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        Investor's Insight - April 10, 2006           
          "A Digest of Investment Opinion From the 
             World's Leading Financial Advisers"

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by Scott Burns

Financial Planning 1.0 -- what most of us encounter 
through advisers or on the Internet -- meet Financial 
Planning 2.0. This eight-part series of columns, writt-
en by Laurence J. Kotlikoff and me, explores the con-
sumption smoothing approach to lifetime personal fi-
nance. While the idea has been developing for nearly a 
century, it has taken the power of today's personal 
computers to build the necessary tools. When we use 
these tools, we find that conventional planning is more 
likely to lead us astray than take us to financial se-

In his day, Andrew Carnegie was the world's richest man. 
He was also one of the most humble and generous people 
to ever walk the Earth. He attributed much of his succ-
ess to others. Following his dictum -- "The man who dies 
rich dies disgraced" -- he donated his entire estate to 

Carnegie was particularly passionate about education and 
educators. In 1918 he endowed the Teachers Insurance Ann-
uity Association, now known as TIAA-CREF, to help ensure 
the financial well-being of our nation's teachers. Over 
the years, TIAA-CREF has done a fine job fulfilling its 
mission, not just for teachers, but for the general pub-
lic it now serves. It does high-quality research and de-
livers low-cost investment management.

But we've got a complaint. 

The one area where the nonprofit has fallen short is fi-
nancial advice. Here the company seems more concerned 
with marketing than with providing sound guidance. Case 
in point: TIAA-CREF has not one, but two, life insurance 
needs calculators on its Web site.

The Simple Life Insurance Calculator has five questions.

The Detailed Life Insurance Needs Calculator has 20 


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Both calculators ask you how much of the insured's earn-
ings need to be replaced and for how long. They both ad-
vise using a 75 percent income replacement rate if the 
household has no mortgage. They advise a higher rate if 
it does.

Both calculators solicit your mortgage balance and college 
and emergency funding needs. The Detailed Calculator also 
asks about household demographics, assets, taxes, inflat-
ion and the rate of return on one's assets.

Neither calculator asks about the surviving spouse's/
partner's current earnings, future earnings or retirement 
date. This is remarkable because the fundamental goal of 
life insurance is maintaining the household's living stan-
dard. You can't understand insurance needs without knowing 
the living standard that needs to be protected. And you 
can't calculate the household's living standard without 
knowing about all its economic resources -- including those 
of the surviving spouse/partner.

The calculators also ignore all Social Security survivor 
benefits -- another huge omission. There's nothing about 
the survivor's planning horizon, housing plans, pension 
benefits, retirement accounts and a host of other factors 
that can make a major difference to life insurance needs.

Does it matter? Yes.

Take the Middles -- a middle-aged, middle-class married 
California household with two children. Both spouses are 
40. The kids are 7 and 10. Mr. Middle earns $75,000 per 
year. Mrs. Middle earns $50,000. The couple has $75,000 
in regular assets and owns a $300,000 home with a $125,000 
20-year mortgage, with monthly payments of $1,250. Pro-
perty taxes, homeowner's insurance and maintenance total 
$6,000 per year. The couple plans to spend $25,000 in 
today's dollars on college tuition and other expenses for 
each child for four years. Each spouse will retire at age 
65 and begin collecting Social Security benefits in that 
year. Both spouses experienced 4 percent wage growth since 
they started work at age 22. The couple expects inflation 
to run at 3 percent annually and to earn a 6 percent nom-
inal rate of return on savings.  

According to ESPlanner (Kotlikoff's commercially available 
financial planning program), Mr. Middle needs $485,000 in 
coverage and Mrs. Middle needs $129,000 to smooth their 
consumption. This will ensure survivors with the same li-
ving standard, assuming they live to age 95. 

In contrast, using an 80 percent lost-earnings replace-
ment rate assumption, TIAA-CREF's Simple Calculator tells 
Mr. and Mrs. Middle to buy a whopping $1.825 million and 
$1.325 million in life insurance, respectively. The De-
tailed Calculator tells them to buy a bit less. Mr. Middle 
is to buy $1.054 million in life insurance, and Mrs. Middle 
is to buy $777,790. 

Either way, the amount of insurance recommended is a 
multiple of the amount recommended by consumption smooth-
ing. If the couple were to follow TIAA-CREF's Detailed 
Calculator's recommendations, they'd pay close to $3,000 
in premiums, or 2.3 percent of their combined annual 
earnings. If the couple follow the Simple Calculator's 
advice, they'll spend over $5,000, or 4 percent of their 
earnings. This is a lot of money to pay for insurance 
they don't need.


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If you're beginning to think that TIAA-CREF is some kind 
of villain, don't. It is simply following common industry 
practice. While there are a multitude of life insurance 
calculators in use, virtually all share a common trait: 
They systematically inflate life insurance needs because 
of the calculation methods they use.

We point to TIAA-CREF because it provides two calculators, 
not one. There aren't two answers to the question of how 
much life insurance a household needs. So if TIAA-CREF 
believes that $1.825 million is the right life insurance 
holdings for the husband in our stylized household, why 
does it offer its Detailed Calculator, which tells Mr. 
Middle to dramatically underinsure by purchasing only 
$1.054 million in life insurance? Alternatively, if TIAA-
CREF believes that $1.054 million is the right coverage 
for Mr. Middle, why does it provide the Simple Calculator, 
which will lead him to dramatically overinsure?

We think there is a clear answer: Marketing. 

As with most financial institutions, the primary goal is 
selling policies. Whether the amount of insurance is app-
ropriate is secondary.

TIAA-CREF senior vice president Bret Benham, when called 
for comment, said: "Our site clearly states that the 
simple life insurance calculator is intended to provide 
customers with a rough approximation of the amount of life 
insurance needed if death occurred today, but we recognize 
that the actual amount required to help meet dependents' 
needs may be higher or lower than the amounts shown."

An $800,000 difference, on its own calculators, is a
pretty good demonstration of "rough."

Next: Part 4, Soliciting Risk


Laurence J. Kotlikoff's Web page: 

ESPlanner software Web page: 

"The Coming Generational Storm"(at MIT Press): 

"The Coming Generational Storm" (at Amazon.com): 

Full comment from Bret Benham, senior vice president for 
Individual Protection Products, TIAA-CREF:

"As Dr. Kotlikoff has said regarding his own insurance 
calculator, they are simply tools to help find a solution. 
Web-based calculators are not designed to replace a com-
prehensive evaluation of an individual's life insurance 
needs. Many factors go into evaluating life insurance 
needs, and the more information included in that assess-
ment, the more closely one can accurately determine the 
level of coverage appropriate for their individual cir-
cumstances, goals and attitude toward investment risk.

"Our site clearly states that the simple life insurance 
calculator is intended to provide customers with a rough 
approximation of the amount of life insurance needed if 
death occurred today, but we recognize that the actual 
amount required to help meet dependents' needs may be 
higher or lower than the amounts shown.

"We also clearly state that these calculators do not re-
flect the effects of inflation, taxes or the time value 
of money. For a more detailed analysis we recommend that 
customers contact our planning consultants, whose compen-
sation is not tied to commission sales, for a more detail-
ed assessment of their individual life insurance needs, 
which could include factors like a spouse's income or 
Social Security benefits."

(Questions about personal finance and investments may be 
sent to Scott Burns, The Dallas Morning News, P.O. Box 
655237, Dallas, TX 75265; or by fax: (214) 977-8776; or 
by e-mail: scott@scottburns.com. 

Check the Web site: www.scottburns.com. 

Questions of general interest will be answered in 
future columns.)

(Investor's Insight reflects the opinions of experts. It does 
not recommend any specific investments, and no endorsement is 
implied or should be inferred. For more information, contact 
the individual firms cited).



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