The Traditional Net Cost Method of Comparing Life Insurance Policies

The traditional net cost method works like this:

1. Add up the premiums on the ledger sheet over a stated period of time such as ten, fifteen, or twenty years.

2. Add up the dividends projected on the ledger sheet over the same period of time.

3. Subtract the total dividends from the total premiums to find the total net premiums paid over the period being measured.

4. Add the cash value and any “terminal dividends” shown on the ledger statement as of the end of such period (and minus any surrender charge) to find the net cash value.

5. Subtract the net cash value from the total net premiums to arrive at the total net cost of the policy over the selected period.

6. Divide the total net cost by the face amount of the policy (in thousands) and again by the number of years in the selected period to arrive at the net cost of insurance per thousand dollars of coverage per year. (In the figure below, numbers were calculated per $1,000 of coverage from the start.)

This is the easiest method to understand and use, but its simplicity is its weakness. This measure ignores the time value of money, which makes it possible to manipulate policy illustrations by shifting cash flows. Even without intentional manipulation, the traditional net cost method grossly understates the cost of insurance coverage and, in many cases, implies that the average annual cost of coverage is zero or negative. The result could be misleadingly low measures of policy costs. Few states sanction this method for comparing policy costs, although it can be used by the planner, together with the other methods described below, to make a quick and rough first-level relative comparison of policies.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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