Overview

Main Menu Name: Net Cost

Calculates the net coverage, the net coverage per thousand dollars of face amount, the opportunity cost on cash value, the "real" cost of coverage, and the net cost per thousand of coverage.

In this article:

• Background
• Why should I use this calculator?
• Getting Started
• Entering Data
• Results

Background

Life insurance costs are typically calculated in terms of the price per thousand dollars of coverage. To compare two or more policies, it is important to be able to equate each policy payment to be the cost per thousand dollars of protection.

It is easy to compute the cost per thousand of term insurance. Divide total cost per year by the number of thousands of dollars of coverage. For instance, if the policy provides $120,000 of coverage, there would be 120 units of coverage. If the premium (including any policy fee) is $280, then the cost per thousand of coverage would be $280 / 120 = $2.33.

Whole life presents a more complicated problem. The problem stems from the fact that policy cash value is involved. An "opportunity cost" is incurred. That is, the cash values, if not "invested" in the whole life contract, could have been put to work elsewhere. Stated in a slightly different manner, the policyholder has allowed someone else (the insurer) to use the money and has deferred personal use until a later date. It is necessary to factor in a "discount" (interest) rate to reflect a conservative after-tax rate of return that (over a long period of time) could have been earned on the money had it not been "loaned" to the insurer.

Current cash value, a key number in the equation, is found in the policy cash value chart. The current cash value is based on the age of the insured person at the time the policy was purchased and the length of time the policy premiums have been paid. The increase in cash value is the difference between last year and this year's cash value. This number can be obtained from the insurer.

Dividends paid on "participating" (mutual) policies must be considered in computing net cost. Dividends can be considered either by appropriately reducing the premium or by increasing the cash value.

Why should I use this calculator?

• To compare the cost of a term life policy to a whole life policy.
• To compare two or more whole life policies.

Getting Started

Life insurance costs are typically calculated in terms of the price per thousand dollars of coverage. To compare two or more policies, it is important to be able to equate each policy payment to be the cost per thousand dollars of protection.

It is easy to compute the cost per thousand of term insurance. Divide total cost per year by the number of thousands of dollars of coverage. For instance, if the policy provides $120,000 of coverage, there would be 120 units of coverage. If the premium (including any policy fee) is $280, then the cost per thousand of coverage would be $280 / 120 = $2.33.

Whole life presents a more complicated problem. The problem stems from the fact that policy cash value is involved. An "opportunity cost" is incurred. That is, the cash values, if not "invested" in the whole life contract, could have been put to work elsewhere. Stated in a slightly different manner, the policyholder has allowed someone else (the insurer) to use the money and has deferred personal use until a later date. It is necessary to factor in a "discount" (interest) rate to reflect a conservative after-tax rate of return that(over a long period of time) could have been earned on the money had it not been "loaned" to the insurer.

Current cash value, a key number in the equation, is found in the policy cash value chart. The current cash value is based on the age of the insured person at the time the policy was purchased and the length of time the policy premiums have been paid. The increase in cash value is the difference between last year and this year's cash value. This number can be obtained from the insurer.

Dividends paid on "participating" (mutual) policies must be considered in computing net cost. Dividends can be considered either by appropriately reducing the premium or by increasing the cash value.

Entering Data

1. Face Amount of Coverage:  Enter the face amount of the coverage on the policy.
2. Current Cash Value:  Enter the current cash value of the policy.
3. Annual Premium:  Enter the annual premium paid on the policy.
4. Increase in Cash Value this Year:  Enter the current year's increase in cash value.
5. Discount Rate:  Enter the discount rate of the policy.

Results

The program calculates the net coverage that is derived by subtracting the face amount from the cash value. It also calculates the net coverage per thousand, the opportunity cost on the cash value, the real cost, and the net cost per thousand.