As readers of these missives, and really any financial press, are aware, there are two broad categories of life insurance; cash value and term. Traditionally, term policies covered deaths that occurred during the term defined in the policy, while the cash value in cash value policies had a reserve which, while ostensibly was to help pay future claims, was also made available to policy owners.
Like many things, the lines have become blurred and it is not so black and white anymore. Many guaranteed universal policies and, to a lesser extent, indexed universal life policies have no cash value, but the policy will remain in force provided a predetermined premium is paid.
To get back to the title question, while the cash value is indeed a reserve to pay claims, since it is made available to the owner of the policy, he can logically view it in one of two ways; as a savings component, or as a prepayment of future premiums.
If viewed as a savings account, the obvious question is “what is the return?” Fortunately, that is easily determinable. Subtract a representative term premium from the policy premium, then compare that annually to the cash value to arrive at the internal rate of return. (Email me if you would like an excel spreadsheet that does that.)
Viewing cash value insurance as a prepayment of future premiums, while certainly logical (pay more than the pure cost of insurance in the early years so that less can be paid later when the cost of insurance becomes prohibitive), is much more problematic to quantify. In fact, it may be close to impossible without making several simplifying assumptions.
Unfortunately, there is a third way, maybe the most common way, that policy owners view cash value life insurance, and that is as an expense. They equate the premium notice to all the other bills they receive. Viewed that way, it is logical to want to pay as little as possible.
However, if it is viewed as savings, then paying as little as possible may not be the best way to go. Certainly, if viewed as savings, then it shouldn’t be viewed as an expense, any more than a 401(k) contribution should be viewed as an expense.
To summarize, cash value life insurance can be viewed in many ways; as a tax deferred savings vehicle, as a way to prepay future premiums, or simply as a way to guarantee that a policy will be in force on the day you (eventually) die. But the one way it should not be viewed is as an expense.