Buying permanent life insurance can be confusing. The illustrations are hard to decipher, and every company’s products have different fees, which makes it difficult to compare policies directly. Here's a guide for comparing life insurance policies.
Internal Rate of Return
When buying permanent life insurance primarily for the death benefit, the goal is to objectively measure and evaluate the return on the dollars allocated to the insurance premium. Fortunately, there is a way to cut through the confusion by using the internal rate of return (IRR) of the death benefit as an evaluation tool. IRR is a common measure used to evaluate investments or projects. It measures the interest rate at which the net present value of the premium paid equals the net present value of the death benefit.
Life insurance has a very high IRR in the early years of policy, often more than 1,000%. It then decreases over time. This IRR is very high during the early days of the policy because if you made only one monthly premium payment, and then suddenly died your beneficiaries would still get a lump sum benefit.
The best way to truly evaluate a policy is to request an optional report that shows the IRR of a policy.
When buying coverage, it’s best to work with an independent broker who can offer guidance about underwriting and provide illustrations from different companies. Here are some issues to consider when buying coverage:
- How much death benefit is needed?
- Your age and health. (Insurers have different preferred client profiles and rate health issues differently which affects the cost of insurance.)
- When the death benefit is needed—at the first death, second death or at both deaths? In many cases, a survivorship policy that insures two lives has a lower premium and higher IRR than an individual policy.
- The financial rating and stability of the insurance company.
- Who takes the risk? Policies with a no-lapse guarantee have set premiums and costs but build little cash value. As long as the premium is paid on time the death benefit is guaranteed by the insurer to remain in force until a defined age. With non-guaranteed policies, the risk is shared. The premium is determined in part by an assumed rate of return. Thus, the higher the assumed rate of return the lower the illustrated premium. However, if the assumed return is not achieved, or the insurer increases fees in the policy then additional premium payments may be required, or the policy will lapse.
The next step is to select companies and request illustrations. To be consistent all illustrations should:
- Have either the same level premium or death benefit.
- Last until a specified age.
- Use the same premium payment mode – monthly, quarterly or annual.
- Use a consistent assumed interest rate for non-guaranteed policies.
- Exclude any riders that have an additional cost.
- Include the IRR report.
Here's how to evaluate the illustrations:
- Decide on a guaranteed or non-guaranteed death benefit.
- Review the financial ratings of the insurer.
- Determine, which policy, offers the highest IRR at the lowest premium.
Assuming all other factors are equal such as premium, death benefit, financial ratings for the insurance company, etc. The policy with the highest IRR on the death benefit over time may be the better choice.
Once a selection is made you will need to submit an actual application and go through underwriting. In some cases, the offer from the insurer may have a different rating. If this occurs your broker can help shop the case to other companies to see if a more favorable offer is available. (For related insight, read about the biggest life insurance companies in the US.)