Cost of Life Insurance

1
Cost of Life Insurance

• Lecture 17

2
Cost Factors

• In general, cost is difference between what you
  pay (premiums) and what you get back
• Annual premiums
• Cash values
• Dividends
• Time value of money
• Two Methods Net Cost MethodInterest Adjusted
  Method

3
Traditional Net Cost Method

• Totals premiums
• Subtracts
• Total dividends
• Cash value at end
• Ignores time value of money
• Assumes surrender constant dividend
• Understates true cost of insurance

4
Traditional Net Cost Method
5
Interest Adjusted Method

• Considers time value of money
• Surrender cost index measures the cost of life
  insurance if you surrender the policy in 10 or 20
  years
• Calculates FV of premiums at 5
• Calculates FV of dividends
• Calculates Annuity amount
• Convert to cost/1000

6
Surrender Cost Index
7
Net Payment Cost Index

• Measures relative cost of a policy assuming
  policy is not surrendered
• Calculated like surrender cost except that cash
  value is not subtracted

8
Net Payment Cost Index
9
Comparison of Life Insurance Costs for Selected
Companies
10
Obtaining Life Insurance Premium Quotes Online
Be sure to compare apples with apples
11
Rate of Return on Saving Component

• Whole life is a bundled product
• Term insurance (permanent)
• Savings plan
• Total premium
• Cost of insurance protection
• Administrative costs (plus insurers profits)
• Savings component
• Dividends deducted from premium

12
Linton Yield

• See previous slide
• Calculate rate of return which causes the savings
  component to compound into the guaranteed cash
  value at the end of a specific period
• Complex information not readily available

13
Yearly Rate of Return Method

• Rate (value at end cost of term) / value at
  beginning
• I (CVD) YPT(DB-CV).001 - 1
• (P CVP)
• Where CV cash value YPT price/1000
  protection (see next slide) DB death benefit
  P premium D dividend

14
Benchmark Prices
15
Example

• 100,000 participating policy
• CVP 7,800 CV 9,200
• 42 year old
• P 1,500
• D 400
• I (9200400) 4(100000-9200).001 -1
• (1500 7800)
• 7.1

16
Taxation

• Lump-sum to beneficiary generally income tax
  free
• Settlement option principal tax free interest
  taxed as ordinary income
• Dividends on policies income-tax free
• Interest on dividends retained ordinary
• Increase in cash value income-tax free
• Surrender gain is ordinary

17
Estate Tax

• If insured has incidents of ownership, the entire
  proceeds are included in the estate
• Right to change beneficiary
• Right to borrow against or surrender
• Included in estate if payable to estate
• Can be removed from estate with absolute
  assignment

18
Shopping for Life Insurance
19
Rating Categories of Major Rating Agencies