Life insurance math question
July 19th, 2007 by KenricI have a life insurance policy that has a cash value of $14,000. Every year my the cash value of this policy goes up by $1,000. My policy’s premium is $766.00.
So on a simple level, I pay $766.00 to get $1,000 (net $234). I get a 30% return based on the simple premium vs. cash value increase.
In addition, this policy pays out $500 in dividends per year. I apply the dividends to my premium each year. Therefore I’m really paying $266 to get $1,000 (net $734). My return is 275%.
Why would I ever cancel this policy?
To make things more complicated, I decided to not pay the $266 out of my pocket. Instead, I borrowed the $266 at 5.8% interest from my cash value of $14,000. By my calculations, this is what will happen in the next years.
- July 2007 cash value $14,000, $266 loan balance
- July 2008 cash value $15,000 ($14,000 + $1,000)
- Premium owed $266 ($766 - $500 dividend)
- Loan interest $15 added to loan amount
- July 2008 final cash value $15,000, $547 loan balance
Net increase $719.00
- July 2008 cash value $15,000, $547 loan balance
- July 2008 cash value $16,000 ($15,000 + $1,000)
- Premium owed $266 ($766 - $500 dividend)
- Loan interest $32 added to loan amount
- July 2008 final cash value $16,000, $845 loan balance
Net increase $702.00
It seems to me like I have a semi self sustaining policy. I don’t have to put a penny into it and it will continue to increase in value for many years. Assuming my premiums and dividends don’t change, is this correct?
Posted in Finances | 
Stumble it!
I think your numbers look right, however the tricky part is in the dividends. Now that the market is going up and breaking records almost every day the dividends are good. When the market goes down then it will be a lower amount you will get.
By Andres on Jul 19, 2007
Your return is the increase in value divided by the entire value of the investment. You’ve got to divide that 734 by 14,000.
=5.2%
As the cash value increases, the 734 remains constant, and the yield goes down. By the time its worth 19,000 the yield is under 4%
By Sam on Jul 19, 2007
The dividends were actually higher in the past. They came down to $500 during the low interest rate years which prompted me to have to pay out of pocket.
By Kenric on Jul 19, 2007
Sam, I understand what you’re saying. I could cash out the $14k and stick it in a 6% CD and make $840 a year. So I think the question is, is the life insurance policy worth it combined with the decreasing return to 4%.
By Kenric on Jul 19, 2007
I agree with Sam. Look at it this way, if you bought a rental property for $100K one year and got $10K in income, you would say your return for the year was 10%. Then the second year you get another $10K. You didn’t spend money to buy the house in the second year, but you wouldn’t claim your return was infinite.
I’m assuming the $500 dividend and $1000 yearly increase are constant. Don’t forget the loan will need to be paid off. At some point, your loan will be growing faster than your cash value. In 2009, your loan balance will be $1175 ($1111 + $64 in interest). From that point on, your loan balance will be greater than your cash value increase. Eventually, your interest charges will also be greater than the $500 dividend. At that point, you’ll be losing money.
By Shaun on Jul 19, 2007
Shaun,
I think the tough thing to account for is the benefit of the policy. Do I count that in my decision. If this policy had a $50,000,000 payout, it’s a no brainer to keep it until I started losing money. If the policy is only $20,000 then I would have cashed it out a long time ago. But at $100,000 or $200,000, it becomes a harder decision.
By Kenric on Jul 19, 2007
Most level headed advisors will tell you to keep your investing and your insurance separate. Keep the policy if you need the insurance. Don’t let the investment portion of it influence that decision.
By Sam on Jul 19, 2007
Unless you got dependents, I’d rather have the money now.
By knuckleheaded on Jul 19, 2007
You drop this investment if the returns do not meet your expectations…. Not just because the dividend covers the premium.
Based on the data you provided - running an excel IRR shows you are making about 3.8% return on your investment over 7 yrs once the dividend reinvest and premiums are accounted for.
If you don’t want to run the full IRR - think about it this way: at 5% simple interest you would have had 14205 after 7 yrs -and you kicked in 2184 in premiums on top of it.
By gte601 on Jul 21, 2007
I pulled your data from the SDCIA Board
2001: cash value $10,600, dividend $498, premium $766
2002: cash value $11,600, dividend $451, premium $766
2003: cash value $12,281, dividend $404, premium $766
2004: cash value $13,086, dividend $420, premium $766
2005: cash value $14,092, dividend $442, premium $766
2006: cash value $15,418, dividend $468, premium $766
2007: cash value $16,247, dividend $495, premium $766
By gte601 on Jul 21, 2007
Two things… I believe you are getting far to low ROI for an insurance product. Have you looked into Variable Universal Life? (VUL) That 5% is actually minus 3.4% inflation. I think you can do better than an effective 1.6% return. Loaning your insurance company 14K, for them to go into the market and earn 10-15% on your money and only pay you 5%
Also, why let the dividends pay the premiums, are you not reducing taxable income by paying them with earned income thereby saving yourself twice on the taxation side? (Reducing taxable income and an appreciating tax deferred asset)
By Oreomind on Jul 22, 2007