Reading 21

Question 1

total wealth

Answer 1

human capital + financial capital

Question 2

human capital

Answer 2

discounted PV of expected future labor income

Question 3

Pension is HC or FC?

Answer 3

FC

Question 4

economic net worth

Answer 4

sum of the individual’s FX and HC less any liabilities owed by the individual

Question 5

Is value of net worth always positive?

Answer 5

could also be negative based on the adequacy of savings versus projected needs

Question 6

Life insurance benefit/ face amount

Answer 6

the future payout - may be a lump sum or annuity

Question 7

life insurance cash value

Answer 7

what an owner can withdraw before payout, which reduces or terminates final payout

Question 8

life insurance paid up

Answer 8

a date when the insurance is fully paid for and no additional premiums are required

Question 9

life insurance contestability period

Answer 9

time period of the insurance company to investigate or deny payment of the claim

Question 10

life insurance riders

Answer 10

additional provisions included in the policy

Question 11

temporary (term) insurance

Answer 11

covers only a designated period such as 1, 5 or 20 years
- cost can be fixed or increasing over the period
- policy ceases at the end of the period unless it includes a provision to renew
- less costly than permanent because mortality risk is lower for insurance company as risk of dying increases later in life.
- term insurance for younger people or for shorter time period costs less

Question 12

permanent insurance

Answer 12

more costly, lasts for the life of the insured
- premium per period is fixed
- policy builds value as the premium exceeds the pure cost of insurance in the initial years. in later years, this built up value covers the increasing cost that would be paid for pure term insurance. permanent insurance can be whole life or universal insurance.

Question 13

whole life insurance

Answer 13

• typically fixed premium payment
• policy continues and cant be canceled by the insurance company as long as premiums are paid
• may reach fully paid status in later years and require no further premiums
• participating whole life shares in company profits and may increase in value more quickly

Question 14

universal life insurance

Answer 14

• similar to whole life insurance, but more flexible
• premium payment can be increased or decreased or decrease amount of insurance and/or the rate at which cash value grows
• there may be investment choices for where the premiums are invested
• premium payments can be discounted and the insurance continues as long as the cash value and earnings on cash value are sufficient to pay the pure cost of insurance each period

Question 15

Gross Premium of life insurance

Answer 15

load + net premium

Question 16

insurance load

Answer 16

company’s operating cost and expenses for writing the policy, can include a sales commission to sell the policy and cost of any medical tests to determine insurability

Question 17

Annuity

Answer 17

one time premium payout in exchange for fixed payouts received for the life of the annuitant

Question 18

Deferred variable annuity

Answer 18

allow the owner to select from a list of investment options. higher/ lower returns will increase or decrease the future payouts received.

Question 19

Advanced life deferred annuity

Answer 19

• lower cost way to hedge the longevity risk of the annuitants outliving their other assets.
• require immediate premium payout at purchase
• payouts are fixed but the delay period before they start is long, often age 80 to 85 for the annuitant.
• low premium reflects these factors

Question 20

Immediate variable annuities

Answer 20

start payouts immediately, but the amount of future payouts is indexed to the performance of some reference asset, such as stock index. as the reference price increases or decreases, the payouts increase or decrease.

Question 21

immediate fixed annuity

Answer 21

begin payout immediately and payout amount does not change

Question 22

will 60 year old male receive higher annuity or 60 year old female

Answer 22

male as females live longer and the total payouts made for the female by the company will be higher

Question 23

60 year old male or 80 year old male - who has higher annuity?

Answer 23

80 year old male because life expectancy is shorter, so less payouts

Question 24

A rider specifying payouts to be made for at least 10 years versus no rider

Answer 24

rider reduces payout because higher cost to the insurance company - it no longer benefits from cessation of payouts to annuitants that live less than 10 years

Question 25

how do future market expectations of interest rates impact annuity decision?

Answer 25

payouts on fixed annuity are largely determined by initial bond interest rates. if rates are expected to icnrese, delay in purchase can lead to higher payouts on annuities purchased later.

Question 26

fees for variable annuities

Answer 26

tend to be higher. they are more complex and difficult to analyze. this difficulty tends to reduce price competition and further increase the price of variable annuities - ie lowers the annual payout received for premium invested compared to fixed annuities.

Question 27

self insurance of longevity risk

Answer 27

invest in financial assets and set a withdrawal amount that lasts to an assumed life expectancy

Question 28

an individual in higher risk HC will choose?

Answer 28

lower risk FC