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Email: bruce.roth@rothassociatesinc.com (Insurance)
Email: broth@fscadvisor.com (Securities)

Sample Policy Cost Analyzer

There are many different ways insurance companies and agents can present an insurance ledger which hides the actual costs inside a policy, especially since they don't have to disclose them. They can focus on the cash value at some future point, like 20 or 30 years. They can look at the internal rate of return (IRR) over time, or they can just look at the Interest-Adjusted Net Cost for a specific point in time (e.g. the 10th year or 20th year). But what is the policy really costing?

Determining the actual cost of insurance is really quite simple. There are 3 variables that make up the costs in every policy: interest, mortality and expenses (these include sales expenses, surrender charges, administration expenses, etc.). The basic formula is as follows:

• Take the first year premium and multiply it by the stated interest rate (or assumed rate of return in a variable policy).

• Add this result to the first year premium and you will get the theoretical cash value if there were no expenses.

• Subtract the illustrated cash value at the end of the first year, and you will be left with the "Implied Policy Cost" for that year.

To take the analysis one step further, subtract the cash value at the end of the year from the death benefit. This becomes your "Net Amount of Risk," which is the true amount of insurance that is being purchased. Divide the "Implied Policy Cost," from above, by the "Net Amount of Risk," and you will have calculated the cost per $1 of insurance. This method is a comprehensive way to compare policies because it considers all of the factors simultaneously (premium, death benefit, interest, mortality and expenses).

Why are cash values and policy costs important? Can't we just look at the premium and cash values over long periods of time - especially if we plan to keep the policy until death? The reality is that 50% of insurance policies lapse in the first 5 years, and 80% lapse by the 10th year. The high lapse rate may be due to policies becoming uncompetitive, tax law changes, changing needs, or changing ability to pay premiums. When a policy lapses, the cash value is returned to you. This makes it very important to know what your policy is costing during the early years as well as the later years. A loaded policy has a very large front-end load (typically 100% of the first year's premium) and therefore has very little or no cash surrender value for the first few years. Since there is no cash value in the early years, most agents want to draw your attention to the later years.

According to life insurance expert and Professor Emeritus of Insurance at Indiana University, Joseph Belth, "the main thing companies need to disclose … is the consumer's annual price per $1,000 of protection." Using his theories, we have developed an interactive spreadsheet, which allows us to calculate the "real" cost of insurance and eliminate any games that agents and insurance companies can play within their illustrations.

In summary, there are many different ways that an insurance illustration can be manipulated. The bottom line is that the expenses are still there, but they may be hidden one way or another. As a consumer, always request that an insurance agent show you a full disclosure ledger for the policy that they are illustrating. If one is not available, there are most likely some hidden costs that you should expose.

Our goal at Roth & Associates is to help our clients make informed decisions about their insurance needs. We do this by taking as much of the conflict of interest out of the buying process as possible. Offering a No-Load policy on a fee basis ensures that the client is aware of all the costs and expenses of the insurance.

Need more information? Contact us today ...