Cash value insurance is permanent life insurance as it provides coverage for the life of the policyholder. Traditionally, cash value life insurance has a higher premium than term life insurance because of the cash value element. Most cash value life insurance policies require a fixed level premium payment, of which part is allocated to the cost of insurance, and the rest is deposited into a cash-value account.
The cash value of life insurance earns a modest interest rate, with a deferred tax on retained earnings. Therefore, the cash value of life insurance will increase over time. As the cash value of life insurance increases, the insurer’s risk decreases, as the accumulated cash value offsets part of the insurer’s liabilities.
Examples of Cash Value Life Insurance
Consider a policy with a $ 25,000 death benefit. This policy has no outstanding loans or prior cash withdrawals and an accumulated cash value of $ 5,000. Upon the death of the policyholder, the insurance company pays a full death benefit of $ 25,000. The money collected into cash value now belongs to the insurance company. Since the cash value is $ 5,000, the actual cost of the liability to the insurance company is $ 20,000 ($ 25,000 – $ 5,000).
Whole life, variable life and universal life insurance are all examples of cash value life insurance.
Advantages and Disadvantages of Cash Value Life Insurance
The cash value component serves as a life benefit for policyholders from which they can obtain funds. The net cash value of life insurance is the balance left by the policyholder or their beneficiary once the insurance company deducts its fees or any expenses incurred during the ownership of the policy. There are several options for accessing funds. For most policies, partial surrender or withdrawal is allowed but this can reduce the death benefit.
Tax is deferred on income until withdrawn from the policy and distributed. Once distributed, the income will be taxed at the policyholder’s standard tax rate. Some policies allow unlimited withdrawals, while others limit the number of draws that can be taken over a period or calendar year. Some policies limit the amount available for removal (e.g., a minimum of $ 500).
Most cash-value life insurance arrangements allow loans from the cash value. Just like any other loan, the issuer will charge interest on the outstanding principal. The outstanding loan amount will reduce the death benefit dollar for dollar in the event of the policyholder’s death prior to full repayment of the loan. Some insurers require repayment of loan interest, and, if not paid, they can deduct interest from the remaining cash value.
The term “present value” comes from financial mathematics and is commonly used in investment calculations. However, the term can now also be found in the areas of bookkeeping and accounting, where it is relevant for the evaluation of
- liabilities and
The value that must be used to achieve a final value (nominal value) with an interest rate of X% is referred to as the cash value. The present value is calculated by discounting the final amount.
When and how is the present value determined?
If an interest-free claim or liability only becomes due after more than one year at the nominal value or the nominal value is repaid in installments without interest surcharge, the present value (the actual value) of the claim or liability is below the repayment amount ( nominal value) or the sum under the installment payment.
If interest were paid on the present value at the time of observation, then the nominal value would result on the due date. During the term of a receivable, the present value is determined by recalculating the interest. This also applies to a liability or installment payment at the time of consideration.
Where is the present value applied?
Present value is one of the most fundamental principles in finance. For example, the capital value method can be used to consider the advantages of investments based on the cash value. Among other things, it is also possible to compare two investments whose payout periods have two different values.
All future payments are related to today by calculating the cash values. The rule is that the further the payments are in the future and the higher the expected return, the lower the current value.
Other uses of cash value:
- In the case of savings and insurance amounts, the cash value determines the future maturity benefit. It can thus be made clear which regular installments or which one-off amount must be paid in today in order to achieve a certain payout value in the future.
- The profit expectations are determined as part of the STOCK analysis. The future expectations, which are determined on the basis of the risk, are discounted to a valuation date using a CALCULATION INTEREST RATE . The present value determined from this shows the current value of the SHARES and can be compared with the current share price.
- The value of the company is evaluated as part of the company valuation as the present value of the future free cash flow.
Present Value vs. Net Present Value
- The net present value differs from the present value in that the sum of the investment payment is also deducted from the net present value.
- An example:
- On January 1st, 100,000 euros are invested in a project and a payment from the project of 40,000 euros (also known as payment surplus: annual payments less annual payments) is paid out for three years on December 31st, and then is the project ended.
- The imputed interest rate is 5%.
The calculation of the cash value
- To calculate the present value, each of the three payments is now discounted accordingly. First, the deposits and payments are entered in a table or a timeline, ie the payments are assigned to the points in time or periods.
- Present value calculation example
- A year later, the investor receives a payment of 40,000 euros for his investment and, according to the calculation, he receives a present value of 38,096 euros. If the three cash values are added together, the investor receives a total cash value at the end of the project of 108,928.
- For the investor, this means that he receives a series of payments with a cash value of 108,928 in return. This means that the net present value is positive at 8,928. The investment is positive, so worthwhile for him.
How is a present value calculated?
- The present value is the sum of all future payments to be expected. These are discounted to the current date using the expected calculation interest rate :
- Present value = sum of all payments x (1 + i)^-t
- Deviations from this arise if there is a so-called perpetual annuity. This is a constant, regular payment that is not subject to a term.
- In this case, the following applies: Cash value = C / z
- In this case, C denotes the annual annuity that is paid out. z, on the other hand, is the interest rate, i.e. the return on the perpetual annuity that is expected.