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for the population as a whole, average healthcare spending us $1,190 per year. those with a family history of cancer (5 percent of the population) spend $20,000 on average, and those with no family history (95 percent of the population) spend $200. An insurer is offering first-dollar coverage for $1,200.
a. You are not risk averse and do not have a family history of cancer. Do you buy coverage?
b. You are not risk averse and have a family history of cancer. Do you buy coverage?
c. If you were risk averse, how would your answers to the two previous questions change?
d. What could an insurer do to prevent this sort of adverse selection?
e. What would be wrong with having everyone undergo a physical exam to qualify for coverage?
NON-EXCEL help on Growing Annuity Problem
In this problem, we will assume all cash flows occur at theBEGINNING OF THE PERIOD (Annuity Due). Therefore,you need to set the calculator to BEGIN. You maywant to review the Lecture Video on Growing Annuity for help inworking the exam.
Problem:Assume you are 32 years old and plan to retire in 35 years at age67. You are currently earning $75,000/year and expect averageannual salary increases of 4.0%/year over the next 35 years. Youhave $0 saved for retirement.
You are trying to determine how much money to save (invest) eachyear in your 401(k) Plan to fund your retirement in order to payyourself 70% of your final salary each year (that increases withinflation). [Remember this is an Annuity Due, so your first annualinvestment is made in Year 0â¦.and your final payment is in Year34.] You plan to maintain an investment as a percent of yoursalary, which simply means your payment into the 401(k) will alsoincrease by 4.0% per year as your salary increases 4.0% eachyear.
You believe that you can earn 8.0%/year over the next 35 yearswhile saving for retirement.
Once you retire, you have a life expectancy of 25 years. Youplan to be more conservative in your investments and expect to earnonly 5.0%/year on your investments over the 25 years while inretirement. You also want to maintain your purchasing power byincreasing your âannual retirement payâ by the expected inflationrate of 3.0% each year. [Remember, your first withdrawal will bemade in Year 0 of retirement (i.e., Year 35 on the timeline.]Assume that after you withdraw the 25th payment, you will have $0left in the account.
Instructions:- SET CALCULATOR TO âBEGINâ!- Set up and show your Timeline with payments. You MUST âshow yourworkâ in order to get partial credit.- For this Exam it would be better to handwork the problem and saveas a pdf before submitting.- BOX in all your ANSWERS!- You may round all answers to the dollar throughout theproblem.- Carry your adjusted interest rates out to 6 decimal places toreduce rounding errors.
Questions: [NOTE: there are obviously many steps to get to theseanswersâ¦scoring is below.]1. What is your final yearâs salary?What is 70% of your salary? [Round to the dollar.]
2. How much will you need in your 401(k) at retirement in orderto âpay yourselfâ 70% of your final yearâs salary,AND have that payment to yourself increase at 3.0% each year tomaintain purchasing power?
3. How much do you need to contribute each year (i.e., save,invest) over the next 35 years in order to fund your retirement.Remember, payment into the 401(k) is increasing by 4.0% eachyear.
Scoring (Do not use Excel):
1. Readability of your Exam. Is it organized, do you show allwork, are your answers BOXED in, etc. (10 points)2. Correctly work problem as an Annuity Due (10 points)3. Calculate the FV of salary and 70% of salary as first withdrawalfrom your 401(k) in retirement. (15 points)4. Do you show a Timeline and is it labeled properly? (15points)5. Calculate adjusted interest rate for Retirement Annuity section.(10 points)6. Calculate the PVA for the Retirement Annuity. (10 points)7. Calculate the adjusted interest rate for the saving/investingsection of problem. (10 points)8. Calculate the adjusted FVA correctly that is used to determineamount to save each year. (10 points)9. Calculate the amount you need to save each year; where paymentincreases as salary increases. (10 points)
