Introduction
Calculation of the future value of the life insurance policy and annual premiums for a given period is done with various methods. Such methods are traditional net cost method, surrender value cost method and net payment cost index. These methods are applicable in the calculation of the net cost per thousand per year of life assurance policy. Despite the fact, all the methods yield the same outcomes accuracy and factors in the time value of money. For the prediction of the future, the need to use time value of money is very imperative. Therefore this paper focuses on the calculation of the resulting premium value of the life assurance policy of a client for twenty years.
A participating ordinary life policy amounting to $10,000 is sold to an individual, age 35. The following cost data are given: Amount to which $1 deposited per year at the start of each year will accrue in 20 years at 5 percent $34.719
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(A). C ompute the annual net cost per $1000 of life insurance at the end of 20 years using the traditional net cost method.
Traditional net cos t calculation:
Total premiums for 20 years (20 ×34.719) $694.38
Fewer dividends for 20 years –30.00
Net premiums for 20 years 664.00
Less cash value after 20 years 824.00
Insurance cost for 20 years –160.00
Net cost per year (–160.00/20) –8.00
Net cost per thousand per year (–8.00/10) –0.80
From the calculation in the table above, the traditional approach of calculating net cost of the policy is simple to use fails to take into account the time value of money. The method uses the current value of the money and assumes that other factors like inflation are kept constant (Diacon, 2016). This method is advantages because it's straightforward and easy to understand. The problem is that the method can be used as the basis of advising customers and the clients of the life assurance policy.
B. Calculate the annual surrender cost index per $1000 of life insurance at the end of 20 years.
Annual surrender cost index can be computed as follows. For each $1000 of life insurance at the end of 20 years, the value of is $ 2.7 as shown below.
(b) Surrender cost index calculation:
Future value of the premiums $1842.40
Less future value of the dividends –79.59
Net premiums for 20 years 1,762.81
Less cash value after 20 years – 824.00
Insurance cost for 20 years 938.81
Interest-adjusted cost per year ($938.81.00/34.719) 27.04
Cost per thousand per year (27.04/10) 2.70
The surrender cost index is $2.70 per thousand per year
Surrender cost index is practical and uses future value of the money in the computation of the outcomes. These methods are more accurate for generating the value of the policy and the surrender cost index. The method factors in the time value of money and therefore its ideal for advising clients in a given insurance firms (Arora & Arora, 2014). About the traditional cost index, surrender cost index is more accurate and generate a reasonable value. For instance, the calculation from traditional approach is 8 per thousand per year while surrender cost index can be done as follows.
(c) Net payment cost index calculation:
Future value of the premiums $1,842.00
Less future value of the dividends –79.59
Net premiums for 20 years 1,762.81
Interest-adjusted cost per year: ($1,762.81/34.719) 50.77
Cost per thousand per year (50.77/10) 5.08
The net payment cost index is $5.08 per thousand per year.
The net payment cost index approach uses the future present value obtained from the surrender cost index method and thus is a subsequent process of surrender cost index calculation. Therefore from the approach above there are enormous cost variations among similar life insurance policies. Purchase of a high-cost system can cost thousands of extra dollars over the insurers’ life- time for the same amount of insurance protection. The traditional net cost method is incomplete because it overlooks the time value of money, and the insurance is often revealed to be free. The interest-adjusted method is a more accurate scheme for ascertaining the cost of life insurance. The time value of the dollar is taken into consideration by incorporating an interest factor to each component of cost (Cabral et al., 2014). If you are interested in abandoning the policy at the end of a specified period, the surrender cost index is appropriate. That maximizes commissions rather than meeting the client’s needs. To reduce the possibility of receiving bad advice or being sold the wrong policy, you should consider the professional qualifications of the agent. More importantly, officials who hold the former professional designations are expected to abide by a code of ethics that places their clients’ interests above their own. Agents who are currently studying for these professional designations should also be considered.
Annual rates-of-return data on the saving component in traditional cash-value life insurance policies are not readily available to consumers. However, the yearly rate-of- return method can be helpful to users in this regard. Life insurance death proceeds paid in a lump sum to a designated beneficiary are received income- tax-free by the recipient. If a policy is abdicated for its cash value, any gain is taxable as usual income. If the cash value is more than premiums paid by any dividends, the excess amount is taxed as ordinary income. The yearly increase in cash value on a permanent life insurance policy is not taxable income to the system owner.
Conclusively, calculation of the future value of the premiums and cost of the system requires the use of the future value to determine accurate and more precise value. The use of the surrender cost index methods in the determinations of the premium value is more acceptable and forms the basis of decision making. Therefore other methods may be used for the provision of advice to the clients, but surrender value method remains to be ideal in the calculation of the surrender cost.
References
Arnold, U. &. (2015). Economic risk analysis of decentralized renewable energy infrastructures–A Monte Carlo Simulation approach. Renewable Energy , 227-239.
Arora, N. &. (2014). Insurance Premium Optimization: Perspective of Insurance Seeker and Insurance Provider. Journal of Management and Science , 43-53.
Bowne, B. P. (2015). Patent No. U.S. Patent No. 8,930,229. Washington, DC: U.S.Patent and Trademark Office.
Cabral, M. G. (2014). Does privatized health insurance benefit patients or producers? Evidence of Medicare Advantage (No. w20470). National Bureau of Economic Research.
Diacon, S. (. (2016). A guide to insurance management. Springer.
