For some 15 years I have been intensively studying and modeling the economics of cash-value life insurance (specifically, Whole Life). There’s a tendency to talk to other experts in this niche subject, such as my recent InFi podcast interview with Bobby Samuelson. But when I interact with even experts on insurance who specialize in other product types—such as property and casualty (P&C)—it reminds me just how unique cash-value life insurance really is.
To see a full-blown introduction to the mechanics of a Whole Life insurance policy—and how it can be used as a cash management vehicle—please review my earlier post. However, in the present post, I want to highlight the “cash surrender value” feature, because that is what is so unique in this class of insurance products.
What Is the Cash Surrender Value?
As the name suggests, the cash surrender value (CSV) is the lump-sum payment that the owner of a certain type of life insurance policy is contractually entitled to receive, upon surrendering the policy back to the carrier. In a typical contract, the CSV marches steadily upward over time, until it finally equals the face death benefit at an advanced age. (In the US, this maturity point used to be 100 years, but now it’s 121 years. If the insured is still alive at this late stage, the owner of the policy receives the “death benefit” payment and the policy completes.)
In a life insurance textbook, they will define the cash surrender value (CSV) as something like, “The actuarially expected present-discounted value of the death benefit minus any remaining premium payments.” This explains the two-fold process that makes the CSV march upward over time. Reason #1: The death benefit gets closer, actuarially speaking, and so it is discounted less heavily (because present dollars are more valuable than future dollars). Reason #2: If there are still contractual premium payments due on the policy, then with the passage of time, there are fewer such payments remaining, so that the CSV jumps upward because of this force as well.
Why Don’t Other Types of Life Insurance Have a Cash Surrender Value Feature?
To appreciate why cash-value life insurance is so special, it’s helpful to consider why the other types of insurance lack the CSV feature. We can get a clue when we consider that even among life insurance, term policies don’t have an analog of the CSV feature. So we see that “cash-value life insurance” is actually corresponding to permanent life insurance. That is to say, we see the CSV feature go hand-in-hand with the types of life insurance policies that have guaranteed renewability at a pre-specified premium.
For example, a standard Whole Life policy might contractually obligate the policyholder to pay annual premiums up through (say) Age 75. After that, the policy is “paid up” and the beneficiaries will receive a death benefit for sure—they just don’t know when.
In contrast, if a policyholder has (say) a 30-year term life insurance policy on himself, then even if he faithfully makes every contractually obligated premium payment, his beneficiaries don’t know that they will ever see a dime. If the insured happens to outlive the 30-year term, then the policy expires with no money due. (Of course, this explains why it is so much cheaper to buy a given face amount of death benefit coverage via a term policy, rather than a Whole Life policy.)
Intuitively, when the carrier takes incoming Whole Life premiums, it must “put them to work” in a growing asset portfolio, because the carrier knows it will eventually have to pay out the death benefit (if the policyholder maintains his or her end of the bargain). In contrast, in a short-term life insurance contract, the premiums are mostly covering the “pure mortality cost” of the death benefit coverage. Effectively, the premiums on the Whole Life policy are much higher than the pure mortality cost of the coverage in those early years, and so the carrier builds up a large pool of assets “backing up” that in-force Whole Life policy. This is why the carrier is willing and able to “buy the person out” decades down the road, for a very significant cash surrender value.
(Two quick points for purists: There is such a thing as an “endowment contract,” in which a beneficiary receives the death benefit if the insured dies during the term, but otherwise the policyholder receives a cash payment at the end of the term. This is functionally equivalent to a standard Whole Life policy, except the endowment age is younger than the now-standard 121 years on a Whole Life. Also, if people make pre-payments on their term policy, but then end the policy ahead of time, they might get a partial refund on the length of the term that they haven’t yet used. This is arguably a second-cousin of a CSV in a Whole Life policy, but they are so distinct that I feel comfortable classifying them as different types of features.)
Why Don’t Non-Life Insurance Policies Have a Cash Surrender Value?
To further appreciate the uniqueness of cash-value life insurance, we can also consider insurance contracts on things other than a human life. For example, suppose a man has a hefty fire insurance policy on his commercial building. Why can’t he surrender the policy, say, 20 years into the “life” of the building, in order to get a large cash payment from the carrier?
The reason is that the fire insurance policy will be a term policy. Unlike the risk of death for a human, the actuarial odds of a large building burning down do not increase over time. In other words, if a human manages to last 50 years without dying, the probability of him lasting the 51st year are lower than the prior year. But if a building manages to avoid burning down for 50 years, it’s not as if it’s more likely to burn down in the 51st year.
But what about something that does have a “natural” life cycle, such as a heavy-duty truck that a roofer uses for his business? Just like the carriers can reasonably place the upper limit on a human life at 121 years, couldn’t there be a “cash-value truck insurance policy” that promises to indemnify the owner in case the truck needs to be replaced, either when the replacement is needed or when the truck survives to (say) 30 years old, whichever comes first? And then, if there were such a policy, it would make sense that the roofer could cash it in after (say) 20 years if he decides to leave the business and no longer wants to keep making his premium payments.
Now in principle, we can imagine the conceptual outlines of such a truck insurance policy, but in practice we see how different it would be from a cash-value life insurance policy. First and foremost, there’s nothing crisp to determine whether a truck is “alive or dead,” and hence qualifies for an early payment on the policy. The extreme limit is if the truck ever needs so much in repairs that it would make more economic sense to just replace it, but there are lower-threshold events (such as a minor fender bender) where standard auto coverage kicks in. If we wanted something analogous to a Whole Life policy on your truck, it would only pay out once, and hence the owner would need to supplement his “permanent truck policy” with a standard term policy. This complication might help explain why we don’t see, in the real world, permanent insurance policies on vehicles.
Speculation for the Future
In closing, let me mention two trends that might upset the current state of affairs. First, as medical science progresses, the crisp line between a human being “alive or dead” might start looking more like the case of a truck. So developments with 3d printing of new organs, using “nanobots” to repair damaged tissue, etc. might eventually force the life insurance carriers to alter the new contracts they issue.
Second, if we continue to see advancements in Large Language Models (LLMs) housed in robot bodies, the owners of such machines may take out insurance policies on them that begin to resemble those on human beings. In this context, it’s possible that something analogous to a cash-value product could make economic sense.
In any event, I hope this article has underscored just how special a human life is, and why cash-value insurance policies on a human life are unique in this asset class.
NOTE: This article was released 24 hours earlier on the IBC Infinite Banking Users Group on Facebook.
Dr. Robert P. Murphy is the Chief Economist at infineo, bridging together Whole Life insurance policies and digital blockchain-based issuance.
Twitter: @infineogroup, @BobMurphyEcon
Linkedin: infineo group, Robert Murphy
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To learn more about infineo, please visit the infineo website
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