What’s the difference between whole life insurance and term life insurance?

Prior to the introduction of compulsory superannuation, whole life insurance was a popular form of permanent life insurance in Australia and a commonly-used retirement savings vehicle.

Whole life insurance is generally no longer sold in Australia and has been largely replaced by term life insurance (although some people who took out a whole life insurance policy when it was available might still have it in place).

Let’s take a look at how the two types of life insurance differ and how term life insurance, which is the main type of life insurance available in Australia today, stacks up as an alternative.

What is whole life insurance?

As its name suggests, whole life insurance is a policy type designed to cover a person for the duration of their life.

When whole life insurance was widely available in Australia, among the main features offered were:

• Lifetime coverage: The policyholder would typically be covered for their entire life, as long as they continued to pay their premiums when they were due.
• Guaranteed death benefit: A lump sum guaranteed to be paid to the policyholder’s beneficiaries upon the policyholder’s death.
• Investment component: A portion of each premium would be put into a savings account and invested by the insurer in order to earn interest for the policyholder. These guaranteed earnings were referred to as ‘cash value’ or ‘surrender value’.
• Level premiums: Premiums would stay the same throughout the life of the policy with no increase in line with age or health factors.
• Dividends: Certain policies would allow the policyholder to receive dividends on their cash value. Dividends could be withdrawn, used to increase the cash value or to reduce premiums.

Policyholders could terminate their policy by surrendering the death benefit and collecting the cash value, minus surrender charges. Prior to the introduction of the compulsory superannuation scheme, many people used whole life insurance as a means of saving for retirement, and would often surrender their policy upon retirement to access the cash value.

Why is whole life insurance no longer available?

After the federal government introduced compulsory superannuation in 1992, the popularity of whole life insurance declined. Whole life insurance is now no longer available in Australia and is only used by those who purchased policies prior to 1992.

Like whole life insurance, superannuation includes a death benefit. The super death benefit consists of the member’s super account balance at the time of death plus any life insurance cover the member may have had through the super fund. This benefit is typically paid to the fund member’s nominated dependants or estate when the member dies.

What is term life insurance?

Whole life insurance has been largely replaced by term life insurance. Unlike whole life insurance, term life insurance only provides coverage for a certain period of time, as chosen by the policyholder when taking out the policy. This means that if you die (or are diagnosed with a terminal illness) within the specified term, and a successful life insurance claim is made, your beneficiaries would receive a lump sum death benefit. However, if you die outside of the term without having renewed your policy, your beneficiaries wouldn’t receive a benefit.

The main features of term life insurance are:

• Death benefit: A lump sum paid to your beneficiaries if you die within the life insurance term. This benefit generally increases each year to keep up with inflation.
• Level, stepped or hybrid premiums: Depending on your age, term life insurance policies generally allow you to choose between level, stepped or hybrid premiums. In comparison to level premiums which remain constant, stepped premiums increase as you get older to reflect your higher risk of death. Hybrid premiums are a mixture of level and stepped premiums.
• Flexible coverage: Typically, you can apply to increase or decrease the amount of your cover at any time. Usually your applications would be subject to the same eligibility criteria that your insurer used to assess your eligibility for the product initially and you may not be required to undergo additional medical tests. However, additional premium costs will often apply if you decide to increase your cover.

Compare Life Insurance

What is the difference between whole and term life insurance?

The biggest difference between whole and term life insurance is that term life insurance does not include an investment component like whole life insurance policies did when they were available. The other main point of difference is that whole life insurance was designed to cover policyholders for their entire life, whereas term life insurance only covers you for a certain period of time and then expires if not renewed, even if the insured person is still alive.

Below we summarise some of the key differences between whole and term life insurance:

Cover duration

Whole: Cover for your entire life, as long as premiums were paid.
Term: Covers you for a specified term.

Death benefit

Whole: Guaranteed death benefit.
Term: Not guaranteed. If you die outside of the policy term, your beneficiaries would not receive a death benefit.

Flexibility

Whole: Not usually flexible if you need to change your cover.
Term: Policyholders can generally apply to increase or decrease cover as needed and may not need to give medical evidence.

Premiums

Whole: Level premiums.
Term: Level, stepped or hybrid premiums.

Inflation

Whole: Cover tended to remain the same regardless of inflation.
Term: Cover typically increases each year to keep up with inflation.

Compare Term Life Insurance

Image Source: wk1003mike (Shutterstock.com)