The Effect of Premium Payment Frequency on Life Insurance Cost Rankings

Abstract

This paper examines the extent to which shifts in cost rankings occur between annual premium-based interest-adjusted cost indices and indices based on premiums payable more frequently than annually. The N.A.I.C. Model Solicitation Regulation and all published data use annual premiums as the basis for all calculations. Yet fewer than one in five purchasers of life insurance pay premiums annually. Thus, manipulation of annual premium-based cost figures is theoretically possible. The National Association of Insurance Commissioner's (N.A.I.C.) Life Insurance Solicitation Model Regulation and the laws of the states having any form of life insurance cost disclosure, require the consumer be given, on request or automatically, interest-adjusted cost and other information [ 13, pp. 545-552]. The Federal Trade Commission staff report also would require disclosure of life insurance costs, but based on the 20-year surrender index and Linton's rate of return pricing method [9, pp. 99-100, 153]. All the above require that costs be calculated using annual premiums. Moreover, all published data on life insurance costs use annual premiums as the basis for all calculations. Yet, as Table 1 shows, most purchasers of life insurance do not pay premiums on an annual basis. In fact, fewer than one in five currently pay premiums annually. Insurers differ in the assumptions they make in computing premiums payable more frequently than annually (hereafter called non-annual premiums) [3, pp. 152-154]. It is possible, therefore, for an insurer to illustrate a competitive cost based on annual premium payments but, by using conservative assumptions to compute more frequent premium payments, to have a high net cost if the policyowner chooses to pay premiums monthly, quarterly, or semi-annually. This paper examines a segment of the life insurance business to determine whether and to what extent shifts in cost rankings occur between interestadjusted cost indices calculated on an annual premium basis and cost indices