There are numerous ways to compare cash value life insurance policies. Some of them are pretty well recognized though of relatively little use like the Net Cost Surrender Index. Others are known within the circles of more advanced practitioners but sparsely discussed because of their complexity both from a conceptual and applicable point of view. One such comparative process that falls into the slightly more advanced category is the Linton Yield Method.
Comparing life insurance contracts next to one another can sometimes be a tricky venture. There’s a fair degree of variability among contracts and there is also a tendency to make incorrect assumptions about what variables are constant among carriers, which can draw one to an incorrect conclusion. The Linton Yield Method was conceived as a measure to avoid such a mistake.
The Linton Yield Method is an interest-adjusted process for comparing the cost of life insurance. That's great. But what exactly does that mean?
There are four things in any given year that we need to know in order to start the process of calculating the Linton Yield Method:
- The Premium
- The Death Benefit
- The Cash Surrender Value
- The Cost of One Year Term Insurance for the Net Amount at Risk
The first three are easy variables we can get from the policy. The last one is a bit tricky. But alas our friends at the Internal Revenue Service have a handy guide we can use. The IRS publishes a schedule of one-year term insurance rates we can use for calculating the Linton Yield. Or we can use the company in questions published one-year term rates. Most companies have them.
One-year term insurance (also known as OYT) is the cost of providing a term life death benefit that is only good for a single year. Because it's not renewable like the level term life insurance I'm sure most of you know about, it's much less expensive.
From there we need to calculate the net amount at risk. This is simply the difference between the death benefit and the cash surrender value. This is the amount of actual life insurance that exists. Or put in another way, this is the amount of money the insurance company is on the hook for if you die.
Net Amount at RiskDeath Benefit Minus Cash Surrender Value
Once we know the net amount at risk, we need to figure out how much that insurance costs. We do this by calculating the one year term insurance cost of the net amount at risk.
Calculating Cost of One Year Term Insurance Death Benefit
If we are using the IRS schedule, this is found in the handbook the IRS publishes each year for Human Resources departments all across the United States and is the same table of costs used to compute imputed income for such plans as group life insurance death benefits beyond $50,000 or the bonus income recognized by a participant in a Split Dollar.
If we are using the insurance company's schedule of term costs, we simply reference their table of published one-year term costs.
The charges are always calculated in cost per $1,000 so we would first need to divide the net amount at risk by $1,000 and then perform the calculation.
One other quick note, if you’re using the IRS table, those charges are quoted on a monthly basis, so you’ll need to multiply the whole equation by 12 in order to get the correct cost. To recap the equation looks like this:
(Net Amount At risk in 1,000’s) x (OYT cost) x 12 = Annual Cost of Death Benefit
From there, we subtract the cost of death benefit from the premium paid for that given year and we perform an internal rate of return calculation for cash surrender value.
Why We don’t often Use the Linton Yield
We admittedly don’t use the Linton Yield Method all that often. The reason being that it’s rather easily manipulated by death benefit and most of the time our focus is on cash and what you can do with it.
What I mean by this is some companies blend their products with extremely cheap level one year term insurance and require a much higher death benefit to get the same amount of premium into the policy that we want. These policies tend to have better-looking Linton Yield Methods (at least in earlier years) despite having lower cash values vs. some of the competition. This may lead someone to an incorrect conclusion about which product is better.
This being said, the Linton Yield Method is a perfectly fine method of evaluation for people who just want to buy normal unblended whole life insurance.
It's also potentially useful for someone looking to buy blended whole life insurance for cash, but also wants to maximize death benefit. I wouldn't normally recommend this approach. That's because more death benefit often leads to less cash value accumulation. But some people find themselves seriously stuck between choosing which direction is most important and this method of evaluation might prove helpful.
A Note about Universal Life Insurance
Because it can easily be manipulated to inflate death benefit, universal life insurance can be a bit tricky to evaluate with the Linton Yield Method. The underlying principles exist and as such the method will work in its originally intended sense. Just keep in mind that assumptions about how the universal life policy accumulates cash value matter significantly.
You need to understand what drives those assumptions and consider their plausibility.
Not for Cash Accumulation Purposes
I’m being intentionally redundant on this last point. The Linton Yield Method is NOT a method for comparing life insurance policies for retirement income/life insurance as an asset class purposes. It’s a method for comparing life insurance contracts the more traditional way. What gives me the “cheapest” death benefit form a net economic cost point of view?
One might think that these two things go hand in hand, but again it’s rather easy for the method to be skewed by variations in policy design (especially by varying methods of policy blending). So while the Linton Yield Method is a great process for comparing policies from multiple carriers, it has a very specific application for comparing proceed with care and caution.