Term life assurance - flat payments or "inflation adjusted" payments ?

February 18, 2007 6:12 PM

I'm considering buying term life assurance for a term of 19 years. The default deal is $x per month for $z of cover (the amount of cover does not alter over time). However (this amazes me but it's true) the Company gets to determine $x on a year to year basis. You can also pay for the same cover by a different means in which your payments are a fixed number of dollars, $y, every month for the duration of the cover. The quote I have makes $x = $y/2.54 (obviously based upon the inital value of $x). The term is 19 years. Assume for the moment that $x truly is related to inflation. How can I calculate the rate of inflaction which is assumed by these two deals ? Just realised this sounds horribly like a homework question - if only it was !

Help me understand whether a larger flat-rate premium for life cover makes more sense than a smaller variable rate premium .

posted by southof40 to work & money (9 comments total)

I'm sorry I confused the 'short summary' and 'complete question' areas. Hence the enormous summary !
posted by southof40 at 6:15 PM on February 18, 2007

I think you are asking what inflation rate would make the total
undiscounted nominal costs equal, assuming that the variable rate increases at the rate of inflation. Then the formula would be $x*(1+pi)^19=19*$y, where pi is the annual inflation rate.
For your numbers, this implies 1.2% annual inflation.
posted by thrako at 6:31 PM on February 18, 2007

Level term is generally $x/year for $z coverage for N years. That's why you get it... level term. They are stuck with the rate they quote. It's one of the reasons that the rate differential on the two types (multi year and single year) are so large.

Sounds like a wierd policy. If they get to determine it, what's to keep them from raising the rate the the equivalent single year term? I'm just puzzled.

I'd be interested in know what company offers this.
posted by FauxScot at 7:01 PM on February 18, 2007

Wow I messed that up. The formula you want is
$x * sum_{j=0}^{j=19} (1+pi)^j = 19*$y, which is more difficult. Plugging it into excel gave me an implied inflation rate of about 8.5%, for what its worth
posted by thrako at 7:26 PM on February 18, 2007

Thanks for the numbers thrako, that's what I was trying to figure out (although as you'll see I was working on a misunderstanding).

FauxScot your question made me review the email I got sent. It turns out that the $x is not for term cover at all, to quote from the email :

I've done a quote for you for straight life cover of $Z:

Fidelity Platinum $x per month

In answer to your questions, the premiums would increase on a yearly basis in line with your age. You can also choose to have CPI applied, in which case, the amount of cover would increase accordingly. This type of policy would run until the event of your death, or until you choose to cancel it.

... so I'd misunderstood the $x number was not for term cover at all (although seeing as I only asked for term cover I think I've got reason to be confused).

The $y number is indeed for term cover so it's not surprising the two numbers have a strange relationship to each other.

I'm only interested in term cover but I'm puzzled as you are by what stops them jacking up the premium on the other cover as you get older until you decide to cancel ... then again many aspects of insurance leave me puzzled so there's nothing new there.
posted by southof40 at 7:32 PM on February 18, 2007

Uh.... Look, the technique you want is called "time value of money". Google if you like. There's a whole slew of equations for comparing flows of money, over time, with lump sums of money in the present or future, depending on various rates of inflation and interest.

But I'm going to answer your unspoken question, the real one that you actually want to ask: what you want to do is NOT to sign up for life insurance for a period of 19 years based on financials that you don't understand. There's a saying: if you sit down at a poker table, and you don't know who the sucker is, it's you. Do not sign a 19-year commitment to ANYTHING unless you understand the deal extremely well.

I would suggest you obtain term life insurance on a year-to-year basis. It's cheap, easy to shop around, and easy to compare plans from different companies. Buying a one-year term life insurance policy is like looking at a row of bags of sugar in the supermarket: they're all 5 lbs, the price is right there, you just pick the cheapest one. Buying a 19-year term life insurance policy where the premium varies according to some obscure formula..... well, I could try to describe that in terms of sugar, but it would be hard. There's no way to compare their policy with any other company's policy, and what that means is: you're getting screwed.
posted by jellicle at 7:33 PM on February 18, 2007

Hi Jellicle - Thanks for both answers. I'm interested in what you say about buying year-to-year but let me put something to you about that.

There seems to me to be two benefits to committing to 19 years.

First if I develop, for instance, angina in two years time as long as I keep up payments the insurer has to keep covering me at the rate agreed for the next 17 years. If I'm buying it year-to-year the first time I declare some condition which indicates my life may end soon they get to revise the rate at which they wish to cover (or whether they wish to cover at all)

Second doesn't the buyer enjoy a 'discount' by committing to buy a lot of at one time ?

I'm not criticising your comments, I'm grateful for them - I'd be interested to hear what you (and others) think of my counter-points.

thanks
posted by southof40 at 7:43 PM on February 18, 2007

southof40,

There IS a benefit to having level term, and it IS cheaper the earlier you establish it. It is several times more expensive in the early years than the equivalent in straight term, but fractional by comparison in the later years.

The big thing is to insure for the right reasons. I don't have kids, college tuition or mortgage/debt issues, so mine is purely a bet for my estate. I'm considering dropping it as I am way over insured for what I need. However, if you have kids or other obligations that you're planning for, 20 years worth of coverage will get them from birth to college with some financial protection. I could see it being worthwhile in that situation.

Most folks use the advice...'buy term and invest the difference' when considering whole life and similar instruments. I'm not sure how that would stack up for you if you did the same for the first 10 years, but you may want to do the math on it and see how it plays.

Don't feel too bad if some of this crap seems to be designed to obfuscate... I honestly think it is. Insurance gives me headaches, and you may want to do a year or two of just term while you REALLY figure out what you need. It really does take a while to bone up on the concepts and terminology. There is a huge array of products, too, but fortunately, they cluster around a small number of basic categories.

Also, shop around USING YOUR COMPUTER. There are wide variations in rates, even among insurers with similar or equivalent A.M. Best ratings.
posted by FauxScot at 8:41 PM on February 18, 2007

If what you're looking for is the future value of the term life payments over the period accounting for inflation, I think I may have it.

Try : pv (1+i)n[as superscript]

pv = present value
i = interest (or in your case the cost of living projected)
n = number of years

That should give you a rough idea of what your investment should track as total payments over the period.
posted by pezdacanuck at 5:37 AM on February 19, 2007