Discuss about a Case Study on Life Insurance for Legal Contract ?
Life insurance can be defined as a legal contract or agreement between insurer and insurance policy holder in which it is promised on the part of the insurer to the policy holder or his or her designated beneficiary to pay a sum of money after death of the insured person (Cockerell, 2005). This thesis provides both theoretical and analytical ideas about the concepts of traditional net cost method and interest adjusted method that are applicable in the process of computing cost of life insurance.
Presently, it has become necessary on the part of policy holders to understand these concepts so that they can avoid the losses that may occur to them as a result of inaccurate cost variations that exist most of the times among similar or comparable life insurance policies(Murphy, 2010). Because of these erroneous cost variations, different levels of costs get associated with the same level of insurance protection offered by different insurance companies. This means that purchase of high cost policy do not always confirm additional insurance protection thereby resulting in wastage of the extra dollars paid (McKnight et al., 2012). Thus, in order to avoid such circumstances, it is necessary to understand the advantages or benefits of interest adjusted cost method over traditional cost method and this thesis is expected to pave for the same.
It is important to accumulate and disseminate detailed ideas regarding the concepts of traditional cost methods and interest adjusted cost methods of calculating cost of life insurance so that the advantages and disadvantages of one over the other can be comprehended on the part of policy holders in an efficient manner and cost methods associated with highest levels of advantages can be applied so as to make sure minimum loss and maximum advantage from a life insurance policy.
The main purposes of the paper are to communicate the advantages of the interest adjusted cost method over traditional cost method to the users of insurance policy and to educate purchasers of life insurance policies on how to deal with a life insurance agent in the process of purchasing life insurance policies.
This thesis covers case study summary and the theoretical and practical discussions on the advantages of interest adjusted cost method of calculating insurance policy cost over traditional cost method. This paper also discusses how clients should assess quality of insurance agents before purchasing insurance policies.
Background information
It has often been observed that due to the presence of erroneous variations in costs of life insurance among comparable life insurance policies considerable amounts of additional costs are incurred on the part of the insurance policy holders for the same amount of insurance protection (Hardy et al., 2007). In other words, costs vary across similar sort of insurance protections offered by different policies of different companies and this most of the times result in incurrence of extra dollars on the part of policy holders (Vogel & Blair, 2007).
It is important on the part of the clients to assess relative advantages and disadvantages of costing methods and apply the same in a beneficial manner while selecting insurance policies (Maclean, 2009). It is also important on the part of researchers to communicate to the users of insurance policy holders that when it comes to insurance policy cost, interest adjusted cost methods are more accurate that traditional cost methods. This is mainly because of the fact that traditional net cost method used in the process of ascertaining life insurance cost fails to take in to account time value of money and these shows insurance to be free which is false. On the other hand, interest adjusted cost methods are more accurate in the sense that they take in to account time value of money through application of interest factor to each cost element (Zartman & Price, 2011). Again, in the context of traditional cash value life insurance policies, data on annual – rates – of – return are not easily available to the consumers. This drawback is absent in the case of interest adjusted life insurance policies as the same make yearly – rates – of – return easily available to the customers.
It goes without saying that selling is always a tough job and selling life insurance is even tougher (Huebner & Black, 2006). In the insurance industry of today, competition is extremely fierce and under such circumstances, insurance agents are made to sell insurance policies without providing them with sufficient training. Moreover, they are made to work under immense sales pressure so that they can accomplish targeted sales without fault. This is not only the case with new agents but also with mature agents. Under such circumstances, some agents resort to dishonest sales practices such as misrepresentation of insurance to clients or recommendation of policies to clients that maximise commission and do not fulfil client needs (Zartman& Price, 2011). In this regard, it is important to educate the clients about the matter that interest adjusted insurance costing method is more accurate than traditional method and an agent calculating cost of a proposed insurance policy through traditional costing method can be considered incompetent and unacceptable. To be ideally educated, an insurance agent must be a Chartered Financial Consultant (ChFC) or Chartered Life Underwriter (CLU) or Chartered Financial Planner. Moreover, he or she must be technically competent and a good advisor (Magee, 2010).
Computation of annual net cost per $1000
Annual net cost = (tenure of life insurance x annual premium) – total dividends for 20 years – cash value at the end of 20 years
= [(20 x 230) – 1613 – 3620]/ (20 x 10) = – $3.165
The above figure of annual net cost is indicative of the fact that the insures will have to pay $3.165 to the client each year for every $1000 of life insurance coverage bought on the part of the client(Gerber, 2008). No insurance company is expected to accept this as this a loss go the company.
Annual surrender cost index = [(tenure of life insurance x Annuity due factor for 20 years) – accumulated value of dividends for 20 years – cash value at the end of 20 years] / annuity due factor for 20 years x 100
= [(230 x 34.719) – 2353 – 3620)] / (34.719 x 10) = $0.58
The above figure of annual surrender cost index indicates that if the stated policy is held on the part of the client for 20 years and then surrendered, it would cost $0.58 per $1000 per year(Gaines, 2012).
Annual net payment cost index = [(tenure of life insurance x Annuity due factor for 20 years) – accumulated value of dividends for 20 years] / annuity due factor for 20 years x 100
= [(230 x 34.719) – 2353)] / (34.719 x 10) = $1.622
The above figure of annual net payment cost index indicates that if the stated policy is held by the client for 20 years and then the client continue to hold it or died, it would cost $1.62 per $1000 per year(Gaines, 2008).
An educationally competent insurance agent is a Chartered Financial Consultant (ChFC) or Chartered Life Underwriter (CLU) or Chartered Financial Planner (Raynes, 2013).
In addition to having proper educational qualifications, an insurance agent needs to be technically competent and a good advisor.
Interest adjusted cost method is more appropriate than traditional cost method because of the fact that the former one takes in to account time value of money(Gaines, 2010).
In order for an insurance company to make profit, annual net cost index has to be positive
Annual net payment cost index is usually higher than annual surrender cost index (Zartman and Price, 2014)
A number of recommendations have been given at the end of the thesis. First an insurance clients should take in to account professional qualifications, technical competencies and advisory capabilities of an agent before purchasing a life insurance from him or her. Second an insurance client should make sure that his or her insurance costs are calculated through interest adjusted cost methods and not through traditional cost method as the former one is more efficient than the later one(Gerber, 2008). Third, an insurance company should not make a deal until and unless annual net cost index is positive, otherwise the company would make a loss from the deal.
Cockerell, H. (2005). Insurance. London: English Universities Press.
Gaines, P. (2008). Interest-adjusted index. Cincinnati: National Underwriter Co.
Gaines, P. (2010). Interest-adjusted index; life insurance payment and cost comparisons. Cincinnati.
Gaines, P. (2012). Cost facts on life insurance: interest-adjusted method. Cincinnati: National Underwriter Co.
Gerber, H. (2008). Life insurance mathematics. Berlin: Springer.
Hardy, E., Huebner, S., Michelbacher, G. and Mudgett, B. (2007). Insurance. New York: Alexander Hamilton Institute.
Huebner, S., & Black, K. (2006).Life insurance. Englewood Cliffs, N.J.: Prentice-Hall.
Maclean, J. (2005).Life insurance. New York: McGraw-Hill.
Maclean, J. (2009). Life insurance. New York: McGraw-Hill.
Magee, J. (2010). Life insurance. Homewood, Ill.: R.D. Irwin.
McGill, D. (2013). Life insurance. Homewood, Ill.: R.D. Irwin.
McKnight, R., Reuter, J., &Zitzewitz, E. (2012).Insurance as delegated purchasing. Cambridge, Mass.: National Bureau of Economic Research.
Murphy, S. (2010).Investing in life. Baltimore, Md.: Johns Hopkins University Press.
Raynes, H. (2013). Insurance. London: Oxford University Press.
Sneyd, M. (2013). Insurance. New York: Prentice Hall.
Vogel, R., & Blair, R. (2007).Health insurance administrative costs. Washington, D.C.: U.S. Department of Health, Education, and Welfare, Social Security Administration, Office of Research and Statistics.
Zartman, L. and Price, W. (2014). Life insurance. New Haven: Yale University Press.
Zartman, L., & Price, W. (2011).Life insurance. New Haven: Yale University Press.
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