Opportunity Cost of a Single Term Premium

Illustrate the cost of one single term premium to age 65 and age 80

What does term insurance really cost?  This has been the concern of many and to gain understanding you must consider the time value of money.  Let’s enter the amount of this year’s premium payment, your current age and the interest rate you feel you are currently earning in your other investments.  If your investments are earning 8% then it would stand to reason that the money we are sending to an insurance company for term coverage is costing you 8%.  If we are still alive at the end of the year then the dollars we paid in premiums would have earned 8% had we put them in our investment account. However, if you die during the term, your beneficiary will have received the death benefit of the term insurance.

Opportunity cost on term insurance considers the cost of the insurance assuming that you did not purchase the protection and took the risk yourself - which we are not suggesting that you do.  However, the true cost of owning such protection must be factored into the equation.

When you look at the cost of one years term premium to age 65 or age 80 it is easy to see that term insurance is transferring a great deal of money.

Compounding is done annually on this screen.  The annual rate to compound at is found by converting the investment return to a decimal and added it to one:

Compound Rate = (1 + Investment Return / 100)

The periods to compound are simply the difference in either age 65 or 80 and the client's age.  For example, the periods to compound for opportunity cost to age 65 are:

Periods65 = (65 - Age)

The Opportunity Cost to age 65 is the premium (input on the screen) times the Compound Rate raised to Periods between 65 and age:

Opportunity Cost to age 65 = (Premium X Compound Rate ^ Periods65) - Premium

For example, the age 65 opportunity cost on a $500 per year premium paid at age 35 and an investment return of 10% is:

Convert 10% to decimal of .1

Annual compound rate is 1.1 (in decimal).

Years to compound are 65 - 35 = 30.

Opportunity Cost at 65 = 500 X(1.1)^30 -500=$8724.70 - $500 = $8224.70

Notice the premium is subtracted.  The opportunity cost is only the interest the premium could have earned.