In the beginning, life insurance was perceived as just another gamble, or a game of chance, involving three parties. The owner of a policy paid premiums to an insurance company, which was obligated to pay the beneficiary a death benefit, if and when the insured died.
In contrast to fire or property insurance, life insurance — profiting from someone’s death — was viewed with a jaundiced eye. In many European countries, life insurance — betting on lives, as it was often called — was illegal. And where it was legal, there wasn’t much thought given to how much insurance people should own, and the entire sales process itself was ad hoc and arbitrary.
But then Solomon S. Huebner came along and transformed the marketing and sales into a scientific process. A professor at the venerable Wharton School of Business, he brought the tools of economics and human capital valuation into a field that lacked discipline and respect.
Professor Huebner’s main idea, and the one for which he is recognized today, is that people should insure their human life value, which is the present value of all the wages, salary and income that a breadwinner will earn over the course of his working life. He argued every head of household had a moral responsibility to have life insurance to protect that capital.
While you are working, you must ensure your dependents and loved ones are properly taken care of, in case you are no longer able to work. Once you have retired, should you — can you actually afford to — leave them anything?
Imagine that your generous uncle has promised to give you $100,000 from his estate when he dies, but he is currently 65 years old and quite healthy. Or, assume the same uncle has a life insurance policy with a death benefit he no longer needs. He is thinking of selling the policy to a third party in exchange for some cash now.
How do you derive a present value for the sum of money that your beneficiaries will receive at some random time in the future? The equation above shows how.
Using the spreadsheet above to handle all the numbers, the equation computes the discounted value of a $100,000 death benefit, under a variety of interest rates and at various ages. For example, the value of a permanent $100,000 death benefit at the age of 65, under a 5% valuation rate, is $41,656.
If the rate is lower, say 3% for example, the actuarial value of the policy is $57,776. With higher rates, the present values are lower. Notice the impact of age as well. If Uncle Generous is 80 years old (under a 5% interest rate) the value is $65,780 because he is more likely to die sooner.
Although most students of the industry rightfully view Professor Huebner as a huge advocate of permanent and everlasting life insurance, he actually had quite a bit to say about retirement as well. His master plan was to have a policyholder convert some of his life insurance into a life annuity around the age of retirement.
His argument involved more than just mortality credits and insurance economics. In echoes of Jane Austen, he wrote:
“…Annuitants are long livers. Freedom from financial worry and fear, and contentment with a double income, are conducive to longevity. If it be true that half of human ailments are attributable at least in part to fear and worry, then the effectiveness of annuities for health and happiness must be apparent…”
I venture to guess that if Professor Huebner were alive today, he would be on the road with annuity wholesalers giving seminars to financial advisors and their clients, extolling the virtues of longevity insurance and life annuities.