Traditional Net Cost Method

by Jack Ori

Some investors use life insurance as part of their estate planning. When you purchase life insurance, your beneficiary gets money from it after your death without having to wait for your will to go through probate. Many life insurance policies use the traditional net cost method of accounting to predict the total cost of your life insurance policy over the remaining years of your life.

Purpose

The traditional net cost method uses a series of calculations to determine the actual cost of a life insurance policy over the course of your lifetime. By comparing traditional net costs of several policies, policyholders can get a truer picture of the relative costs of the policies than by comparing the premium amounts on the policies. This allows policyholders to choose the policy that gives them the most value for their money.

Dividends vs. Premiums

The traditional net cost method compares the dividends the policy is expected to pay out over the years with the premiums the policyholder puts into it. This method applies a standard annual interest rate to both the premiums and the dividends for a fixed period of time -- usually 10 to 20 years. It then adds the dividends to the policy's total cash value and subtracts this value from the total premiums to determine the net cost of the policy.

Net Cost Per $1,000

Some life insurance companies take the traditional net cost method a step further and determine the net cost per $1,000 the policyholder pays into it. After completing the net cost calculation, the company divides the result by the number of years the policy is expected to last to determine the net cost per year. The company then divides the net cost per year by 1,000 to determine the net cost per $1,000. This tells the policyholder how much each thousand dollars he puts into it will be worth when his beneficiary cashes in the policy.

Consideration

The traditional net cost method doesn't take into account how much the policyholder's money would be worth if he invested it in something other than a life insurance policy. Thus, the calculation is useful for comparing life insurance policies to each other but not for determining whether purchasing life insurance is the best use of the policyholder's funds. Discuss this issue with your financial planner so you can take into account the costs of not investing elsewhere when deciding whether to purchase life insurance.

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