Should the premiums paid for a life insurance policy be viewed as an expense? It depends on the type of life policy in question; the premiums paid on a term policy should be viewed as an expense, whereas those paid on a whole life policy shouldn’t be. This isn’t just my contention; the accounting profession also prescribes this treatment of premiums.
I realize that paying the premium on any type of policy feels like an expense, but when analyzed, it is logical that whole life premiums not viewed (or accounted for) in that matter.
The reason that term premiums are properly viewed as an expense is the same reason that automobile premiums are an expense; they represent pure protection for a specified period of time. If there is no claim during the specified period, the money is gone.
Whole life, on the other hand, has a cash value component that must be accounted for. The entire premium isn’t allocated between pure protection (the expense component) and cash value (the asset component). Let’s look at an example.
If the annual premium is $1,000 and the cash value increases by $900, then the expense (the protection component) is only $100. “But I wrote a check for $1,000. That is my expense, as I no longer have use of that $1,000” (that is not a true statement, as I will explain).
Using that reasoning, it would also be an expense when you buy a stock, which it clearly is not. However, if you later sell the stock at a loss, the loss portion would be considered an expense.
That brings us to mortgage payments. Expense or not? For the most part, yes. The interest component is clearly an expense, and even the principle component can be viewed as one because while increasing your equity, it isn’t necessarily readily available.
To access home equity, one needs to qualify, both on a debt to equity ratio and with an income acceptable to creditors. This is unlike the equity in a whole life policy which is available for the asking. So in the example above, after sending the insurance company the $1,000 premium, you could then turn around and borrow the $900.
So even though in the long run, home ownership builds equity, in the short run the mortgage payments are correctly viewed as an expense.
While I admit that can be somewhat blurred to the non-accountant, just remember this: if the payment, or a portion thereof, is readily available, it is not considered an expense. And since the cash value of a whole life policy is available for the asking, that is, no job is required for the loan, it is technically not an expense, although it can certainly feel like one when you are writing the check.