In an insurance context, excess interest describes a specific type of life insurance policy. It is one where the premiums paid by the customer, and the amount paid by the insurer when the customer dies, are both fixed, but the cash value of the policy varies over time. This variation is affected by market conditions and is effectively a varying interest payment, albeit one the customer may not collect. The precise mechanism of an excess interest policy depends on the business structure of the insurer.
All life insurance policies fall into one of two categories. Term insurance is where the customer pays regular premiums over a fixed period and the insurer pays out if the customer dies during this period; if the customer is still alive at the end of the period, the premium payouts cease and the insurer makes no payout. Whole life insurance means the person continues paying premiums for the rest of his life and the insurer then pays out when he dies.
Excess interest falls into the latter category and is based around a specific aspect of whole life insurance known as the cash value. This is a payment the insurer makes to the customer if she decides to stop paying into the policy. The cash value can also be used in other ways: the money can be used to fund ongoing insurance on a term basis after the customer stops paying in, or it can be used as the basis of a loan to the customer, which can be deducted from the final death-related payout if needed.
The cash value grows over the time the customer is paying into the policy. It is the different ways of calculating this growth that distinguish different forms of whole life policy. A common version, known as participating or with-profits, means that the cash value grows by varying amounts, with the money coming from the insurance companies profits. Another version, known as non-participating, the cash value grows by a fixed proportion or amount each year, which is agreed when the customer first takes out the policy.
An excess interest policy is a mixture of these two methods. The cash value grows by at least a certain amount or proportion each year. It may grow by a higher amount depending on the profits of the insurer or another market performance factor, but this isn't guaranteed. Any increase in the cash value above and beyond the guaranteed rise is known as excess interest, hence the name of the policy type. Alternative names include current assumption whole life or interest sensitive.
