How To Compare Best Insurance Policy-A Cost-Benefit Analysis

Select the Best Insurance Policy using Cost-Benefit Analysis

Comparing Best Insurance Policy using Cost Benefit Analysis-ArthikDisha

Yes! Do you know why the Insurance Regulatory Development Authority of India (IRDAI) has ordered all the life insurance operators for offering a Standard Term Life Insurance Policy from 01.01.2021?

Because there are so many term life insurance policies available in the market with different cost and benefits that common people very often get confused regarding which one to choose and what benefits they will get. Sometimes it becomes very difficult for them to select the appropriate one to meet their needs out of the junks that we see in the market.

I again reiterate that there is nothing called the best insurance policy in this universe. Because what is best to you may not necessarily be best for me. Therefore, what is most important is Best suited policy according to your needs.

In this post, I will try to make a cost-benefit analysis that may help you to select the best insurance policy, be it health, life or other general insurance. Your main focus will be calculating the estimated cost and compare it with the benefits you will get from it.

Cost-Benefit Analysis from Insurance perspective

You all know that different policies offer different benefits having different pricing mechanism. This makes it very difficult while shortlisting the best insurance policy which is most suitable for you.

You may also find that some of the policies offering the same benefits but at different prices. So what to do? What to select? There is nothing to worry about. This post will help you in doing that.

But the question is how do you do it. Ideally, at first, you need to shortlist some insurance policies which offers the benefits which are suitable for you. Then you do a cost-benefit analysis of the shortlisted policies before choosing the best life insurance policy in India.

Points to remember while Choosing the Best Life Insurance Policy

We must acknowledge in today’s parlance that life insurance is a basic NEED for everyone and therefore not to be construed as a LUXURY. So people should come out of the myth that insurance is an investment. Insurance is solely meant for risk coverage i.e. protecting the insured person’s life in monetary terms.

If the insured person is the sole bread earner of his family, after his unfortunate demise, this risk insurance coverage would act as the financial protection of his family members to some extent.

Therefore, it is of the utmost importance that the risk coverage must be an adequate one. Financial experts suggest that the minimum risk coverage of life insurance should be 10 to 12 times of one’s annual income.

Therefore, while choosing the best life insurance policy for yourself for safeguarding the financial interests of your dear ones, you should keep in mind the following important points:

How to Choose Best Insurance Policy-Points to Remember-ArthikDisha

  • Understand the product: You must understand clearly the premium cost and the benefits you would receive from the policy;
  • Adequacy of sum assured: Determine the amount of sum assured that you need to safeguard the post-death financial obligations. Ideally 10 to 12 times of your annual income;
  • Plain Vanilla: Always look for the plain and simple life policy without any addons like critical illness cover, health cover;
  • Policy Term: It is always better to get insured up to 62 years of age i.e. 2 years beyond your retirement age. For non-salaried persons, this may be up to 65 to 70 years of age depending upon your other financial obligations;
  • Cost-benefit analysis: This is the most crucial factor while choosing the best life insurance policy that you make a cost benefit analysis of the policy that you have shortlisted as per your requirements;
  • Claim Settlement Ratio: Though Claim Settlement Ratio should not be the sole deciding factor while selecting the best insurance policy, this CSR aspect may be looked into as it enhances the chances of getting a best-suited insurance policy for yourself;
  • Go with the Brand: It has been seen in the past that taking a life insurance policy from the reputed and renowned insurance companies add value to your insurance product. Since the brands are more concerned about their image and reputation so the chances of frauds are less likely.
  • Online Buying: If it possible for you, you must consider buying an insurance policy through online mode. It will not only be cheaper for you but also you may keep the policy documents in online mode and can retrieve as and when required making it a completely hassle-free process.

Cost Benefit analysis for selecting the Best Insurance Policy

Basically for making cost benefit analysis of insurance products two popular methods are followed:

  1. 1. Cost Method;
    1. a. Traditional net cost method
    2. b. Interest adjusted cost method

  • Return on Investment method;

1.(a) Compare Best Insurance Policy using ” Traditional Net Cost Method

The cost method for making insurance cost-benefit analysis is the most widely used and accepted method for evaluating insurance products.

This traditional net cost method is widely accepted due to its simplicity. Like, this method considers how much you are paying for getting the defined benefits under the policy. It depends on the following principles:

  • This method assumes that the policy will be surrendered;
  • This ignores the time value of money concept;
  • It assumes that the bonus or dividend to be received from the policy will be constant throughout the policy tenure.

Let’s take an example to understand the cost of insurance using the traditional net cost method.

Sri Virat Kohli (40 years age) is contemplating to buy a term life insurance policy with a sum assured of ₹50 Lakh at an annual premium of ₹20,000 for the next 20 years. The estimated bonus from the policy is ₹5,000 per year for the next 20 years. The cash surrender value is ₹1,20,000 at the 10th year. Compute the cost of the policy using the Traditional Net Cost Method.

Calculation of cost of the policy using Traditional Net Cost Method:

Particulars Amount(₹) 
Total Premium for 10 years   2,00,000.00
Less: Total bonus for 10 years     -50,000.00
Net premium for 10 years   1,50,000.00
Less: Surrender cash value at the 10th year  -1,20,000.00
Insurance cost for 10 years       30,000.00
Insurance cost per year (30000/10)         3,000.00
Insurance cost per ₹1000 S.A per year(3000/5000)            ₹0.60

1.(b) Compare Best Insurance Policy using ” Interest Adjusted Cost Method”

This method is more concerned about the time value of money. This method assumes that either the policy will be surrendered or it will be continued till the policy term. The following assumptions are made under this method:

  • This method assumes that the policy will be surrendered or
  • This method assumes that the policy will be continued till the policy term;
  • It considers the time value of money concept;

Let’s take an example to understand the cost of insurance using the interest adjusted cost method.

Sri Virat Kohli (40 years age) is contemplating to buy a term life insurance policy with a sum assured of ₹50 Lakh at an annual premium of ₹20,000 for the next 20 years. The estimated bonus from the policy is ₹5,000 per year for the next 20 years. The cash surrender value is ₹1,20,000 at the 10th year. Assume interest rate as 8% p.a. Compute the cost of the policy using the Interest Adjusted Cost Cost Method.

When the policy is surrendered at 10th year:

Particulars Amount(₹) 
Future value of total Premium for 10 years compounded at 8% interest ₹ 2,89,731
Less: Total bonus for 10 years compounded at 8% interest ₹ -72,433
Net premium for 10 years ₹ 2,17,298
Less: Surrender cash value at the 10th year ₹ -1,20,000
Insurance cost for 10 years ₹ 97,298
Present value of Interest Annuity Factor at 8% for 10 years ₹ 14.49
Interest adjusted cost per year(97298/14.487) ₹ 6,716
Interest adjusted Insurance cost per 1000 S.A per year(6716/5000) ₹ 1.34

When the policy will be continued till policy term:

Particulars Amount(₹) 
Future value of total Premium for 10 years compounded at 8% interest ₹ 2,89,731
Less: Total bonus for 10 years compounded at 8% interest ₹ -72,433
Net premium for 10 years ₹ 2,17,298
Less: Cash value at the 10th year(It is being continued till maturity) ₹ 0
Insurance cost for 10 years ₹ 2,17,298
The present value of Interest Annuity Factor at 8% for 10 years ₹ 14.49
Interest adjusted cost per year (217298/14.487) ₹ 15,000
Interest adjusted Insurance cost per 1000 S.A per year(15000/5000) ₹ 3.00

So, what do the above three calculation method provide us? Just look carefully that the cost of insurance per year is different under three methods. A comparison should always be made on a level playing field.

You may want to read the following

2.” Return on Investment Method” to compare life insurance policies

Another very popular method of evaluating and comparing among different insurance policies is the return on investment method. This method measures the return % on the savings component of the policy.

Further, this method follows two different approaches for comparing the best life insurance policy in India.

  • Return on Investment Method
    • a.Linton Yield method
    • b.Belth method

2.(a). Compare Best insurance policy using “Linton Yield Method

Linton yield method basically compares dissimilar policies and the policy which provides the highest Linton yield is considered to be the best insurance policy.

So, technically the Linton yield method calculates the average rate of annual return (Internal Rate of Return) earned on the cash value (CV) of the policy if it is held for a specified no. of years i.e. the IRR earned on the investment portion of the policy over a period of time.

Using this model one can compare various endowment policies, whole life policies based on the return on the cash value of the policy.

2.(b). Compare Best insurance policy using “Belth Method

The Belth method calculates the yearly rate of return on the cash value of a policy if it is held over a certain period of time. So, in simple words, this method follows the approach of finding the yearly cost of protection and rate of return of the policy.

This method tries to determine whether a life insurance policy is competitively priced based on its protection value and it is not bothered about finding the lowest priced policy available in the market.

The formula of Belth Model is given below:

R%= (CV+D)+(YPT)(DB-CV)(0.001)-1 / (P+CVP)

Where, R%= Yearly rate of return on saving component,

CV: Cash value at the end of policy year,

CVP: Cash value at the end of preceding policy year,

D: Annual Dividend;

P: Premium;

DB: Death Benefit;

YPT: Assumed yearly premium price per ₹1,000 of protection.

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