Chapter 7 - Cost Comparison of Life Insurance Policies

Question 1

Regarding the Methods Used to Compare Life Insurance Policies, list the 4 relevant variables.

Answer 1

Annual premiums.
Cash values.
Dividends.
Time value of money applied to each variable.

Question 2

Detail the process of the Net Cost Method Calculation (example on back of card)

Answer 2

Select a period (e.g., 10, 20, 30 years).
Add total premiums for the selected period.
Deduct dividends for the selected period.
Deduct cash value at the end of the selected period from net premiums.
Calculate net cost per year by dividing insurance cost by the term.
Calculate net cost per $1,000 of insurance per year by dividing net cost per year by the face value in thousands.

Question 3

Describe the 5 weaknesses of the Net Cost Method.

Answer 3

Does not consider the time value of money.
Based on projected premiums, dividends, and cash values that are not guaranteed.
Assumes the insured keeps the policy until the end of the selected term.
Yields a cost per $1,000 that may be less than the true cost.
Sensitive to insurer’s assumptions in illustrations, which may be unrealistic.

Question 4

How effective is the Net Cost Method?

Answer 4

Not an effective method for comparing policies due to the mentioned weaknesses.

Question 5

List the 2 types of Interest-Adjusted Methods for comparing Life Insurance Policies.

Answer 5

Surrender Cost Index and Net Payment Cost Index

Question 6

Detail the process of the Surrender Cost Index Calculation (example on back of card)

Answer 6

Measures cost of insurance if surrendered after a selected term.
Calculate inflated value of all premiums at a fixed interest rate for the term.
Calculate inflated value of all dividends at the same rate, subtract from premiums.
Subtract cash value at the end of the term.
Determine insurance cost.
Calculate annual PMT with N = selected term and I/YR = interest rate.
Calculate cost per $1,000 per year.

Question 7

Describe the Net Payment Cost Index Method (an example of a calculation is on back of card, textbook provided no further details on how to do this.)

Answer 7

Measures relative net payment of a policy for a term assuming no surrender.
Similar to the surrender cost index but without cash value consideration.

Question 8

List the 2 advantages of the Net Payment Cost Index Method.

Answer 8

Takes into account the time value of money.
More useful than the traditional net cost method.

Question 9

List the 7 challenges of the Net Payment Cost Index Method.

Answer 9

Sensitive to insurer’s assumptions and selected term and interest rate.
Comparison problems if cash outlays are not equal.
Side investment fund may improve comparability.
Same problems as traditional net method regarding predictability of premiums, dividends, and cash values.
Insurers may manipulate values for favorable costs at routine intervals.
Conflicting results possible when comparing multiple policies.
Comparing different policy types using these methods may be misleading.

Question 10

List the 4 Rating Companies.

Answer 10

A.M. Best, Inc.: Ratings based on public information and management interviews.
Fitch: Uses public information and management interviews; may use public information alone.
Moody’s Investors Service: May assign ratings based on public information alone.
Standard & Poor’s Corporation: Rates companies only upon request.