What is the life insurance ‘cost index’?
UPDATED: Mar 26, 2012
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Asked March 26, 2012
Using a cost index is a popular way of comparing insurance quotes and policies. The reason a cost index is used instead of simply tallying the costs is because you have to take into account money that paid into the policy or withdrawn from it for different purposes, including such things as the overhead of maintaining the policy.
There are three basic types of cost indexes: Premiums, Cash values, and Dividends. Instead of having to do the calculations yourself, you can use one of these indexes, supplied by the insurance company, to allow a simple one-to-one comparison without having to do the complicated mathematical adjustments.
Take the Cash surrender index of life insurance, as an example. This formula allows you to look at the cash value of policies at a given time in the future if you decide to surrender the policy and take a cash payout. The formula assumes that you will keep the policy current until the time it is surrendered, and calculates such things as accrued interest to help you get a close idea of what you have at stake.
The net payment index assumes that the policy is kept in force until the time of your death. This index will illustrate what the cash payouts will be at that time, which allows you to better plan for the inheritance you plan to leave for your descendants.
Determining the cost index for a policy requires the use of another calculated number, called the Equivalent Level Annual Dividend. This number is used to calculate how much cash accrues in an account, the amount of payable dividends, and the rates of increase in the policy if the interest rate remains the same. Variable interest rates are more complicated, but can be used to fine-tune the amount of dividends even more precisely.
Generally, the policy with a smaller index number is a more sound choice. It shows a maximum return on the minimum amount of investment, and indicates stable growth over the long term. However, in order to get an accurate cost index comparison, it is important that the life insurance policies being compared share the same traits, including original face value, type of policy, premiums, and length of terms. Comparing unequal policies will return ambiguous results that cannot be used for accurate estimates.
Answered March 26, 2012 by Anonymous