NewsWire--APRIL 2, 1996

TOPIC: Time Value of Money, Annuities

SOURCE: "Safe but Sorry: Insurers Push 'Immediate' Annuities," by Nancy Ann Jeffrey, Wall Street Journal, March 29, 1996, p. C1.

SYNOPSIS: The article discusses the increase by insurers to push immediate, fixed annuities. These annuities offer investors a fixed-for-life periodic payment in exchange for a lump-sum purchase price. The article offers an opportunity to value these annuities and examine how value is affected by different contractual provisions.

DISCUSSION QUESTIONS:

1. Suppose an insurance company assumes that you have a ten year life span and is willing to sell you an immediate, fixed annuity with a 4 percent annual yield, a $100,000 purchase price, and equal payouts to occur at the end of each year. Compute the annual payment that you will receive from the insurance company.

2. Assume the insurance company offers two contracts. Contract A will make the $12,329.09 annual payment for as long as the purchaser lives. Contract B will make the payment for ten years or as long as the purchaser lives, whichever is longer. Compute the present value of contracts A and B using a 4 percent discount rate, assuming that the purchaser lives for 5, 10, or 15 years.

3. Suppose an investor can invest $100,000 at a return of 7 percent into the foreseeable future. Compute the annual payment this investment will generate for 10 years. Suppose the investor spends only $12,329.09 each year and invests the difference at 7 percent. How much will the investor be able to withdraw for each of the next 5 years?

4. Why would someone buy one of these contracts? What are the risks to the purchasers? Which is preferable, contract A or B?