The Journal of Financial Planning has a rather technical article -
Managing Life Insurance Policies: An Analytical Approach Built on Standard Actuarial Techniques- that uses the internal rate of return (IRR) analysis to properly evaluate the value of an existing life insurance policy and whether to keep funding it or not.
The issue is increasingly important as insurance companies have innovated around life insurance design, making the situation far more complex than it was when all cash value and death benefits were guaranteed in the world where all permanent insurance was whole life. This article provides a framework to understand how to analyze existing life insurance policies, especially when trying to decide whether to keep a policy or fund more to ensure it will remain in force.
The basic approach is to analyze the policy based on an internal rate of return calculation, based on the known/anticipated cash flows, adjusted for the actuarial likelihood of those cash flows occurring - or more specifically, to compare the actuarially weighted present value of future cash inflows against the present value of the requisite cash outflows necessary to sustain the policy.
Of course, the caveat is that to accurately do the analysis, it's necessary to model the policyholder's anticipated mortality year by year, which requires an actuary to analyze the individual health and circumstances. Nonetheless, the outcome of the analysis results in a series of anticipated internal rates of return based on death in various years, which can then be compared against available investment alternatives to determine an appropriate decision; notably, if the analysis is done based on the policyholder's individual health circumstances, the approach will correctly reflect the underlying increase in the value of the policy if held until death, which may actually make the policy more appealing to keep if there has been a decline in health.
Managing Life Insurance Policies: An Analytical Approach Built on Standard Actuarial Techniques- that uses the internal rate of return (IRR) analysis to properly evaluate the value of an existing life insurance policy and whether to keep funding it or not.
The issue is increasingly important as insurance companies have innovated around life insurance design, making the situation far more complex than it was when all cash value and death benefits were guaranteed in the world where all permanent insurance was whole life. This article provides a framework to understand how to analyze existing life insurance policies, especially when trying to decide whether to keep a policy or fund more to ensure it will remain in force.
The basic approach is to analyze the policy based on an internal rate of return calculation, based on the known/anticipated cash flows, adjusted for the actuarial likelihood of those cash flows occurring - or more specifically, to compare the actuarially weighted present value of future cash inflows against the present value of the requisite cash outflows necessary to sustain the policy.
Of course, the caveat is that to accurately do the analysis, it's necessary to model the policyholder's anticipated mortality year by year, which requires an actuary to analyze the individual health and circumstances. Nonetheless, the outcome of the analysis results in a series of anticipated internal rates of return based on death in various years, which can then be compared against available investment alternatives to determine an appropriate decision; notably, if the analysis is done based on the policyholder's individual health circumstances, the approach will correctly reflect the underlying increase in the value of the policy if held until death, which may actually make the policy more appealing to keep if there has been a decline in health.
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