A Critique of the Interest-Adjusted Net Cost Index: Comment

Abstract

In a recent paper [1] Scheel discusses the IA index. He argues that it is too simplistic and that it produces policy rankings which do not reflect the preferences for wealth that most people have. He also suggests that the IA index is subject to manipulation and distortion just as the net cost index is. To get over these difficulties he proposes a Risk Premium (RP) index which takes interest and the probability of survival into account and makes allowance for the cash surrender value schedule as well as the dividend scale. In the present comment, some features of the RP index are examined. In particular, the effect of changes in the projected dividend scale on the RP index is examined. It is found that the dividends shown for the years just following issue are given relatively heavy emphasis. Consequently if the RP Index were adopted this could induce a company to move towards a more level dividend scale and some of the possible consequences are examined. In order to overcome one of Scheel's criticisms of the IA index a Modified IA index is proposed which takes both the projected dividend scale and the cash surrender value scale into account. This proposed new index involves a simple modification of the IA index and only requires the policy details and compound interest functions for its calculation. Finally, some of the problems associated with devising a suitable cost index are discussed. The point of departure is the formula for the IA index. Assuming a planning horizon of H and a rate of discount of r the IA equation is