(5 Hours) “When you buy life insurance, it’s relatively easy to compare first-year premium costs. But that figure tells you nothing about what the policy will cost over the long run.” Consumers Union
04/18/2024 Copyright @ by Sangharsh Regmi All rights reserved 1
DETERMINING THE COST OF LIFE INSURANCE The cost of a life insurance policy is the difference between what you pay and what you get back. If you pay premiums and get nothing back, the cost of the insurance equals the premiums paid. However, if you pay premiums and later get something back, such as the cash value and dividends, your cost will be reduced. When determining the cost of life insurance, four major factors must be considered: 1. Annual premiums 2. Dividends 3. Cash values 4. Time value of money 04/18/2024 Copyright @ by Sangharsh Regmi All rights reserved 2 Two cost methods that consider some or all of the preceding factors are : Traditional net cost method and Interest-adjusted cost method A. Traditional net cost method : Under the traditional net cost method, total expected dividends to be received during the same period and the cash value at the end of the period are then subtracted from the total premiums to determine the net cost of life insurance. The traditional net cost method has several defects and is misleading: It does not consider the time value of money : Interest that the policyholder could have earned on the premiums by investing elsewhere is not considered. In addition, the insurance illustration often showed the insurance to be free (to have a negative cost) : This is contrary to common sense, because no insurer can provide free insurance and remain in business.
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Assume that the annual premium for a $10,000 ordinary life insurance policy issued to a female, age 20, is $132.10. Estimated dividends over a 20-year period are $599, and the cash surrender value at the end of the twentieth year is $2294. Calculate net cost per $1000 per Year.
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reserved Exhibit: Traditional Net Cost Method For example, assume that the annual premium for a $10,000 ordinary life insurance policy issued to a female, age 20, is $132.10.
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B. Interest-adjusted cost method : The interest-adjusted cost method is more accurate because it considers the time value of money by applying an interest factor to each element of cost . Interest-adjusted cost indices can be used to compare policies across insurers There is a wide variation in costs indices across insurers – it pays to shop around Most consumers use premiums as a basis for comparison, but agents will supply cost indices There are two principal types of interest-adjusted cost indexes, I. Surrender cost index II. Net payment cost index
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I. Surrender cost index: The surrender cost index measures the cost of life insurance if you surrender the policy at the end of some time period, such as 10 or 20 years.
Assuming that annual
dividends are accumulated at 5% and becomes $824 at the end of 20th year.
Divide by 34.719 i/o 20 to show
compounding effect of 20 years.
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II. Net payment cost index: The net payment cost index measures the relative cost of a policy if death occurs at the end of some specified time period, such as 10 or 20 years. It is based on the assumption that you will not surrender the policy. Therefore, it is the appropriate cost index to use if you intend to keep your life insurance in force.
The net payment cost index is
calculated in a manner similar to the surrender cost index except that the cash value is not subtracted. Bcoz when death occurs, policy nominee get death benefit not the cash surrender value/maturity amount
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Using Interest-Adjusted Cost Data (Obtaining cost information) If you are approached to buy life insurance, you should ask the agent to give you interest-adjusted cost data on the policy. You should also request similar information from other insurers before you buy. If you use interest-adjusted cost data to compare policies, keep in mind the following points: Shop for a policy and not an insurer. Some insurers have excellent low-cost policies at certain ages and coverage amounts, but they are not as competitive at other ages and coverage amounts. Compare only similar plans of insurance. You should compare policies of the same type with the same benefits. Otherwise, the comparison can be misleading. 04/18/2024 Copyright @ by Sangharsh Regmi All rights reserved 9 Ignore small variations in the cost index numbers. Small cost differences can be offset by other policy features or by services that you can expect to get from an agent or insurer. Cost indexes apply only to a new policy. The cost data should not be used to determine whether to replace an existing policy with a new one The type of policy you buy should not be based solely on a cost index. You should buy the type of policy that best meets your needs, such as term, whole life, or some combination. Once you have decided on the type of policy, then compare costs.
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RATE OF RETURN ON SAVING COMPONENT The annual rate of return earned on the savings component of a policy is an important consideration if you intend to invest over a long period of time. I. Linton yield: The Linton yield is the average annual rate of return on a cash-value policy if it is held for a specified number of years. Current information is not readily available to consumers, so the method has limited use. II. Yearly Rate-of-Return Method : The yearly rate of return method is based on a formula:
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where i = yearly rate of return on the saving component, expressed as a decimal CV = cash value at end of policy year D = annual dividend YPT = assumed yearly price per $1000 of protection (see benchmark prices) DB = death benefit P = annual premium CVP = cash value at end of preceding policy year The information needed for the calculation is readily available to consumers
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i = yearly rate of return on the saving component, expressed as a decimal CV = cash value at end of policy year D = annual dividend YPT = assumed yearly price per $1000 of protection (see benchmark prices) DB = death benefit P = annual premium CVP = cash value at end of preceding policy year Copyright @ by Sangharsh Regmi All rights 04/18/2024 13 reserved TAXATION OF LIFE INSURANCE Life insurance proceeds paid in a lump sum to a designated beneficiary are generally received income-tax free The interest component of periodic payments is taxable as ordinary income Premiums are generally not deductible Dividends are not taxable, but interest on dividends retained is taxable If a policy is surrendered for its cash value, any gain is taxable as ordinary income Proceeds from a life insurance policy are included in the gross estate of the insured for federal estate-tax purposes if: the insured has any ownership interest they are payable to the estate The proceeds may be removed from the gross estate if the policyowner makes an absolute assignment of the policy to someone else The policyowner must make the assignment more than three years before death 04/18/2024 Copyright @ by Sangharsh Regmi All rights reserved 14 A federal estate tax is payable if the decedent's taxable estate exceeds certain limits: A tentative tax on the taxable estate value is calculated The gross estate includes property you own, one-half of the value of property owned jointly with your spouse, life insurance death proceeds in which you have ownership interest The gross estate may be reduced by certain deductions, such as a marital deduction, in determining the taxable estate The taxable estate may be reduced or eliminated by a tax credit called a unified credit The amount of property exempt from taxation will increase in the future Federal estate taxes are scheduled to expire Tax will be reinstated 04/18/2024 Copyright @ by Sangharsh Regmi All rights reserved 15 TAXATION OF LIFE INSURANCE IN NEPAL Tax at the rate of 5% shall be charged on the dividend paid. The existing TDS on the premium paid has been abolished from previous Fiscal year. As per tax rules of Nepal, a person can save taxes on up to maximum of NPR. 20,000/- of his / her earnings, invested in a LIFE INSURANCE POLICY, per annum. It's not only discount but an amount of 20,000 will be completely tax free. For example if that 20,000 falls in the bracket of 25% income tax then you'll save NPR. 5000/-.
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The taxable income computed as above is taxed as follows:
Tax Individual Couple
rates 1% 160,000 200,000 15% 160,000 to 260,000 200,000 to 300000 25% 260,001 to 2,500,000 300000 to 2,500,000 40% Above 2,500,001 Above 2,500,001
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SHOPPING FOR LIFE INSURANCE Developing a sound life insurance program involves seven steps, as illustrated in figure;
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Determine Whether You Need Life Insurance The first step is to determine whether you need life insurance. If you are married or single with one or more dependents to support, you may need a substantial amount of life insurance. You may also need life insurance if you have a temporary need, such as paying off the mortgage on your home. However, if you are single and no one is currently dependent on you for financial support, you do not need life insurance, other than a modest amount for burial purposes . Thus, it is a waste of money to buy life insurance when it is not needed.
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Estimate the Amount of Life Insurance You Need The needs approach is a practical method for determining the amount of life insurance to purchase. Persons with dependents often need surprisingly large amounts of life insurance. In determining the amount needed, you must consider your family’s present and future financial needs, potential survivor benefits from Social Security, and other financial assets currently owned. If you carry a sufficient amount of life insurance, it is unnecessary to purchase additional life insurance as supplemental coverage. These coverages are endless. For example, flight insurance sold at airports is a bad buy for most consumers because commercial jets rarely crash.
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Decide on the Best Type of Life Insurance for You The next step is to select the best type of life insurance policy for you. The best policy is the one that best meets your financial needs . If the amount of money you can spend on life insurance is limited, or if you have a temporary need, consider only term insurance. If you need lifetime protection, consider whole life insurance or universal life insurance. However, remember that the annual rates of return on cash-value policies can vary enormously. Also, avoid purchasing a policy that you cannot afford. Many policyholders let their policies lapse during the early years, especially cash-value policies. Because of a surrender charge, there is little or no cash value available during the early years if the policy is surrendered. If you drop a cash-value policy after a few months or years, you will lose a substantial amount of money. Be sure you can afford the premium . 04/18/2024 Copyright @ by Sangharsh Regmi All rights reserved 21 Decide Whether You Want a Policy That Pays Dividends In recent decades, participating life insurance policies that pay dividends generally have been better buys than nonparticipating policies because of high interest rates that permitted insurers to raise their dividends. If you believe that interest rates will be higher in the future, you should consider a participating policy because excess interest has a powerful impact on dividends. However, if you believe that interest rates will remain at lower levels in the future, then consider a nonparticipating policy. Policies that do not pay dividends generally require a lower premium outlay. You can ignore the above step if you are purchasing a variable life insurance, universal life insurance, or variable universal life insurance policy. These policies are nonparticipating and do not pay dividends.
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Shop Around for a Low-Cost Policy One of the most important suggestions is to shop carefully for a low-cost policy. There is enormous variation in the cost of life insurance. You should not purchase a life insurance policy from the first agent who approaches you. Instead, you should compare the interest-adjusted cost of similar policies from several insurers before you buy . Otherwise, you may be overpaying for the insurance protection. When you shop for a low-cost policy, you should also consider no-load or low-load life insurance . Some life insurers sell insurance directly to the public by using telephone representatives or fee-only financial planners. The major advantage is that marketing expenses are substantially lower than for policies sold by agents to the public.
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Consider the Financial Strength of the Insurer In addition to cost, you should consider the financial strength of the insurer issuing the policy. Some life insurers have become insolvent and have gone out of business. Although all states have state guaranty funds that pay the claims of insolvent life insurers, there are limits on the amount guaranteed. Although death claims are paid promptly, you may have to wait years before you can borrow or withdraw your cash value. Thus, it is important to buy life insurance only from financially sound insurers. A number of rating organizations periodically grade and rate life insurers on their financial strength. 04/18/2024 Copyright @ by Sangharsh Regmi All rights reserved 24 Deal with a Competent Agent You should also deal with a competent agent when you buy life insurance. Selling life insurance is a tough job, and only a relatively small proportion of new life insurance agents are successful. Most new agents receive only a minimum amount of training before they are licensed to sell life insurance. New agents also are often placed under intense pressure to sell life insurance. Even mature agents are expected to sell a certain amount of insurance. As a result, some agents have engaged in deceptive sales practices by misrepresenting the insurance to clients or by recommending policies that maximize 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 (who are abide by a code of ethics). 04/18/2024 Copyright @ by Sangharsh Regmi All rights reserved 25
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