Today’s Lecture - #18 Life Insurance Cost ComparisonsLife Insurance Cost ComparisonsTraditional Net CostTraditional Net Cost Index - ExampleSlide 5Cost Comparison Question 1Interest Adjusted Surrender Cost IndexInterest Adjusted Surrender Cost Index ExampleSlide 9Interest Adjusted Net Payment Cost IndexInterest Adjusted Net Payment Cost Index ExampleEquivalent Level Annual DividendProblems with the Interest Adjusted MethodsYearly Rate of Return MethodYearly Rate of Return Method ExampleSlide 16Cost Comparison Question 2Cost Comparison Question 3Today’s Lecture - #18Life Insurance Cost ComparisonsTypes of Cost ComparisonsUses of Cost ComparisonsLife Insurance Cost ComparisonsTraditional Net CostInterest-Adjusted Net Cost MethodsSurrender Cost IndexNet Payment Cost IndexEquivalent Level Annual DividendYearly Rate of Return MethodTraditional Net CostPremiums Paid- Dividends - Cash Value at the End of the Period= Net CostTraditional Net Cost Index = Net Cost____________ # Years x # $1,000 Policy FaceTraditional 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 YearsTraditional Net Cost Index -ExampleTraditional Net Cost Index =(20x1,000)-6,000-22,00020x100= -4.00The insurer gives you $4.00 each year forevery $1000 of life insurance coverage youbuy.Cost Comparison Question 1What is wrong with the Traditional Net Cost Index that it can show a negative cost?A) Life insurance can be very inexpensiveB) The values used must have been unrealisticC) The calculation was done incorrectlyD) It ignores the time value of moneyE) A negative cost index indicates the customer is paying a positive premiumInterest Adjusted Surrender Cost IndexAccumulated Value of Premiums at Interest- Accumulated Value of Dividends at Interest- Cash Value at End of Period= Total Interest Adjusted CostSurrender Cost Index =Total Interest Adjusted CostAnnuity Due Factor x # $1000 Policy FaceInterest Adjusted Surrender Cost IndexExampleSame Policy Assume 8% Interest Rate (i)Accumulated Value of Dividends = $10,000Annuity Due Factor for n years(1+i)(n+1) - (1+i) i(1.08) 21 - (1.08) = 49.423 .08Interest Adjusted Surrender Cost IndexExample(1000 x 49.423) - 10,000 - 22,000 49.423 x 100= $3.53Based 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 IndexAccumulated Value of Premiums at Interest- Accumulated Value of Dividends at Interest= Total Interest Adjusted Net PaymentsNet Payments Cost Index =Total Interest Adjusted Net PaymentsAnnuity Due Factor x # $1000 Policy FaceInterest Adjusted Net Payment Cost IndexExample(1000 x 49.423) - 10,00049.423 x 100= $7.98Based 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 DividendAccumulated Value of Dividends at InterestAnnuity Due Factor x # $1000 Policy FaceExample$10,00049.423 x 100= $2.02If 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 periodsYearly Rate of Return MethodYearly Rate of Return for Policy Year t =CVt + Dt + (YPt)(Ft - CVt)(.001) - 1 Pt + CVt-1CV = cash valueD = dividendsYP = yearly price per $1000 of renewal termF = death benefitP = premium paid at beginning of yearsubscript indicates the policy yearYearly Rate of Return MethodExampleSame PolicyCash Value at end of 19 years = $21,000Dividend in 20th policy year = $800Cost of Yearly Renewable Term for Policyholder = $5.00 per $1000Yearly Rate of Return MethodExampleYearly Rate of Return for Policy Year 20 =22,000+800+5.00(100,000-22,000)(.001) - 11000 + 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 2Which 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 IndexB) Surrender Cost IndexC) Net Payment Cost IndexD) Equivalent Level Annual DividendE) Yearly Rate of Return MethodCost Comparison Question 3Which 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 IndexB) Surrender Cost IndexC) Net Payment Cost IndexD) Equivalent Level Annual DividendE) Yearly Rate of Return