Cash-value policies come in three forms

Q. Dear Rick: I’ve heard you say that whole life insurance is not a good product to buy. Why is that? — James from Newport

A. James, let’s start by explaining what it is. Cash-value life insurance polices, which include whole life policies, combine life insurance with a savings or investment element. As with term insurance, the owner will pay regular premiums on the policy, and, if the insured dies while the policy is in effect, the insurance company will pay the beneficiary — or beneficiaries — a set sum of money.

However, unlike term life insurance, cash-value life insurance policies remain in effect for most or all of the insured’s life.

With some cash-value policies, after a period of years, you can stop paying premiums on the policy — even though the policy remains in effect.

Generally, there are three kinds of cash-value policies:

• Whole life insurance: Premiums generally remain the same over the term of the policy. A portion of the premium pays for the insurance, while a portion is put into a “savings account” — the “cash value” of the policy.

• Universal life insurance: Very similar to whole life, though the amount of premium that goes toward savings, and how much interest is being paid on that savings, must be disclosed by the insurance company to a great — but not complete — degree. The actual cash value of universal life policies — as well as the rate of growth of these policies’ cash value — is limited because of the numerous fees and expenses.

• Variable life insurance: Virtually the same as universal life policies, with one major exception. With universal life, the insurance company chooses where to invest the “cash value” of the policy holder’s account. With variable life, the owner gets to choose from a number of underlying investment vehicles — usually a mixture of mutual funds, bonds, stocks and money market funds.

So, why are cash-value policies not a good purchase? Because a very large portion of the premium paid on a cash-value policy is deducted to pay sales fees and other “expenses” charged against the policy. Also, the premiums on cash-value policies are much higher than those on term policies, leaving many people who buy cash-value policies greatly underinsured.