What Does Liquidity Refer to in a Life Insurance Policy?

  • By: InsureJournal
  • Date: November 21, 2021
  • Reading Time: 3 min.

Insurance policies can sometimes be daunting. Especially, if you are surrounded by people who are waiting to take advantage of your ignorance. But it’s of utmost importance that you get acquainted with the language of the policies so that you don’t regret your decisions later. Liquidity is one of those misunderstood insurance policy terms. So here, we’ll be looking into the details of what liquidity is and how does it apply to a life insurance policy.

What is Liquidity?  

Liquidity in general refers to the degree to which an asset can be converted into cash value through buying or selling it at its current market value. The more liquid an asset is, the quicker it can be converted into cash which is the most liquid asset possible.

What is Liquidity

How does Liquidity apply to a life insurance policy?

In case of life insurance policy, the term liquidity has a bit more specific function. Liquidity in a life insurance policy directly indicates the amount of cash value available to the insured individual or company. This means, a portion of the cash value is always available to be borrowed for the insured individual/company. It also signifies the idea of the beneficiary being able to carry the expenses quickly and easily right after the death of the insured one.  Some policies offer a cash value amount to the policyholder which can be borrowed anytime for immediate use. Even though, this policy becomes available only after the premium has been paid off.  

What does Liquid Asset refer to?

A liquid asset refers to the asset owned by the policyholder which can be turned into cash value. The investment account of the policyholder is the liquid asset in the life insurance policy. The benefit that the beneficiaries would receive upon the insured individual’s death can also be considered as a liquid asset. However, three factors are needed to be looked at to consider the life insurance policy itself as a liquid asset.  These are –

  • The policy needs to have a cash value. The insured individual can withdraw the cash amount if it has grown.
  • The policyholder can exchange the policy with some cash value by surrendering it if he/she is unable to afford a permanent life insurance policy. 
  • The policy needs to have the viatical settlement quality. The viatical settlement enables an individual to sell his/her life insurance policy if they don’t require it anymore. Senior citizens, especially the medically ill policyholders can avail this great opportunity. 

Liquidity in different life insurance plans 

Term life insurance policy does not include liquidity. But in the case of permanent life insurance, the insured can accumulate a cash value over few years. Then the accumulated value can be treated as a liquid asset and the policyholder can access it anytime. Although, this may cost 15 times the cost of term life insurance policy. 

Within the permanent life insurance policy, there are variations of liquidity. In case of the Whole Life Insurance policy, the policyholders can accumulate cash over time. Such policies facilitate the policyholder with opportunities such as saving money and earning some interest.   

Meanwhile, policyholders earn interest that is based on the market index performance through the universal life insurance policy.

On the other hand, the variable life insurance policy offers their policyholders, the freedom to choose which funds they would like to invest based on their market value.  

Key Note 

As we can see, not all the life insurance policies offer the privilege to liquefy. Even the ones that do, also vary in terms of the details of their respective policies. The way liquidity applies to general economics, is a bit different from how it does in insurance policies. So one must thoroughly understand the term liquidity and how it applies to life insurance policies to really ensure the best use of it.   

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