Once a person/client has determined which policy they would like to purchase it is necessary to analyze the cost versus the overall benefit. When determining the cost of the policy a person must include the opportunity cost as well as the actual out-of-pocket expense. There are two methods used to analyze the cost/benefit.

  • Surrender Cost Index- This analysis is useful if a person is considering surrendering the policy 10 or 20 years in to the contract.
  • Net Payment Cost Index- This analysis is useful if a person is concerned with the death benefits and would like the policy compared to the death benefits of similar policies.

Generally, the smaller the index numbers, the more beneficial the policy. For the index to be accurate a person has to compare similar policies. Also, the analyses are only useful in comparing new policies.

How to calculate the surrender cost index:
1. Calculate the Future Value of the following...
  • Assume that premiums are paid at the beginning of the year on an annual basis (payment). The account they are paid into will grow at a specified interest rate, i.e. 5%. (interest) Assume that this will be done for a specified number of years. The present value should be zero. Write down the Future Value
  • Assume that the dividends paid are paid at the end of the year (payment) and placed into an account earning a specified interest rate, i.e. 5% (interest). Assume that this will be done for the same number of years used in the previous step. Again, the present value should be zero. Write down the future value.
  • Assume an expected cash value for the number of years used in the previous step.

2. Subtract the expected cash value (step c) and the future value of dividends paid (step b) from the future value of premiums paid (step a). example (step a - step c - step b = cost)

3. Discount the results of step 3 back at 5% for the number of years used in the previous steps to determine a beginning year annuity. (compute the payment, not the present value)

4. Divide the results of step 3 by the number of thousands of dollars of the death benefit. Example: if the death benefit is $500,000, step 3 would be divided by 500. This gives you the estimated annual cost. The lower the number the better.


Net Payment Cost Index

Related Articles
  1. Managing Wealth

    Life Insurance With an Increasing Death Benefit

    Why buy a life insurance policy with an increasing rather than level death benefit
  2. Insurance

    Understanding Cash Surrender Value

    The amount of money an insurance company pays the owner of an insurance policy if the policy is voluntarily surrendered prior to the event that is insured
  3. Financial Advisor

    How to Compare Permanent Life Insurance Policies

    How you can use the internal rate of return to compare and purchase a permanent life insurance policy.
  4. Insurance

    How a Death Benefit in a Variable Annuity Works

    A look at how the death benefit in a variable annuity works.
  5. Insurance

    Cashing in Your Life Insurance Policy

    Tough times call for desperate measures, but is raiding your life insurance policy even worth considering?
  6. Managing Wealth

    Mistakes to Avoid When You Own Life Insurance

    How to avoid some common mistakes that can cause tax and inheritance problems when you own life insurance.
  7. Insurance

    6 Ways To Capture The Cash Value In Life Insurance

    If you die with cash value left in your life insurance policy, the money goes to the insurance company – not to your beneficiaries. Here's what to do instead.
  8. Investing

    Understanding The Time Value Of Money

    Find out why time really is money by learning to calculate present and future value.
  9. Insurance

    Cashing In Your Life Insurance

    In tough economic times, tapping into a life insurance policy can provide a needed source of funds.
  10. Investing

    Calculating Future Value

    Future value is the value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today.
Frequently Asked Questions
  1. Depreciation Can Shield Taxes, Bolster Cash Flow

    Depreciation can be used as a tax-deductible expense to reduce tax costs, bolstering cash flow
  2. What schools did Warren Buffett attend on his way to getting his science and economics degrees?

    Learn how Warren Buffett became so successful through his attendance at multiple prestigious schools and his real-world experiences.
  3. How many attempts at each CFA exam is a candidate permitted?

    The CFA Institute allows an individual an unlimited amount of attempts at each examination.Although you can attempt the examination ...
  4. What's the average salary of a market research analyst?

    Learn about average stock market analyst salaries in the U.S. and different factors that affect salaries and overall levels ...
Trading Center