The Concept of the Level-Premium Whole Life Insurance Policy. Reexamined

Abstract

The traditional concept of the level-premium whole life insurance policy is misleading. It has led to an explanation of the policy in terms of a divisible product with its components of decreasing protection and increasing savings. It suggests a divisible premium with one part used to pay for decreasing amounts of insurance protection and one part used to build a savings account. A more realistic explanation of the level-premium whole life insurance policy would appear to be one of an installment purchase agreement. Furthermore, level-premium whole life insurance is offered to the public as a means of obtaining tax-sheltered buildups of cash values with the implication that these tax-sheltered buildups are unique to life insurance. Arguments are presented to (1) show the faulty logic in the contention that levelpremium whole life insurance offers a unique tax-sheltered buildup of cash values and (2) demonstrate that level-premium whole life insurance, instead of offering favorable income tax treatment, is treated adversely. On several occasions, congressional committees have considered the concept of including as taxable income to the policyowner roughly the amount by which the cash value of his policy increases for the year in. excess of the premium paid for that year.' The motivation to tax cash,. value buildups in life insurance policies as ordinary income arises from. the successful manner in which life insurance salesmen and others have been able to sell the concept of life insurance as a tax-sheltered savings or investment medium. The attention in this paper is restricted to the need to reexamine (1) the traditional explanation of level-premium cash value life insurance, (2) the concept of cash value life insurance as a divided contract, one part decreasing death protection and the other part increasing savings, and (3) the illusion of a tax-free buildup of the cash values of a whole life policy. Robert I. Mehr is Professor of Finance at the University of Illinois at UrbanaChampaign. He is a past president of ARIA, a past director of the American Finance Association, a founder of the Risk Theory Seminar, the Pacific Insurance Conference, and the Interamerican Risk and Insurance Forum. This paper was presented at the 1974 annual meetings of the Risk Theory Seminar. This paper was submitted in June, 1974. ' See Charles E. McLure, Jr., The Income Tax Treatment of Interest Earned on Savings in Life Insurance, published by the Joint Economic Committee, 92nd Congress (1972).