Death Benefits: Rule-of-Thumb Fallacies

Cordell, David M.
September 2004
Journal of Financial Planning;Sep2004, Vol. 17 Issue 9, p32
Academic Journal
This article describes a case addressing some rule of thumb fallacies in calculating the economic value of a life being insured in a life insurance policy. Today, every company that markets life insurance provides software that uses some type of capital needs analysis--an algorithm that discounts the survivor's projected, inflation-adjusted expenses of living--but few emphasize the human life concept. Many insurance agents simply rely on traditional rules of thumb, such as seeking a death benefit equal to six to ten times annual compensation. Even agents who use well-designed software rarely understand the mathematics behind the model and typically compare the result with the rule of thumb, using the latter as a sort of safe harbor. According to the author, therein lies the problem. Expected inflation, projected time frame, and the discount rate are among the implicit factors that determine the appropriate level within the range for the six-to-ten rule of thumb. According to the author, when financial advisors do not understand the underlying tenets of the rule of thumb, which in this case have quantitative underpinnings, they may have satisfied being within the range, even though they are far off the mark.


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