The Visible Policy
Page 6, Deflate This!
Ride the Wave!
So, is there some other way to represent dissimilar data? A way
that allows comparison on both a localized and a global level? (There
better be, or this is going to be a short section!) How about comparing
the dissimilar things with something else -- something you understand as
a valid reference for all sets of information involved? Ladies and
gentlemen, step inside -- become -- the Wave of Inflation, and see
how the investments look from its perspective:
The Black Box Annual Gain curve showed one personality aspect for the
investment strategies, this curve shows another. Instead of focusing
on the year-to-year gains, this view steps back and watches how the total
investment is doing in terms of real value. If the investment is
at the 0% line, it is keeping up with inflation. A loaf of bread
may cost more 20 years from now, but investments that keep up with inflation
have the added value to pay for this increase without noticing.
Investment strategies which map above the 0% line are gaining real
value. In a sense, that loaf of bread is getting cheaper, even
though its cost is going up. Here is the formula for Inflation
Wave Ratio, Cash Value:
totalCashValue - totalInflatedCost
Let us look at each strategy, beginning again from the top right. Click
the curve above to get a smaller version in a different window. You can
compare it as you read the following analysis.
- The solid green line represents Total Cash Value (TCV) of the OPP strategy.
($33,000 is put into the policy over 14 years.)
In this strategy, from the first policy years I am exercising my Option to Purchase
Paid-up-insurance. Presuming my model for this strategy is correct,
doing so clearly pays off in the long run. Even so, it takes 13 years
to get ahead of the inflation line and be considered any kind of useful
investment. Finally in the 21st year it overtakes the max T+I curve.
There is a reason all the curves flatten out for a few years in the center.
For most future years, the model uses a 3% inflation rate. For past
years (beginning 1996) it uses actual inflation rates. The "flat" years,
however, model a 6% inflation rate; I was curious to see what the impact of a
higher inflation rate would be.
- The long-dashed and dotted turquoise line represents the "max T+I" case.
($33,000 is invested for 14 years; $485/year is deducted to purchases term
insurance for 30 years.)
For the first 21 years, it is the leading curve. However it begins to
lose ground after year 14. In the Whole Life w/OPP case, the
cost of insurance is minor, at least until age 70 or so.
Two things then occur at about the same time. The Term+Invest
strategy completes its 30-year term period, and no longer has to not-invest
$485/year. Within the Whole Life policy, cost of insurance becomes
significant. This can be seen on the BBAG curve,
To give you an absolute reference, by age 89 this case has a value of
$304,000 and the OPP a value of $336,000.
- The dotted turquoise line represents the "min T+I" case.
($21,168 total is invested for 12 years; $485/year is deducted to purchase
term insurance for 30 years.)
Once the term period stops, its gain easily surpasses that of the Base Policy
case. In the long term, this is even a more efficient strategy than the
"Base Policy with XP" case -- in absolute dollars, the XP case stays ahead,
but it used $33,000 out-of-pocket dollars to get there.
- The dashed orange line represent TCV for the XP strategy.
($33,000 is put into the policy over 19 years.) While it earns
more absolute dollars than the Base Policy case, the efficiency of
those earnings is only slightly better. That is not to say the absolute
dollars don't matter; by age 89 XP has a TCV of $212,000, Base Policy has
a TCV of $132,000, and the "min T+I" has a value of $160,000.
Why does efficiency of "XP" dollars begin to exceed "Base" dollars?
Examination of the models shows that there are three annual sources of gain
in both cases. Guaranteed Cash Value increases each year exactly the
same in both. Dividends increase in both, but the dividend rate is the
same, so this does not affect efficiency. The third source of gain
eventually becomes significant -- "linear increase in value"
(LIV) of the Paid Up Additional insurance
purchased by dividends. It takes years for the extra LIV to noticeably
improve efficiency over the Base Policy case, but you can see that it
The OPP case excels for two reasons. In the first
place, more money is put into the policy earlier, increasing dividends and the
LIV earned on the PUA purchased with those dividends. Secondly, OPP
adds a fourth source of annual earnings -- LIV earned on the PUA purchased
with OPP dollars.
- The solid brown line represent TCV for the Base Policy case.
($21,168 is put into the policy over 12 years.)
Two things are important about this curve. The first is that it is
probably the strategy which most purchasers of participating whole life
insurance will follow. The second is that it does eventually become
an "investment" -- total cash value begins to exceed its inflated cost.
It takes 15 years for this to become true, however. (It only took
11 years to exceed absolute cost, but until year 15, less loaves of bread
can be purchased than before you started.)
"I don't see inflation!"
It is there; you are riding inflation, remember? Every strategy
is ratiod against inflation, putting it exactly at the 0% line.
There are actually three inflation curves involved.
Each strategy is ratiod against its appropriate inflation curve.
Depending on how much money was invested
for each year, the inflation curve is different. For example,
$30,000 invested up front would be inflated 3% of the whole amount each
year. All of it will increase in a compounded manner from the second
year on. But if $3,000 were invested each year for 10 years, the
total effect of inflation will be less. E.g., the $3,000 invested in
year 8 does not have many years of inflation history and compounding behind it.
Dead Man's Wave!
Since the primary purpose of insurance is to provide for one's dependents, the
effect of inflation upon Death Benefit should not be ignored. One of the
advantages of whole life compared to some other types of permanent insurance is
that it can be structured, at no extra cost, to automatically raise the Death
Benefit. To do so, one keeps the dividends within the policy. Over
time, they purchase more paid-up additional insurance (PUA), increasing the
Here is the formula for Inflation Wave Ratio, Death Benefit:
currentDeathBenefit - inflatedBaseDeathBenefit
By themselves, dividends and the PUA they purchase are not enough to keep the
Death Benefit current with inflation. I am purchasing extra PUA under the
terms of my OPP rider. Along with the dividend PUA, I have been
purchasing roughly enough extra insurance so that the Death Benefit
keeps up with inflation. As in the Cash Value curve, there are a few years
in the center where I brought the inflation rate up to 6%; most future years
use 3%, and past years use actual inflation numbers.
To follow along with my line-by-line description of the curve, click the one
above. As usual, a smaller version will appear that will stay on top as you
read the description below.
- The solid green line at top represents Death Benefit with OPP.
A total of $33,000 was spent out-of-pocket over 14 years.
This is my actual strategy, with extra purchases of Paid Up Additions.
It not only keeps up with the effects of inflation on Death Benefit, it
eventually surpasses it.
Some people purchase a more expensive policy, with a higher Death Benefit than
they need right away. They reason that inflation will eventually stifle
the monetary value that DB had in the early years. You can see that, by
committing to pay somewhat extra in the early policy years, one need not
purchase a higher cost policy merely to account for inflation.
Note: this is a primary advantage of Participating Whole
Life insurance. The value of PUA Death Benefit is several times
more than the cash you pay for it. Thus its effect is multiplied.
Extra payments made to Interest-Sensitive Whole Life, Universal Life, and
Variable Life policies experience no such Death Benefit multiplier.
Thus it would be more expensive to use extra payments to keep the DB even
- The fine-dashed turquoise line is the "max Term + Invest" strategy.
Money is invested the same as the OPP strategy, $33,000 over 14 years.
It does a reasonable job of keeping up with inflation until out-of-pocket
dollars cease. Then it gradually drops off until its earnings enable
it to start exceeding inflation's effect on Death Benefit. Just
about that time, however, the 30-year term policy ends, and it instantly
loses $100,000 in absolute value. Still, it manages to make a good run
at inflated DB, and by age 99 it is almost caught up.
- The dashed orange line represents Death Benefit with extra payments (XP).
A total of $33,000 was spent out-of-pocket over 19 years. None
of the extra dollars occur until after the 12 years of the Base Policy
case. You can see that the extra money helps, but not nearly as much
as the OPP case, where most of it is put into the policy earlier.
However, no PUA is ever sold back; DB never drops in absolute dollars.
- The dashed and dotted turquoise line is the "min Term + Invest" strategy.
Money is invested the same is in the Base Policy case, $21,168 over 12 years.
For the 30 year that the term policy exists, total DB exceeds that of the
Base Policy case. When that $100,000 goes away, though, it has some
catching up to do. In my early 90's it would catch up with the Base
Policy curve, but it still has a long way to go before making up for the
effect of inflation on Death Benefit.
- The solid brown line represents Death Benefit for the base policy case.
A total of $21,168 was paid out-of-pocket over 12 years. Observe how
sharply inflation-relative DB drops off when external premium payments cease.
The policy is not yet earning enough dividends to fully make the annual
payments. To make up the difference, PUA is actually sold back for
about 7 years. Thus, DB is going down in both the absolute and
- The solid turquoise line is our old friend "Buy Term & Don't Invest".
A total of $14,550 is spent -- $485/year for 30 years.
After that, there is no insurance and no nest-egg. The Base Policy
case tends to follow this curve for 16 years because of the seven years it
spent selling off accumulated Death Benefit. If one only saw these two
curves, the hostility some people have towards cash value insurance is almost
understandable. $21,168 was spent on the Whole Life policy, and until
the term policy ends, there seems to be little advantage gained. Still,
the term policy does end, and the Whole Life policy does not.
- The solid red line at 0% is our old enemy, inflation.
It just sits there laughing at everybody but OPP.
Accesses since 3 June 2001
last modified 22 November 2010
© 2001 - 2010 by Rich Franzen
New model incorporated August 2002.
Rich's Home Page
No content within The Visible Policy has been approved,
authorized, or verified by New York Life or any of its representatives.
I have attempted to fairly and accurately portray the policy, but there are
likely to be mistakes. Over time, I shall endeavor to correct any
misinformation found herein.|