Pay careful attention to the hidden interest charges your clients are paying on their insurance policies—they are higher than you think.
Consider that if your client pays premiums monthly, quarterly or semi-annually, they are higher than if they pay them a lump sum—it’s the equivalent of an interest rate charge.
Insurance companies charge more for periodic payments to cover carrying costs, lost earnings and cancellation risk.
A report by the industry newsletter Insurance Forum suggests you should consider not just the higher cost, but the Annual Percentage Rate associated with those higher policy premiums. Take the example of a policy that charges a quarterly premium of $270, or $1,080 per year. That same policy has an annual premium of $1,000. Your client’s decision to pay premiums quarterly means a whopping 21.5 percent annual percentage rate.
You’d think the difference is a mere 8 percent annually, but that’s deceptive, suggests The Insurance Forum’s Joseph Belth, a professor at the University of Indiana.
Unlike a loan, a policyholder who opts to get an advance on the $1,000 annual premium by paying quarterly installments lacks the use of that full borrowed $1,000, Belth says. By knowing the APR, the policyholder can determine whether it’s better to borrow the money to pay the annual premium or opt for fractional premium payments.
An online calculator to find the APR of fractional premium payments is available at http://www.theinsuranceforum.com/pages/aprcalc.html
Think the APR is the same industry-wide, or even within the same company for different fractional premium payments? Think again. A 2013 Insurance Forum survey found there are big differences, with one clocking in at a whopping 95 percent. Only a few companies disclose their APRs on fractional premiums, according to the report.
Another study published in Advisors4Adivsors.com surveyed a 20-year term policy quote and found fractional premiums cost policyholders an internal rate of return of 19 percent for monthly premium payments to 27 percent for semi-annual payments. Rather than APRs, though, his calculation listed internal rates of return, which includes compounding.
In weighing an insurance policy, your client needs to consider the insurer’s financial strength; permanent life insurance crediting rate, which is the interest rate paid on the cash value; the internal rate of return on the client’s cash surrender value; and the cost per $1,000 dollars of insurance coverage. But fractional premium APRs should not be overlooked.
Patrick Bet-David, CEO of the Woodland Hills, CA-based advisory firm People Helping People, says financial professionals must remind clients that fractional premiums are like installment payments.
“The rule of thumb never changes,” he says. “If you can pay anything you’re buying all up front, it will end up saving you money.”
Alan Levine is a contributing writer to REP. and author of some 15 books on investments and insurance. He also writes a column for Dow JonesMarketwatch's "Retirement Weekly."