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.
Here is some additional evidence about Professor Huebner’s impact in retirement income planning. Many economists and financial experts have puzzled over the minimal appetite of consumers for life annuities — an aversion called the annuity puzzle by researchers in the field. And it seems that the annuity puzzle was puzzled over by Solomon Huebner in the 1930s, before any formal model of the lifecycle was properly developed by economists.
“…The prospect, amounting almost to a terror, of living too long makes necessary the keeping of the entire principal intact to the very end, so that … the savings of a lifetime, which the owner does not dare to enjoy will pass as an inheritance to others….Why exist on $600, assuming 3% interest on $20,000, and then live in fear, when $1,600 may be obtained annually at age 65, through an annuity for all of life and minus all the fear…”
As far as I’m concerned, this is yet another reason to include Solomon Huebner amongst the seven intellectual giants on whose shoulders 21st century retirement income planning research stands and the legacy equation should be named in his honour.
Huebner vs. Fisher
One can’t help but compare and contrast Solomon Huebner to Irving Fisher. Both were born around the same time, grew up in religious households, were academic economists and served as professors at Ivy League institutions. They traveled and lectured widely, were activists for public health and life conservation and enjoyed generous compensation for their speaking and consulting efforts. Moreover, it seems they were interested in the exact same economic issues.
But despite the superficial similarities, there were some important differences between them. Fisher was a professor at Yale, but he spent very little time involved in the pedagogical affairs of the university. He didn’t have students who continued his legacy, or were closely devoted to him. He was an academic loner. His research work was highly mathematical and inaccessible to many economists of his era.
In contrast, Huebner fought hard to get the economic profession interested in the study of insurance. He was intricately involved in the management of the Department of Insurance at the Wharton School. He created the department and kept tight control on all aspects of the curriculum. He was first and foremost an educator and teacher.
As you know by now, Fisher lost his life savings in the stock market crash of 1929, but for Huebner the episode proved to be rather profitable. According to his biographer, Huebner held most of his money in ultra-safe life insurance policies, as one might expect. He was opposed to speculation, leverage and buying stock on margin, especially with money you couldn’t afford to lose. He would disapprove of today’s exotic options, derivatives and triple inverse ETFs.
And yet, soon after the 1929 stock market crash, while prices were depressed, he said to his wife Ethel Elizabeth: “For once I’m going to do what I’ve always described to my students. Things are sinister, dark and discouraging. Now is the time to buy stocks.” He then invested thousands of dollars — which would be equivalent to hundreds of thousands today — across many different companies. He claimed that: “One share in 50 companies is better than 50 shares in one company, because it gives the spread of averages.” He profited handsomely from this diversification philosophy back in 1930, which, coincidently is the year that Professor Harry Markowitz – the Nobel winning founder of modern portfolio theory in the 1960s – turned 3.
Not bad for an insurance man.
Reprinted by permission of the publisher, John Wiley & Sons Canada, Ltd., from The 7 Most Important Equations for Your Retirement, by Moshe A. Milevsky. Copyright © 2012 by Moshe A. Milevsky.