Suppose you are 46 and have a $420,000 face amount, 14-year, limited-payment, participating...

Question:

Suppose you are 46 and have a $420,000 face amount, 14-year, limited-payment, participating policy (dividends will be used to build up the cash value of the policy).

Your annual premium is $1,470.

The cash value of the policy is expected to be $16,800 in 14 years.

Using time value of money and assuming you could invest your money elsewhere for a 8 percent annual yield, calculate the net cost of insurance.

Use Exhibit 1-B. (Do not round intermediate calculations. Round time value factor to 3 decimal places and final answer to the nearest whole dollar.)

Net cost of insurance

Participating Policy:

A participating policy is a type of insurance contract that pays out dividends to the buyer through out the life of the insurance. These dividends can either be distributed to the buyer or accumulated to build up cash value of the policy.

Answer and Explanation:

The net cost of the policy is $6,399.2.

The net cost of policy is the present value of the premiums, minus the present value of the cash value. The premium is an annuity of 1,470 for 14 years. We can use the following formula to compute the present value of an annuity with periodic payment {eq}M {/eq} for {eq}T{/eq} periods, given periodic return {eq}r{/eq}:

  • {eq}\displaystyle \frac{M(1 - (1 + r)^{-T})}{r} {/eq}

Applying the formula, the net cost of the policy is:

  • {eq}\displaystyle \frac{1,470(1 - (1 + 8\%)^{-14})}{8\%} - \frac{16,800}{(1 + 8\%)^{14}} = 6,399.2 {/eq}

Learn more about this topic:

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How to Calculate the Present Value of an Annuity

from Business 110: Business Math

Chapter 8 / Lesson 3
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