An Economic Indemnity Model as the Basis for Life Insurance Programs

principle of economic is used to develop a general model for planning an individual's life insurance program. model is based on the right of dependents, as recognized by the courts in wrongful death cases, to recover the present of that part of the deceased's income which they would have enjoyed. Income increases due to age, experience, inflation, and increases in national productivity are provided for. model also includes the effect of taxes, dependents' proportionate share of income, and the reduction in insurance requirements due to social security death benefits. Discount rates are assumed to be directly related to inflation rates. Applied to a sample of life insurance owners, an average of 7.4 percent of gross income would be required for term insurance premiums to buy the amounts computed by the model. average total face of life insurance policies owned by the subjects was about 40 percent of the indemnity amount computed by the model (ratio of adequacy). Regression analysis was used to investigate to what extent, age, income, and number of dependents explained the degree of adequacy of insurance owned by the subjects. age of the insureds was the major explanatory variable. For all the observations 23.2 percent of the variations in the ratio of adequacy of insurance owned is explained by all three variables taken together. In their 1968 article' Aponte and Denenberg (A-D) questioned the insistence of Huebner, McGill and others that cash insurance should be the basis of an individual's life insurance program. Traditional writers, represented by Huebner, view life insurance as the principal vehicle not only for income protection but also for retirement and other savings.2 A-D Frank W. Taylor, D.B.A., is Lecturer in Finance and Insurance in California State University, Fullerton. This paper was submitted in February, 1974. author is grateful to Dr. Herbert C. Rutemiller, California State University, Fullerton for his very helpful comments and suggestions. IJuan B. Aponte and Herbert S. Denenberg, New Concept for the Economics of Life Value and the Life Value: A Rationale for Term Insurance as the Cornerstone of Insurance Marketing, Journal of Risk and XXXV, No. 3 (September, 1968). 2 For example: S. S. Huebner, Human Life Values-Role of Life Insurance, Life and Health Insurance Handbook, 2d, ed.; Davis W. Gregg (Homewood, Ill.: Richard D. Irwin, Inc.), p. 13; Robert I. Mehr and Robert W. Osler, Modern Life Insurance (New York: Macmillan Co., 1961), p. 2. ( 227 ) This content downloaded from 207.46.13.33 on Wed, 12 Oct 2016 04:50:33 UTC All use subject to http://about.jstor.org/terms 228 Journal of Risk and Insurance propose that decreasing term insurance avoids needless costs for unneeded coverage, and recommended their definition of value as the initial building block for life programs.3 By inference, A-D offer term insurance as the means to obtain adequate income protection, with savings for retirement and other uses being provided for after the solution of income protection.4 The insurable value of a human life, as developed by A-D, corresponds closely with the economic evaluation of wrongful death, as accepted in most courts. Briefly, the courts recognize the right of dependents to recover the present of that part of the deceased's income which would have been enjoyed by them, had the breadwinner not been killed. Computation of future income includes present wages or salaries augmented by increases expected because of maturity in the trade or profession, plus increases to be expected because of national productivity increases and inflation. After subtraction of the deceased's expected personal expenses, the remainder is that which the dependents would enjoy. Discount to present determines the award from the tortfeasor.5 above is oversimplified. For example, controversies abound among plaintiffs' attorneys and defense attorneys as to whether income taxes should be subtracted from the earnings. Attacks are made on the collateral sources rule, which prevents the subtraction from awards of any insurance or other income available to dependents as a consequence of the death. Conceptually, however, the principles for economic evaluations in tort cases provide an appealing basis for estimation of adequate insurance benefits. An model is therefore proposed for application to the life insurance program of a family, using those principles. purpose of the investigation was to ascertain if such a model would provide a vehicle for the determination of what is enough term life insurance. model when applied to a sample of 184 men who had recently purchased life insurance gives some assurance that such an approach is reasonable and practicable. Purpose of the Model model is designed to compute the capital amount which, invested in prudent types of securities,7 provides for dependents the same or comparable standard of living they would have enjoyed had the insured survived past his retirement, assumed for this study to be age 65. assumption is made that the bread winner will provide for his dependents' economic protection solely by buying a term policy which, over time, will increase and decrease in face amounts. proceeds from 3Aponte and Denenberg, p. 343. 4Ibid. 5 Philip Eden, The Use of Economists and Statisticians in Impaired Earnings Cases, Personal Injury Annual (1964), p. 802. 6 Avery Averback, The Collateral Source Rule, Ohio State Law Journal, CCXXI ( 1960), p. 23. 7 Securities of no greater risk than Moody's Baa bonds. This content downloaded from 207.46.13.33 on Wed, 12 Oct 2016 04:50:33 UTC All use subject to http://about.jstor.org/terms An Economic Indemnity Model 229 the policy will provide their customary standard of living. Investments for retirement or other income would be a separate consideration. Of additional interest is the cost of such a term insurance program-whether the premium cost of the income protection can be borne by the insured without excessive penalty to the current standard of living. It can be implied that if dependents are accorded their share of the income lost by the death of the income earner, then the spouse's retirement income could be provided by not consuming her entire share of income from the insurance. In other words, the widow would accumulate capital for her retirement income exactly as would occur if the husband should live. As contemplated, the term insurance program to retirement age provides income protection at younger ages when most needed. At older ages protection is more expensive but less needed. Capability of saving usually increases with age-hence a separate program of saving is indicated which involves more saving later in life. An economic model estimates future income, including increases from experience and maturity, from increases in the national standard of living, and from future inflationary trends. Further, the amount of insurance (face value) changes with time automatically, thereby keeping premium costs within reasonable limits. Once purchased, the contract would not require revision unless the pattern of earning power of the insured should change greatly from that planned in the model. Life Value Model A-D make a distinction between human life and insurable value. In calculating human life value, income is discounted for contingencies which would decrease earning power, such as death, illness and unemployment. Insurable value, on the other hand, represents the loss suffered by dependents as the result of the death of the insured; hence contingencies other than death are not discounted. A model which is indicative of the cumulative risks of a societal class would also discount the contingencies within the beneficiaries of the class. In order to develop the hypotheses and assumptions in the model, a human life-beneficiary life model is first reviewed.