Comparing Insurance

You know life insurance costs money, but how much? When you talk to an agent, they aren't always clear about how to decipher the policy illustration - yet this illustration is the most reliable way to figure out how much your level term life insurance policy is costing you. Cost is important because it's the only way to know whether you're making the right decision. If you pay in more than you benefit, it's a bad deal.


The Cost Index


Cost indexes take into account three main factors when comparing rates of any insurance: cash value, dividends, and premiums. Taking a look at the cost index will allow you to evaluate similar policies and make an informed decision. The better buy is always indicated by the smaller index number.


For term policies, there is no cash value and no dividend payment, so it's down to the premiums and how much of that is used to pay for the death benefit. With a level term policy, you're not dealing with a pure cost for insurance.


All level term policies have a "side fund" that the insurance company uses to guarantee that the premiums remain level for the length of the term. To establish this side fund, the insurer collects premiums in excess of the pure cost of the death benefit. Then, the insurer invests this excess. Later on, when the cost of insurance rises, the insurer will use the excess (plus interest) to hold down the premiums. The result? You pay a flat premium for a set period of time.


The cost index shows you how much you're paying per $1,000 of insurance. Because the insurer's clever investment scheme, the actual cost you pay is usually pretty low - even though the cost to insure you increases each year.


How To Use The Cost Index


The net payment index, which is what you'll see on your term policy illustration, is how you compare other similar policies. It's not useful to compare term insurance to cash value insurance in most instances because term policies are often only held for 10, 20, or 30 years, whereas whole life may be held for 50 years or more depending on how old you are when you first purchased the policy.


Use the net payment index to compare one term policy with another. You might be surprised to see that, even though a 10-year policy has a lower premium, a 30-year term policy has a lower cost of insurance and a higher initial premium. The 30-year policy is actually the better buy, despite its higher premium. In this way, premiums can be deceiving. Cost indexes are not.


What the net payment index allows you to do is look into the future. The 10-year term policy may have to be renewed if you need coverage beyond the 10 years. If you renew it, you'll pay a higher premium. Think of it in the same way that you buy groceries.


When you buy the small packages of frozen veggies at the store, the cost might be lower than the bulk bag of veggies, but the unit cost on the bulk bag is lower. If you plan on eating a lot of veggies, buying in bulk makes sense. It's the same with insurance, except that the discount happens due to time duration, not bulk. In other words, the longer you hold your insurance contract, the cheaper it gets.


How (and when) To Use The Surrender Index


While it's usually not a good idea to compare term insurance to whole life (or universal life), there are exceptions where the cost indices can be very valuable for just such a comparison. With cash value life insurance, the net payment index is typically higher in the early years of the policy and tapers off in the later years.


Likewise, the surrender cost is high in the early years and shrinks in later years. The surrender cost index is useful when trying to figure out how much a permanent policy costs if you cash in the policy at some future date. Because cash value is an important part of a cash value policy, the surrender index shows you the impact as it relates to the cash value.


This is useful if you want to know whether it makes sense to keep your term policy and build a separate savings or whether it makes more sense to just combine your insurance and savings together into a permanent policy. This can have important implications in regards to retirement planning, because insurance is often only one-half of an insurance plan. The other half is savings - savings that will one day replace your need for insurance.

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