Life Insurance stuffs

CFA Level III Portfolio Management
#1

Hello everyone,

I realize that the explanations on life insurance are not enough for me in schweser and so i can’t understand some stuffs…

In an example, they say : - « a 25-year time horizon till death and a 5% discount rate on a $100,000 insurance policy » - « Policy has annual beginning of year premiums of $2,000 and an assumed annual end of year dividend (return of premium) of $500. Terminal 25 year cash value projected (by the insurance company) to be $25,000. »

if the premium is $2 000 with a dividend of $500, why the premium is not just $1 500 ? How the cash value can be only $25 000 if i pay $2000 by months during 25 years ?

There is really something i don’t get about life insurance…

Thank you for helping !

#2

Hi,

For the first question: the premiums are paid at the beginning of the period and dividends are received at the end of the period. So you calculate the FV of premiums as an annuity due (set calculator to BGN), and the FV of dividends as an ordinary annuity (set calculator to END).

For the second question: the cash value of a life insurance policy if only built up if the premium is sufficiently high. If the premium just covers the pure (term) cost of insurance, no value is built up. You’re effectively financing the death benefits of other policy owners. In the Schweser books they mention that in some cases the premium is a bit higher to allow for cash value to be built up. That is, you’re paying a bit more than the cost of insurance as a sort of deposit.

#3

Thank you very much for your answer !

I read many stuff now and i am getting it progressively… For the first question, where do come from the dividends ? For example, the first year of the contract, i pay $2000 but will i receive $500 immediately at the end of the first year ? If it is the case, I feel like it is an annualized dividend on the average growing cash value during 25 years… For the second question, if i understand well, after paying $2000 each year during 25 years (whose FV = $100227), i can get $25 000 in cash at year 25 and if i die before, someone will get $100000. If i don’t die before the end of the life insurance, the cost of the life insurance is really high ! not sure what i say is true

#4

  1. Dividends are paid on participating policies. If the actual investment earnings, expenses, and benefits paid are more favourable than those assumed in premium pricing, then the policyholder receives the dividend. In the real world, the dividends start very small and grow over time.

  2. Most participating plans are whole life or endowment payable at age xx. If you make to age 100 or xx, respectively, then the full face amount is payable on survival. Of course, the face amount is payable if death occurs prior to the policy expiry.

The cash value is not a simple roll up of premiums with interest. It takes into account all sorts of inflows (premiums, investment income, etc.) and outflows (expenses, death/surrender/maturity benefits, taxes,etc.).