A Price Index for Life Insurance

Abstract

This paper is an attempt to develop a method that may be used to measure the movement over time of the price of life insurance protection. Consideration is given to the problem of selecting an appropriate price concept, and a method of constructing a price index for life insurance is developed around this price concept. In order to illustrate the method, certain limited data are used to construct a tentative price index for the period 1925 to 1965. The life insurance industry is one of the few that have been able to provide their services or products to the public at declining prices over the years. Falling mortality rates and rising interest rates often have been mentioned as the two primary reasons for the decline of the price of life insurance protection over the years, but the magnitude of the decline never has been measured systematically. This article has two purposes: (1) to outline briefly a method of constructing a price index for life insurance designed to measure the yearly movement of the price of life insurance protection over time, and (2) to illustrate the method by computing a tentative price index for the period 1925 to 1965. A Definition of Price In life insurance, premiums are distinguished from prices. The distinction is made because premiums are often the payments for a combination of life insurance protection and savings, while prices or costs are often defined as the payments for life insurance protection alone. The fact that a series of level premium payments is made to purchase changing amounts of protection and savings, and that these two elements are basically different, complicates the problem of price calculation in life insurance to such an extent that there has been a considerable difference of opinion about the definition of the price of life insurance and the method by which the price should be calculated.' In this article, the historical yearly price of protection is used as the definition of the price of life insurance for the construction of a price index for life insurance. The calculation of the historical yearly price of protection can be expressed as follows:2 (BCV + GP) (1 + i)-DIV-ECV x 1,ooo FACE-ECV Cheyeh Lin, D.B.A., is Associate Professor of Finance at the University of Cincinnati. This article was submitted in February, 1971. The author is indebted to Dr. Joseph M. Belth, Professor of Insurance, Indiana University, for his valuable comments on an earlier draft of this paper. 1 For a discussion of different methods of calculating the price of life insurance, see Joseph M. Belth, The Retail Price Structure in American Life Insurance (Bloomington, Indiana: Bureau of Business Research, Graduate School of Business, Indiana University, 1966), pp. 7-20. 2The method of calculating the historical yearly price is based on the level-price method developed by Joseph M. Belth. See Belth, op. cit., pp. 19-20, 35-38.