What is the 'Yearly Price Of Protection Method'

The yearly price of protection method is used by actuaries in the insurance industry to find out the cost of protection of a life insurance policy that includes a savings component, such as a cash value life insurance policy. The calculation gives an estimate of the cost in any given year of the net death benefit of the policy that the insurer would have to pay out.

BREAKING DOWN 'Yearly Price Of Protection Method'

Insurers view any policies that are paid out as a cost, since they require the insurer to distribute funds to the policyholder or the policyholder's estate. The yearly price of protection method helps insurers establish an estimate of the cost of life insurance plans they have written that include a savings component. An example of this type of policy is a cash value life insurance policy. In this type of plan, part of the policyholder's premium is allocated to a savings account that earns a modest amount of interest. In the event of death, the insurer must pay out both the life insurance benefit as well as the accumulated value of the savings account component of the policy.

Calculating the Yearly Price of Protection

The cost to the insurer of a life insurance policy with a savings component is based on the cash value at the beginning of the year. Any premiums paid for that year are added to the initial cash value. The sum of these two components is then multiplied by an assumed interest rate factor of (1+i). This interest rate factor is determined by the insurer, and represents the rate of return on the savings account portion of the policyholder's insurance plan. The result of this calculation provides the forecasted cash surrender value of the policy. Add any dividends that will be paid for the year. Divide this total by the face value of the policy minus the year-end cash surrender value. This gives the yearly price of protection for the policy.

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