What Is The Baldwin Method?
The Baldwin method may be used to evaluate all types of life insurance, but it is primarily useful in evaluating a life insurance policy with a savings (investment) component. It calculates the rate of return on the savings (investment) component of the policy and considers as well the value of the protection component of the policy and the effect of taxes on the value. The results can then be used to compare similar or dissimilar life insurance policies.
How It Works
The Baldwin method differs from other methods in that it calculates the rate of return on the investment portion of the policy but also considers the impact of policy loans, the opportunity cost of cash left in the policy (i.e., what was not borrowed that could have been borrowed and then invested), and tax implications. In short, it measures the return after considering all costs, including life insurance costs. It can be used both by individuals concerned with the investment value of the policy and individually connected with the protection value of the policy. The Baldwin method calculation has many steps, but they can be summarized as follows:
- Determine the annual rate of return on the policy and adjust for the impact of taxation on the return. Then, this figure can be used to determine whether the rate of return is reasonable and/or better or worse than the rate of return you could receive on your investment elsewhere. For individuals only concerned with the investment value of the policy, this may be the end of the calculation. But for others who are concerned with the protection value of the policy, the calculation continues.
- Determine how the annual value of life insurance protection in the contract compares with the minimum term insurance cost of an equivalent amount of insurance purchased elsewhere, considering the annual net gain or loss and after-tax rate of return. The value, when determined, should be at least equal to the minimum term insurance cost of an equivalent amount of insurance purchased elsewhere.
A Comprehensive Evaluation Method
Like many other methods, the Baldwin method calculates the rate of return and value of protection. However, the Baldwin method is more comprehensive than other calculations because it considers factors most other methods do not, such as policy loan interest cost, the opportunity cost of cash left in the policy, and tax implications. It also can be used by individuals who are seeking rate of return information and by individuals who are seeking protection value information.
May Not Accurately Measure the Policy's Performance
Like other methods, the Baldwin method calculation relies on assumptions that may not be entirely realistic, such as the cost of cash left in the policy. The results may be more reliable if the Baldwin method is used to calculate the rates of return for several years. However, if the rates of return vary widely from year to year, it may be difficult to interpret the results.
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