September 2003 Q2

[Snowy]

Hi,

For this question can we talk about the $50,000 that the life insurance co (us) gets in return for providing the annuity?

So if we want to show to the manager that although we only pay out <$35,000, can we say that we "set aside" the $50,000 (ie we cannot use this money as long as the policy is still in force.)... so in effect we would have "paid" out (so to speak) the $60,000 ($10,000 lump sum plus $50,000 set aside)?

 

[didster]

Technically, if you split the product into
a) a loan
b) an annuity
which seems to be along the lines you're thinking (but remember that it is one product - take it or not)

Then the annuity pays out £75,000 = 5,000 *15
in return for intial premium of £50,000
which is what we would expect due to discounting (and effects of probailities of dying in 1 year etc).

You may be wondering why the question says £35,000, but this is because you need to take the annuity payments to first pay the tax collector, and the interest on the loan, which leaves £35,000

Going into the need for reserves etc, for the annuity is too complex as an answer to this question.

The crux of the question is that you are taking out a loan, but instead of getting it all at once, you get a lump sum plus annual payments, until the end of the loan (which is at death).