How Adjusted Premium Method Works

Policyholders contribute regular payments to their life insurance policies. These payments are known as premiums, which the insurance company requires for a certain amount of time to provide insurance coverage. The total amount of these premiums is divided into two parts: one part is directed to the reserve fund, while the other part is directed to savings.

In the early years, when the premiums are divided, a bigger part is moved to the reserve fund, which is used to cover the insurance policy's death benefits. Meanwhile, the savings amount accumulated will be smaller than the reserve amount during the same period.

When a policyholder decides to cancel their life insurance policy ahead of time, the adjusted premium method is used to calculate the cash surrender value (CSV) – the sum of money paid by the policyholders to the insurance company in case the policy is voluntarily canceled ahead of time or due to an insured event occurrence.

Example of Adjusted Premium Method

The adjusted premium method is calculated through the cash surrender value (CSV). The CSV is calculated by considering the total of premiums already paid to the insurance company until the date of policy termination and subtracting from it all the fees and costs assembled in obtaining and servicing that specific life insurance policy.

Say a policy holder wants to terminate their life insurance policy. While processing their request, the insurance company will deduce the cash surrender value total in two separate ways:

  1. The company will destinate a share of the CSV total to reduce from the policy’s expense allowance, which shows the expenses obtained by the insurance company to acquire that specific insurance contract.
  2. The company will then deduce the surrender fees from the CSV. These fees increase in the early years of the contract cancellation and can amount to up to 10% of the cash surrender value. Therefore, it is usually unprofitable to terminate a policy prematurely.

Adjusted Premium Method vs. Adjusted Premium

The adjusted premium method is used by insurance companies to estimate how much money is owed to a policyholder who decides to cancel their life insurance policy prematurely. More specifically, it is used to estimate the cash surrender value (CSV) of a life insurance policy, as explained in the above section.

You should not confuse it with the term "adjusted premium," which is related to a premium (regular payments to one’s life insurance policies) within an insurance policy that does not endure at a fixed price permanently. Its rates can oscillate up and down within a limit established in the contract, according to the insurance company’s preferences, and during the whole duration of the insurance policy.

The adjusted premium is also different from the adjusted premium method as its adjustment is calculated by the total amount of the policy, from its initiation until its end, divided by the sum of years the insurance policy is expected to last. Many factors can cause changes on it, such as the policyholder's life expectancy and the earnings of paid premium investments.