Rate of Return versus Interest-Adjusted Cost

Abstract

The over-all objectives of this study were: 1). to establish the average rates of return on the savings element of cash-value life insurance for 1972 policies, 2). to determine the interest-adjusted cost for the policies, and 3). to establish the relationship between the rate of return of a policy and its interest-adjusted cost. In addition, this study compares the returns of stock and mutual companies and the returns based on actual twenty-year dividend histories. The results of the study showed a high negative correlation between the rate of return method and the interest-adjusted cost method. This leads to the conclusion that both methods are good for comparing like policies issued by different companies. The over-all objectives of this study were: (1) to establish the average rates of return on the savings element of cash-value life insurance for 1972 policies, (2) to determine the interest-adjusted cost for the policies, and (3) to establish the relationship between the rate of return of a policy and its interest-adjusted cost. In addition, this study compares the returns of stock and mutual companies and the returns based on twenty-year dividend histories. The determination of the rate of return on the savings element of cash value life insurance was accomplished, in part, by substituting for cash value life insurance a program of term insurance and a separate investment. The method involves the comparison between cash value life insurance and a term insurance policy supplemented with an investment built by the difference in premium costs, adjusted for dividends, and taking into account the time value of money and the projected dividend schedule. The process is an application of the techniques developed by Linton (5) and Belth (2). This paper utilized Belth's model which can be found in his works. The cost approach to life insurance is an attempt to provide a means whereby prospective insurance buyers can compare the premiums, dividends, and cash values of comparable policies that are offered by different life insurance companies. The cost approach attempts to establish the cost Robert C. Hutchins, D.B.A., is an Associate Professor of Finance in San Diego State University. Previously he was Financial Analyst at Hughes Aircraft Co. Charles E. Quenneville, M.B.A., is senior Specialist Engineer in Boeing Computer Service. The authors acknowledge support of this research by the San Diego State University Foundation. This paper was submitted in August, 1973.