Company Retention. An Unreliable Indicator of the Cost of Life Insurance to the Policyowner

Abstract

Company retention is shown to be non-unique for policies with different underlying cost structures. The formulation is examined to see if it accurately reflects a policyowner's viewpoint of expected cost. An alternative is proposed which adjusts for the understatement of the protection element and overstatement of the savings element. The company retention measure devised by Joseph M. Belth and recommended by him as part of a price disclosure scheme for life insurance has been described as an indicator of what the insurance company keeps to cover its expenses and make a profit on a particular policy. The retention value is considered by its originator to be a suitable measure for assessing relative costs when making a purchase decision.' This article will show that the retention measure, if used as suggested by Belth, can be misleading and produce inconsistent-even deceptiveindications of relative cost. Specifically, it will be shown that the retention indicated for a particular policy is not necessarily unique. That is, two or more policies can have the same retention value and yet be such that a rational buyer would have definite preferences for one or another based on cost considerations alone. It will also be demonstrated that there is a bias in favor of dividend payouts as opposed to wealth accumulations through savings-a bias that can lead to nonsensical results. William C. Scheel, M.A., CPCU, is Lecturer in the Department of Risk and Insurance and Actuarial Science in the University of Wisconsin, Madison. He was previously a member of the Faculty of Business Administration and Commerce in the University of Alberta. This paper was submitted in October, 1973. 1 The retention measure is discussed both in Joseph M. Belth, Price Disclosure in Life Insurance, Wisconsin Law Review, Vol. 1972, No. 4, pp. 1054-1069; and in Belth's book, Life Insurance a Consumer's Handbook (Bloomington: Indiana University Press, 1973). Belth has described the usefulness of the retention measure in his price disclosure article as follows: [The company retention is] what the company keeps to cover its expenses and make a profit-from the policyholder's point of view. This is the difference between what the policyholder pays in (the present expected value of the premiums) and what he gets back (the sum of the present expected values of the protection element, ( 81 ) This content downloaded from 157.55.39.215 on Wed, 31 Aug 2016 05:07:21 UTC All use subject to http://about.jstor.org/terms 82 The Journal of Risk and Insurance