Named for actuary M. Albert Linton, the Linton yield method is a way to mathematically analyze the cost of a cash value life insurance policy. It makes the cash value policy equivalent to a combination of decreasing term insurance and a side fund (savings fund) so that the investment performance of the side fund over time can be evaluated. The information can then be used to compare the rate of return for one policy to the rate of return of a similar or dissimilar policy, primarily to determine which policy should be purchased. It can be particularly useful in comparing permanent insurance with term insurance. Decreasing term insurance has a level premium, but the death benefit decreases each year.
How it Works
The Linton yield method splits a permanent life insurance policy into a term insurance portion and a savings portion so that it can be compared with other life insurance policies. Here’s how the calculation begins:
The cash surrender value of the policy is subtracted from the face amount. The resulting figure is the net amount of risk, which is considered to be the term insurance portion of the calculation.
Then, based on the insured’s age, gender, and health, it’s determined how much the insured would have to spend to buy term insurance equivalent to the net amount of risk. This cost of protection is then subtracted from the policy’s annual premium amount. Also subtracted from the annual premium is the projected annual dividend. The resulting figure is the savings deposit portion of the policy.
Example: Todd owns a permanent life insurance policy with a face value of $100,000. His cash surrender value is $10,000, which is subtracted from the face amount of the policy. Thus, $90,000 is considered to be the term insurance portion of the policy. Based on Todd’s gender, age, and health, it’s determined that if Todd were to buy $90,000 worth of term life insurance, it would cost him $300 per year. Currently, he pays $900 per year for his permanent life policy and receives a dividend of $50 annually. So, the savings deposit (investment portion) of the policy is calculated like this:
|
Current Annual Premium
|
$900
|
|
Dividend:
|
-$50
|
|
$850
|
|
|
Cost of Protection
|
-$300
|
| Savings Deposit |
$550
|
After the savings deposit portion of the policy is determined, the Linton yield is calculated. It is the average rate of return on the savings (investment) component of the policy. The calculation, which is complex and requires the use of a computer, should be completed for a number of years (e.g. 5, 10, 15 or 20), because the rate of return in one year may be quite different than the rate of return in another.
After calculating the Linton yield, the results can be used to compare life insurance policies in order to decide which life insurance policy should be selected. According to the Linton yield method, the policy that has the highest yield (rate of return) is the better deal.
Strengths
Dissimilar Policies can be Compared
It’s difficult to compare permanent insurance with term insurance, but the Linton yield method provides a way to do this. It can help the individual who is considering replacing a whole life policy with term insurance evaluate whether buying the whole life policy is a better choice financially than buying the term policy and investing the difference.
Tradeoffs
Results May not Reflect True Cost of Policy
Because the calculation is based on insurance company projections (such as dividends and future cash values) as well as assumptions about term rates that may vary from company to company, the Linton yield method may produce results that don’t accurately measure the true cost of insurance. The results should not be considered a measure of the actual cost of an individual policy; rather, they should be used to compare one policy to another. When comparing policies, however, the individual must make sure that the term rates being used are the same for each policy and perform the calculation for several years.
If you have questions, contact the experts at Henssler Financial:
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- 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.
