What is the opportunity cost of funding a policy?

How it works

if one is missing the answer is no

Four things required before anything else

1. Durable surplus cash flow, in an ordinary year
2. A horizon measured in decades rather than years
3. A place in the household's wider position
4. A clear purpose for the contract itself

Measured on growth alone across decades, the comparison usually favours the alternative, and a presentation that hides this is not worth reading. That is the honest starting point and not the conclusion.

Computing this figure is arithmetic a household can do on its own, once two things are chosen honestly: the actual alternative use of the money, and the rate of return assumed for it. Neither of those two choices is supplied by a general page, since the honest alternative differs by household. For one household it is a low cost index portfolio; for another it is unused registered contribution room sitting empty this year; for a third it is a debt carrying its own interest rate, which is itself a return, guaranteed and not assumed, the moment the debt is paid down instead.

The rate used for that comparison is a choice, not a fact, and different people choosing different rates for the same household will reach different conclusions from the exact same starting numbers. A rate borrowed from a decade of unusually strong markets tells a different story than a rate borrowed from a longer run that includes weaker years, and neither rate is wrong on its own; the honest habit is to run the comparison at more than one assumed rate, and not the one that happens to favour a conclusion already reached.

In practice, the household is the only party positioned to run this comparison honestly, since only the household knows what it would actually do with the money if it were not funding the contract. An insurance representative can supply the contract's own numbers, and a portfolio provider can supply historical performance for its own products, but neither one can supply the other side's data, and a comparison assembled by only one side of the transaction, using only that side's own figures, tends to look better for that side than a comparison built from both sets of numbers side by side.

The cost or the catch

the cycle a contract is used through

Funding, drawing and repaying

1. 01Premium funds the contract on the agreed schedule
2. 02Value accumulates under the terms of the contract
3. 03The insurer advances against the cash value
4. 04Interest accrues to the insurer while a balance stands
5. 05Repayment restores the capacity that was used

Now here's the key. What the growth comparison leaves out is that one of the two pays a death benefit whenever death occurs and the other does not, and that the contract sets a contractual floor while a portfolio outcome is not contractual at all. Both sides have to be measured the same way.

Costs sit on both sides of this comparison, and are easy to leave out of either one. A portfolio carries its own fees, described in its own disclosure documents, that reduce the return actually realized below the rate quoted in a marketing illustration for it. A contract carries the costs already described elsewhere on this site, disclosed in its own illustration. A comparison that states one side's costs and omits the other's is not a comparison; it is an argument dressed as one, and the direction the omission favours is worth noticing before trusting the conclusion it produces.

The behavioural side of the comparison is real but is not something either side's paperwork can measure. A contract requires a scheduled payment that, once missed, has consequences described elsewhere on this site. A portfolio requires no such scheduled discipline, which is precisely why the money set aside for it is the amount most often spent on something else instead, a pattern no historical return figure captures, because a return figure assumes the money was actually invested every year and not only in the years it happened to be.

What to check before comparing

The insurer's annual statement shows the year's surrender value, which makes it possible to recalculate the comparison against real figures and not the original illustration. Asking a portfolio provider for the same comparison is rarely possible; that recalculation is the household's own to redo, once a year, statement in hand. That yearly habit ends the day the contract itself does, and what that day actually involves is set out under what happens if I cancel my policy.

Redoing this calculation every year, and not once at the start, keeps the comparison honest as the two actual outcomes move closer to, or further from, what was projected at the time of purchase.

The same written record also serves next year, without starting over.

What to ask, and of whom

four settled, then one question

What comes before any product

1. 01Accessible cash for something unexpected
2. 02High interest debt repaid before anything accumulates
3. 03Protection verified by a needs analysis, not an assumption
4. 04Capital, which has to exist before it can do anything
5. 05Then where it is held, and how many jobs each dollar does

For the alternative side of the comparison, ask for the actual fee adjusted return the specific alternative has produced over the same stretch of years being compared, not a market index quoted before its own costs, since an index is not a product anybody can actually buy at zero cost. Ask whoever prepared the comparison which rate they assumed and why that rate, and not another, was chosen for this comparison specifically.

For the tax treatment of whichever alternative is being weighed, whether that is investment income, an amount drawn from a plan, or interest saved by paying down debt, the question belongs to a CPA, since the after tax result is what actually matters and this page states no figure for it. This page does not rank a registered account against a contract for any household, since both can be used, the same dollar can serve more than one purpose over time, and capital itself is the starting requirement common to either path.

Ask, too, over what period the comparison runs, and whether that period was chosen because it is the household's actual time horizon or because it happens to be the period that produces the more favourable number for one side. A comparison run over five years and a comparison run over twenty five years rarely tell the same story, and a household is entitled to see both before choosing which one to believe.

Who this affects most, and who it barely touches

declared annually, never guaranteed

How a policy dividend is decided

1. 01A distribution from the insurer's participating account
2. 02Declared annually at the discretion of the board
3. 03Based on investment results, claims experience and expenses
4. 04It is not interest and it is not a return
5. 05It is never guaranteed, in any year of the contract

The comparison matters most to a household actively choosing between two specific, named uses for the same available dollar this year, where a real alternative exists and can be described in detail rather than assumed in the abstract. It matters far less to a household that has already fully used its other options, has no remaining debt worth paying down, and is deciding only how much further to fund a contract already in force, since there the comparison is no longer between two paths but a question about degree along one already chosen.

It also matters more to a younger household with decades of runway ahead of it than to a household within a few years of needing the money for a specific purpose, since a longer horizon gives an assumed rate more time to compound in either direction, for better or for worse, which is exactly what makes the assumed rate itself worth questioning rather than accepting on faith.

What this page will not tell you

This page does not calculate the figure for you, since that requires your own numbers, your own comparison and your own assumed rate, none of which a general page can supply. It does not rank a registered account against a contract, and states no proportion between them, since that is a suitability question for you and a licensed professional to work through together, not a fact this page states. For the after tax comparison specifically, ask a CPA; for whether a particular contract design suits your own situation, ask a licensed insurance representative, who is ordinarily compensated by commission on the contract placed. Understand that much and you will not be misled.