Evaluating and comparing life insurance policies is complicated. After determining how much life insurance you need, you must decide what type of life insurance to buy. Should you buy term insurance? A whole life policy? A flexible insurance product such as universal life? Or, if you already own a life insurance policy, you may think about replacing it from time to time. How can you be sure that the policy you own is better than another one? When comparing life insurance alternatives, you want to find the policy that’s best for you and one that will match your protection-planning philosophy. You may be buying a life insurance policy mainly for its protection value, or you may be interested in life insurance as an investment.
One of the difficulties in comparing policies is that it’s not easy to find objective information about the true cost or investment value of a policy. As a result, you may end up purchasing a policy that’s not right for you or, worse, end up replacing a good policy with an inferior one. Although nothing is foolproof, several methods do exist that can help you compare and evaluate life insurance policies. They use mathematical formulas to determine the cost of protection and the rates of return received on policies with an investment component. They can also help you compare policies of a similar type (term with term, for instance) or, in some cases, policies of differing types (term with whole life, for instance).
Mathematical Methods Used to Evaluate and Compare Life Insurance Policies
The Baldwin Method
The Baldwin method allows you to determine the annual rate of return you are receiving on the savings (investment) component of a permanent life insurance policy. It takes into consideration the consequences of borrowing or not borrowing funds from the policy, as well as the effect of taxes on the rate of return. In addition, you can also determine the value of the protection component of the policy if this is important to you as well.
The Belth Methods: Yearly Price of Protection and Yearly Rate of Return
The aim of the Belth yearly price of protection method is to help you to determine whether a life insurance policy you are considering is competitively priced, rather than help you find the lowest price policy available. Using a formula, you calculate the yearly price per $1,000 of protection and compare it against a table of benchmark prices. The Belth yearly rate of return method can be used to determine whether the rate of return you are receiving on the savings component of a cash value policy is good, fair, or poor. Using a formula, you calculate the yearly rate of return on the savings component of a policy for several years. If the return is 6 percent or more, the rate of return is good; approximately 5 percent, fair; and approximately 4 percent or less, poor.
Cash Accumulation Method
The cash accumulation method may be used to compare both similar and dissimilar policies (e.g., term with term or term with permanent) where premiums are different. The premium difference is accumulated in a hypothetical side fund at an assumed interest rate, then compared with the cash or face value of the other policy to determine which is the better value.
Equal Outlay Method
The equal outlay method assumes that the policyholder pays (outlays) the same premiums for each policy and purchases equivalent death benefits every year. The goal is to find the policy with the highest death benefit and cash values. It can be used to compare both similar and dissimilar policies but is often used to compare flexible premium policies.
Interest-Adjusted Cost Methods: The Net Payment Index and the Surrender Index
In the 1970s, the National Association of Insurance Commissioners (NAIC) issued regulations requiring insurers to provide buyers with information that would help them compare the cost of life insurance policies. Two indices—the net payment index and the surrender cost index—must be included as part of sales illustrations that show how an insurance product might perform over time given that certain assumptions (such as interest rate and dividends) are correct. The net payment cost index assumes that the policy will stay in force and estimates how much $1,000 worth of coverage will cost you per year (your net premium). The net payment cost index may be useful to you if you are buying life insurance mainly for its protection value. The surrender cost index may be useful to you if you are buying life insurance as an investment, because it measures the cost of insurance, taking into account the cash value aspect. The surrender cost index assumes that the policy will be surrendered at a certain time.
Linton Yield Method
The Linton yield method can be used to analyze the savings (investment) portion of a permanent life insurance policy. The Linton yield is the average rate of return earned on the investment portion of the policy over a certain time period.
In coming weeks we’ll go into more detail on each of these methods. If you have questions, contact the experts at Henssler Financial:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Disclosures: The following information is reprinted with permission from Forefield, a division of Broadridge Financial Solutions, Inc. This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
