Today s Lecture 18 Life Insurance Cost Comparisons Types of Cost Comparisons Uses of Cost Comparisons Life Insurance Cost Comparisons Traditional Net Cost Interest Adjusted Net Cost Methods Surrender Cost Index Net Payment Cost Index Equivalent Level Annual Dividend Yearly Rate of Return Method Traditional Net Cost Premiums Paid Dividends Cash Value at the End of the Period Net Cost Traditional Net Cost Index Net Cost Years x 1 000 Policy Face Traditional Net Cost Index Example 100 000 Whole Life Policy 1 000 Annual Premiums 6 000 Projected Dividends over 20 Years 22 000 Cash Value at end of 20 Years Traditional Net Cost Index Example Traditional Net Cost Index 20x1 000 6 000 22 000 20x100 4 00 The insurer gives you 4 00 each year for every 1000 of life insurance coverage you buy Cost Comparison Question 1 What is wrong with the Traditional Net Cost Index that it can show a negative cost A Life insurance can be very inexpensive B The values used must have been unrealistic C The calculation was done incorrectly D It ignores the time value of money E A negative cost index indicates the customer is paying a positive premium Interest Adjusted Surrender Cost Index Accumulated Value of Premiums at Interest Accumulated Value of Dividends at Interest Cash Value at End of Period Total Interest Adjusted Cost Surrender Cost Index Total Interest Adjusted Cost Annuity Due Factor x 1000 Policy Face Interest Adjusted Surrender Cost Index Example Same Policy Assume 8 Interest Rate i Accumulated Value of Dividends 10 000 Annuity Due Factor for n years 1 i n 1 1 i i 1 08 21 1 08 08 49 423 Interest Adjusted Surrender Cost Index Example 1000 x 49 423 10 000 22 000 49 423 x 100 3 53 Based on an 8 interest rate if you held the policy for 20 years and then surrendered it it would cost 3 53 per 1000 each year Interest Adjusted Net Payment Cost Index Accumulated Value of Premiums at Interest Accumulated Value of Dividends at Interest Total Interest Adjusted Net Payments Net Payments Cost Index Total Interest Adjusted Net Payments Annuity Due Factor x 1000 Policy Face Interest Adjusted Net Payment Cost Index Example 1000 x 49 423 10 000 49 423 x 100 7 98 Based on an 8 interest rate if you held the policy for 20 years and then died or continued to hold it it would cost 7 98 per 1000 each year Equivalent Level Annual Dividend Accumulated Value of Dividends at Interest Annuity Due Factor x 1000 Policy Face Example 10 000 49 423 x 100 2 02 If the insurer paid no dividends then the surrender cost index and the net payments cost index would increase 2 02 per 1000 each year Problems with the Interest Adjusted Methods Results are sensitive to the interest rate assumed Dividends are not assured but some will most likely be paid Assume a specific holding period For surrender cost index the cash value can be manipulated for common comparison periods Yearly Rate of Return Method Yearly Rate of Return for Policy Year t CVt Dt YPt Ft CVt 001 1 Pt CVt 1 CV cash value D dividends YP yearly price per 1000 of renewal term F death benefit P premium paid at beginning of year subscript indicates the policy year Yearly Rate of Return Method Example Same Policy Cash Value at end of 19 years 21 000 Dividend in 20th policy year 800 Cost of Yearly Renewable Term for Policyholder 5 00 per 1000 Yearly Rate of Return Method Example Yearly Rate of Return for Policy Year 20 22 000 800 5 00 100 000 22 000 001 1 1000 21 000 5 4 This policy is providing the equivalent of a 5 4 rate of return to the policyholder This should be compared with similar tax advantaged investments that are available Cost Comparison Question 2 Which cost comparison would be most appropriate for someone who is considering buying a life insurance policy holding it for 20 years and then if he survives cashing it in to pay for his retirement A Traditional Net Cost Index B Surrender Cost Index C Net Payment Cost Index D Equivalent Level Annual Dividend E Yearly Rate of Return Method Cost Comparison Question 3 Which cost comparison would be most appropriate for someone who has an existing policy and wants to determine if he should keep this policy or surrender it to buy another policy A Traditional Net Cost Index B Surrender Cost Index C Net Payment Cost Index D Equivalent Level Annual Dividend E Yearly Rate of Return Method
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