-premium whole life policy from the same insurer.
Like cash value, dividends will increase after the modified period.
Why Buy Modified Whole Life Insurance?
Modified premium whole life may be a good option for younger applicants who anticipate having more disposable income down the road.
In this situation, the modified premiums allow for higher coverage levels with more affordable rates early on.
Then, premiums increase during later, higher-earning years. Overall, you’re able to lock in the higher coverage and lower rates available for younger applicants without over-extending your budget.
Conversely, an applicant who anticipates a future decrease in income will probably be better off with a classic whole life policy with fixed premiums.
If, for instance, you are planning to retire soon, the lower premiums now might not be worth the higher premiums that will come when you’re earning less income.
Fixed premiums—and the budgetary certainty that comes with them—can be a big advantage in retirement planning.
On the other hand, if a major debt like a mortgage will soon be paid off—freeing up significant space in your budget—a modified premium policy may let you obtain higher coverage levels than you could otherwise afford right now.
Even if future modified premiums would be higher than fixed premiums today, the modified premiums will likely be less than fixed premiums for a policy issued in five or ten years.
So, if you need the higher coverage and will be able to afford the premium adjustment when it occurs, a modified policy now is probably a better deal than a fixed-premium policy ten years from now. And you get the benefit of having life insurance in place right away.
A lot also depends on what your objectives are.
If, for example, you like the idea of having life insurance as a backstop but are more focused on accruing long-term cash value for use in retirement planning, a fixed-rate policy that grows faster probably makes more sense.
Or, if your primary purpose is to take advantage of the estate-tax benefits of whole life, a fixed-rate policy is probably a more efficient means of doing so.
Modified whole life insurance—whether modified-premium or modified-benefit—can be a great option for individuals who fall within the groups the products are designed for.
An experienced life insurance professional, such as the team at I&E, can help you decide if you’re better off with modified whole life or a standard, fixed-premium and fixed-benefit policy.