Life insurance policies are a form of mandatory savings. These policies have the benefit of a large payout to the deceased’s beneficiaries: Principles of Finance Assignment, TP

Question

Life insurance policies are a form of mandatory savings. These policies have the benefit of a large payout to the deceased’s beneficiaries or a substantial withdrawal value if the insured surrenders the policy after many years of paying the premiums to the insurer. In addition, there may be a one-off bonus payout if the policy is surrendered after a certain number of years.

However, a financial crisis often causes many policyholders to prematurely surrender their policies so as to raise cash.  This is not advisable since it terminates insurance coverage.  Also, the surrender value may be less than the sum of premiums paid to date, including the loss of the bonus payment.

Rodney Lee, aged 36 tomorrow, has been paying a premium of $400 per month on his life policy for the past 6 years. He started when he just turned 30 years old. His insurance agent provided selected amounts of death benefits, surrender values, and bonus values at various age intervals:

(a) Rodney is considering surrendering the policy now. He uses the applicable surrender value of $30,000 and asks you to help him compute his gain or loss upon surrender. Derive the answer with and without the time value of money. The interest rate is 1% per annum.
(b) Compute the policy’s compounded rate of return per annum (from policy commencement) if Rodney were to surrender the policy at the end of 45 years old.
(c) The agent informed Rodney that if he were to surrender the policy at the end of 70 years old, the policy return (from policy commencement) would be at 6.0% per annum. This percentage return has incorporated the bonus sum. Compute the bonus sum ($Y in the table above) for Rodney.
(d) Discuss two implications for retirement planning from the information and the answers to parts (a) to (c) above. Provide numerical illustrations where necessary.

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