Magazine article The CPA Journal

Evaluating New Life Insurance Products

Magazine article The CPA Journal

Evaluating New Life Insurance Products

Article excerpt

The complexities of life insurance provide CPAs with an excellent opportunity to advise clients on their personal financial and investment problems. Because many current insurance products combine insurance with an investment component, proper analysis can be a daunting task.

In recent years, new life insurance products have proliferated. Single-premium life, variable life, universal life, and variable universal life, are all life insurance products that have been created in the past 15 years. These new products are largely a reaction of the insurance industry to consumer demand for investment products that carry higher rates of return than were historically earned on traditional whole-life contracts.

The success of the new products in the marketplace is evidence that promises of higher returns have been well received by insurance purchasers. These new policies now account for almost half the life insurance sold in recent years. In terms of expected return, many of the new policies are, without question, superior to their older cousins. This fact does not mean, however, that insurance purchasers should automatically sign on the dotted line. Before such products a purchased, there are at least three hard questions that should be asked and answered.

* Is this policy the best way to meet the need for insurance?

* How does this policy work in comparison with traditional life insurance contracts?

* How can the rate-of-return promised by the seller of the policy be evaluated?

Unless an independent evaluation of this issue can be made and articulated, it is unlikely the best interests of the prospective purchaser will be served by such policies. These questions are easily answered by analyzing the rate of return earned on the investment component of these products.

How Does Life Insurance Work?

The premium charged by every life insurance contract, from inexpensive term insurance, to traditional whole-life policies, to the newest universal-life contracts, must contain a mortality charge and an expense load. In addition, the premiums for many policies contain a savings increment. The premiums for term-insurance policies generally contain just the mortality charge and expense load, while the premiums for cash-value policies (sometimes called whole-life policies) contain the additional increment for savings.

Computing the Costs of Mortality

The mortality charge, which every policy must contain, is based on an estimate of the dollars that must be collected from all policyholders in a given year to pay death benefits to the policyholders expected to die during that year. For example, suppose a company sells a $100,000 insurance contract to each of 1,000 40-year-old males.

Table 1 (one of several mortality tables currently used by insurance companies) shows that 3.02 of those 1,000 policyholders are expected to die during their 40th year of life. (Table 1 omitted) The appropriate mortality charge for the first year of the policy is thus easily computed:

Expected deaths per 1,000 policyholders -- 3.02

x Benefit paid per death -- $100,000

= Total dollars required to pay benefits -- $302,000

+ Total policyholders in age bracket -- 1,000

= Mortality charge per policy holder -- $ 302

As can be seen from this example, the mortality charge collected by the insurance company in the first year is exactly sufficient to pay for the deaths predicted to occur in that year. Remember though, every passing year makes each of the surviving policyholders one year older. Table 1 shows that the expected number of deaths per 1,000 policyholders increases to 3.29 at age 41, causing the mortality charge for $100,000 worth of insurance to increase to $329 at that age. Similarly the cost must grow to $671 at age 50, $2,542 at age 65, and so on.

You may have also observed the mortality charge grows very rapidly at the older ages, reaching $100,000 (100% of the amount of the death benefit) by age 99. …

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