What is the Cash Accumulation Method? Example & How It’s Used

The cash accumulation method stands as a fundamental technique within the realm of life insurance evaluation, particularly concerning cash value policies. This method serves to compare the financial efficiency of different policies by analyzing the accumulation of cash values over time. Let’s delve into the intricacies of the cash accumulation method in the context of the finance industry.

The cash accumulation method is a fundamental tool used in the evaluation of cash value life insurance policies. These policies, which are a form of permanent life insurance, include a savings component alongside the death benefit. The cash accumulation method focuses on comparing the cost-effectiveness of different policies by analyzing the accumulation of cash values over time.

Cash value life insurance policies allocate a portion of the premiums towards the cost of insurance, while the remaining funds are deposited into a cash value account that earns interest over time. This cash value component serves as a source of liquidity for policyholders, allowing them to access funds for various purposes such as loans, withdrawals, or premium payments.

To illustrate the cash accumulation method, consider two cash value life insurance policies, Policy A and Policy B. Policy A has an annual premium of $1,400, while Policy B has an annual premium of $1,100. The cash accumulation method requires setting aside the difference in premiums, in this case, $300, and applying an interest rate to simulate the growth of this amount over time.

For example, if an interest rate of 4% is applied, the set-aside amount would grow to $312 at the end of the first year. This set-aside amount represents the difference in premiums between the two policies.

Next, adjustments are made to the face value of each policy to account for the set-aside amount. Once these adjustments are made, the cash values of the two policies can be compared at the end of a specified term, such as 15 years. The policy with the highest cash value at the end of the term is considered the better value.

No, the cash accumulation method is primarily used for assessing the cost-effectiveness of cash value life insurance policies, which feature a savings component. It may not be suitable for evaluating term life insurance policies, which lack a cash value component.

By providing a quantitative analysis of the long-term financial implications of different policy options, the cash accumulation method empowers policyholders to make informed decisions regarding their life insurance coverage. It allows them to weigh the cost-effectiveness of various policies based on their individual financial circumstances and goals.