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?
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