39

There are some people who do not start out with zero, but rather a significant

amount of inherited wealth, and during their life cycle they either increase this
further, or use it up, so they leave more or less to their children41 (or: they may even
leave a debt behind)
It is possible in fact, highly probable that consumption fluctuates much more
during the life cycle than suggested by figure 2.3. The timing of children may be at
very different stages of our lives as well, or due to the differences in the ages of
children, the paying back of the debt could be prolonged for a long time.
The life cycle consists only of an incomplete inactive, or a full young inactive and an
incomplete active phase.
Of the possible deviations, the last one is most significant from the point of view of this
book. The next chapter deals with this deviation and its consequences, as do the sections
dealing with different personal insurance forms in detail. For now lets just say that during the
active phase of the life cycle, not only do we need to produce enough income for our
consumption over life, but beyond this enough to cover the consequences of any unexpected
occurrences that may keep a person from paying back their debt (or raising their children),
from producing the goods needed to support themselves, and from performing the
necessary accumulation.
2.6. THE STRUCTURE OF CASH FLOW DURING THE LIFE CYCLE
The above aggregated cash flow must be examined in its composition, in particular what
the sources of our revenues are, and exactly what our expenditures are for. This structure
depends on two factors:
age and
socio-economic situation.
The structure of outgoing cash flow depends strongly on the current phase of the
individuals life cycle (which can be best represented by age)42, their social situation, and
also on which version of the possible life cycles the individual is living. First we will
concentrate on the differing structure of expenditures during the different phases of the life
cycle assuming a typical middle-class life cycle.
Life cycle phase Description of Typical expenditures Financial
(age) phase decision maker
1-6 Small child age Basic necessary goods (food, Parent
clothing, shelter) (=necessary) (guardian)
7-18 Elementary and Necessary + educational + parent +
high school recreation independently
regarding
pocket money
19-23 University Necessary + educational + parent, state,
recreation + travel independently
24-27 Young entry- Necessary + educational + Independently
level worker, recreation + travel (with different , state
single ratios!)
28-30 Young married Necessary + educational + same
without children, recreation + home buying (also
beginning of different ratios!)

41
It should be noted that leaving an inheritance is not necessarily a voluntary decision. If, for example, the state
taxes its citizens significantly, and from that builds roads etc., then someone can leave a significant amount to
the next generation even if he dies seemingly without a penny to his name.
42
But is should be known that at the same age especially in the adult ages different people are at different
stages of their life cycles. Some are already parents at age 18, some only after 30. Some reach the pinnacle of
their career by age 25, some move forward gradually, etc.

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Life cycle phase Description of Typical expenditures Financial

(age) phase decision maker
career
31-40 Young married, Necessary + educational + same
with small child, recreation + travel + child-raising +
childs education + home(payment,
renovation, trade) car +
precautionary saving for self and
children
41-50 Middle-aged Necessary + self-training + same
married with recreation + travel + child raising +
bigger children, childs education + home(payment,
pinnacle of renovation, trade) car +
career precautionary saving for self and
children (different ratios!)
51-65 Middle-aged Necessary + self-training + Increasing
married, no recreation + travel + occasional financial
dependent support of child + home(renovation, independence
children, stable, trade) car trade + precautionary
high income saving for self (different ratios!)
66-75 Elderly married, Necessary + self-training + Financially
active retired recreation + travel + home independent
renovation + car trade
76-85 Elderly Necessary + recreation + travel + same
widowed, retired healthcare
86- Elderly Necessary + healthcare + Decreasing
widowed, in need personal services/care independence
of care
Table 2.2.: The structure of outgoing cash flow
Figure 2.5. summarizes schematically the most important expenditures:

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 41

Expenditures

Yacht, travel

Purchase of weekend home

Start of a business

Car purchase Car trade-in

Home purchase Home trade-in

Learning Raising children Medical expenditures

Everyday needs: food, clothing, rent, transportation, entertainment etc.

10 20 30 40 50 60 70 80 Kor

Figure 2.5.: The structure of expenditures as a function of age

The incoming cash flow can also be considered in a break-down similar to table 2.2:

Phase of life Description of phase Typical incoming cash flow

cycle (age)
1-6 Small child none (accumulation of debt)
7-18 Elementary and high
Basically none, or some pocket money,
school later some part-time jobs (debt
accumulation continues)
19-23 University Regular part-time work, pocket money
and further accumulation of debt
24-27 Young entry-level worker, Regular wage income
single
28-30 Young married without Regular wage income
child, beginning of career
31-40 Young married, with small Regular wage income (paying back of
child debt)
41-50 Middle-aged married with Regular wage income, beginning of
older children, pinnacle of income from capital (paying back of debt)
career
51-65 Middle-aged married Regular wage income, significant income
without dependent children, from capital (debt is paid!)
stable, high income
66-75 Elderly married, active Basically income from capital, perhaps
retired pension from pay as you go social security
system, irregular wage income

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Phase of life Description of phase Typical incoming cash flow

cycle (age)
76-85 Elderly widowed, retired Basically income from capital, perhaps
pension from pay as you go social security
system
86- Elderly widowed, in need of Basically income from capital, perhaps
care pension from pay as you go social security
system, perhaps income from the
activated LTC43 private insurance
Table 2.3.: The structure of incoming cash flow

The main tendency of incoming cash flow as age increases:

credit wage income capital income (+pension) (perhaps) income from
insurance
Naturally this varies depending on social situation. In social classes with higher income, the
capital income is dominant, possibly even the only form of income during the life cycle.

Figure 2.6 contains a summary of the most important cash flows and reserves. The
horizontal axis shows the phases of the life cycle, on the vertical axes (since we put two
graph on top of each other!) are the Forint amounts.

43
Long Term Care: see in the Explanation of terms appendix!

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Revenues

Time

Expenditures

Savings

Yields

Reserve Utilization
Accidental one-
time expenditure
Credit stock
Payment of loan,
Borrowing interest

Purchase of durable
consumption good

Amortization
Sale

Stock of durable consumption goods

Figure 2.6.: The structure of cash flow during the life cycle

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 44

The debt to society that is accumulated during childhood is not marked on the figure, it
concentrates on the stocks formally showing up as debt. The stock of debt can be regarded
as negative surplus accumulation, so it is shown along with the stock of reserves, as its
mirror image. The net reserves are the difference of the reserves and the stock of credit.
2.7. RISKS THREATENING THE CASH FLOW AND THE METHODS OF DEFENCE
The following requirements must be met by the cash flow of the life cycle:
Liquidity should be assured at every moment, so the needs of the individual must be
financed
There should be sufficient funds for the achievement of goals reaching beyond the
individual (care, leaving a legacy, other obligations to society)
Great fluctuations of the standard of living should be avoided if possible (especially
large drops in it44)
The standard of living is also expected to grow continually45
Let us systematically examine what risks threaten the financial life program reflected in the
figure of the last chapter, or the attainment of a three-phased life cycle, and how these can
be defended against using financial-type instruments?

The most important threats:

Death
Becoming unable to work
Inability to produce income
The devaluation of reserves, the falling apart of the system of institutions that serve
as the frame of our life cycle
Of the above risks we will only deal with the first two here, and to a lesser extent the third.
The description of the last threat is not the subject of this material, but it is important to be
aware of the fact that objectively thinking there exists the possibility of a war, a large scale
economic crisis, regional or world-wide catastrophe, which the country, or the suitable
institutions must prepare for, and which must be avoided along with its consequences.
Death is unavoidable, so it is not its occurrence in itself that causes problems (at least not
from the point of view of long-run financial planning), but rather when death doesnt occur at
the appropriate time, or not at the social average. In this respect, two kinds of deviations
are possible:
Earlier than average, or
Later than average death.
Later than average death causes a problem if we want to end our lives with 0 wealth (or if
we dont want to leave anything behind). In this case there is a need for a risk community,
which redistributes our accumulated wealth among those still living. The solution to this (as
we will see!) is the annuity, which is dealt with by life insurance.
If someone wants to leave some wealth behind, then he can live off of its yield for any
length of time.
The picture becomes more differentiated in the case of earlier than average death. The
problem is different if death occurs within the following intervals:
44
Large increases are also better avoided, because they may cause a fallback later on. When someones actual
income rises, the temptation to immediately increase their standard of consumption is strong. Before anyone
does so, he should ask the question: Will my increase in income be permanent, will it make this high
consumption level sustainable in the long-run? It is also wise to include: Did I raise the level of my savings by
enough to ensure that I will not have to lower my consumption after I retire?
45
Historically, this is a relatively new expectation, but nowadays it has completely assimilated into the
expectations of western man, and seems only natural. More precisely: our expectation is that our standard of
living should not grow more slowly then that of the groups relevant to us (for example neighbours). Overall, it is
important that a person should feel that they are constantly moving forward.

JZSEF BANYR: LIFE INSURANCE