The Geek’s Guide to Calculating the Real Returns on Your Life Insurance

It’s easy to get confused about certain technical terms when you’re not in the financial industry. But we’re here to help you make sense of what insurance returns with cash value is.

If you’re looking to know more about life insurance, the first thing you should know is that there are two categories when it comes to risk coverage – one with cash value, and one without cash value, also known as term policy.


What is insurance with cash value?

Often known as surrender value, cash value is the amount of cash offered to the insurance company by the issuing life carrier upon the cancellation of the contract. Insurance without cash value means that there is no cash in the account when the insurance policy is surrendered.

On the other hand, insurance with cash value means that there is a certain amount of cash in the account when the contract is cancelled and this involves having to pay more premium* every year. With this, the insurance company then uses the extra premium to do some low to medium risk investments, allowing the policyholder to receive cash when the policy is surrendered.

Now that you know the difference between those two insurance policies, this brings us to the question – what is the annual return of this kind of investment? This amount is generally not stated in the policy illustration of the insurance product, but we can use an Excel template to simply calculate this return rate. Let’s look at this example:

Mr Yang is 30 years old this year. After going through a needs analysis**, he understands that he will require a $200,000 coverage for critical illness insurance until he turns 65. If Mr Yang buys an insurance policy without cash value, he’ll need to pay an annual premium of $1,000 until he’s 65.

On the other hand, if he decides to purchase an insurance policy with cash value, he’ll need to pay an annual premium of $3,000 for 20 years, after which he’ll receive a cash value of $60,000 when his coverage ends at 65.

We can fill in the above data into an Excel spreadsheet as shown below:

In the first column, we can insert Mr Yang’s age (30 to 65). In the second column, we insert the cash flow of the insurance with cash value. We use positive numbers to illustrate the payment given by the policyholder, while negative numbers are used to illustrate the amount of cashback he will receive.

In the third column, we insert the cash flow of the insurance without cash value and using the “minus” operation on Excel, we can easily calculate the difference between the second and third columns. This, then, results in the fourth column which gives us the cash flow difference.

After calculating the amount mentioned above, the next important step is to determine the internal rate of return*** (IRR). We can get this amount by using the IRR function in Excel, that is, IRR(D2:D37, 1). The “1” in this formula is our estimation of the internal rate of return, which is 1%.

Based on the date set in our example, the result of this IRR formula is 2.692%. In other words, while providing coverage, the net investment rate of return from the insurance company is 2.692% per annum for this insurance with cash value vs one without cash value.

The opportunity cost of buying term and investing the rest comes into play here. In this case, you will need your investments to earn at least 2.692% to make sense of this strategy, otherwise, you are probably better off getting the insurance policy with cash value.

Aside from ensuring that both the insurance policies are from the same insurance company, also ensure that they provide the exact risk coverage for them to be comparable.

*An insurance premium is the amount of money an individual or business pays for an insurance policy. (Source: Investopedia)

**The needs approach, or needs analysis, is a way of determining the appropriate amount of life insurance coverage an individual should purchase. (Source: Investopedia)

***The internal rate of return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments. (Source: Investopedia)

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Tony Deng is a financial planner providing customised financial planning solutions for foreigners working in Singapore.

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