Inflation is top of mind for consumers and advisors thanks to an 18 year high. How does this impact life insurance policies, and how can you incorporate this into your planning when working with your clients to help them get the right products for today and into the future?
Most people can relate to the concept of inflation as it impacts every aspect of our lives from our largest purchases like our houses to something as small as a cup of coffee. Many reading this will remember a day when a coffee was 70 cents a cup and a loaf of bread was well under $5, not so much today.
Inflation is “The decline of purchasing power of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. The rise in the general level of prices, often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods.”Investopedia
Inflation is top of mind for consumers and advisors thanks to an 18 year high! In-fact, when polled advisors are more concerned with the impacts of inflation than almost any other risk factor.
How does inflation impact life insurance, and how can you incorporate this into your planning when working with your clients to help them get an appropriate amount of coverage today and into the future?
Let's start with the basics and take a look at how we can measure the impact of inflation. One of the best ways to measure inflation is to apply a Present Value & Future Value (PV/FV) calculation to your insurance product analysis to show the purchasing power of the benefit at a future date.
Present value (PV) is the current value of a future sum of money or stream of cash flows given a specified rate of return. Future cash flows are discounted at the discount rate, and the higher the discount rate, the lower the present value of the future cash flows. Determining the appropriate discount rate is the key to properly valuing future cash flows, whether they be earnings or debt obligations.
By using a PV calculation and adjusting our “r” value, we can simulate a rate of inflation and project how much purchasing power our future insurance would yield, adjusted for inflation.
Let's look at a case study to examine the impact of a few different levels of inflation for our hypothetical client Jack Millennial.
Mr. Millennial is a 40 year old Male, Non smoker, who has 2 kids, a new house, aspirations of a cottage. He clears 75k after taxes thanks to a recent promotion, but has a little bit of household debt (in today's interest environment he would be silly not to).
If we look at a snapshot of his current needs we can see he has a roughly $1,000,000 need for life insurance today.
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To the average consumer they might think of their level of million dollars of insurance benefit like this. (provided they pay renewals, we’ll leave that for a moment).
However, if we apply a PV of 2% and look at what happens over the next 45 years:
We can see that our $1,000,000 benefit has a purchasing power of just $410,196.80 in year 45 (age 85 for this client)
Given that inflation hit 4.7% this year, with limited indication that it will slow in the near future, we should adjust our assumptions.
If I change my “r” value or discount rate (inflation rate) to match current inflation rates.
We can see that our adjusted insurance purchasing power is only $126,589.98 at age 85!
For your clients, this means the amount of insurance they purchased may not sufficiently meet their goals and could leave them with a short fall.
For advisors, it represents an opportunity. One to review your clients needs and to highlight something that may already be top of mind for them. Two it represents an opportunity to sell more coverage or a different kind of coverage.
Let's take a look at this same presentation if we use a participating whole life product.
In our first example at 2% PV we can see that under the current dividend** At age 85 we have $1,090,621.18 of coverage, this means that the paid up additions in this plan grew enough to offset the impact of inflation.
However if we adjust to 4.7% inflation rate that number drops to $336,574.32 at age 85.
It’s clear why advisors are correct to fear inflation.
Insurance benefits are one thing, however inflation is a double edged sword. Future premiums, especially in the case of term renewals, may increase. However, because future money is not as valuable as money today, the impact of the renewals are less drastic.
While clients should ideally never have to pay the “guaranteed renewal premium” (you could also illustrate this as a re-issue in LDA (assuming good health and current pricing) it might influence the product & pay schedule you choose (pay to 100 vs guaranteed 20 pay) in high inflation environments.
It's also extremely important to compare these values on a reduced & guaranteed basis (using the interactive legends in LDA) as participating life insurance par-funds face extreme pressure in a low interest high inflation environment. Consider adding a fully guaranteed whole life product in your report.
While client problems always trump product solutions, it is increasingly important to establish and review our clients suitability in a changing financial environment.
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