*Register to read the introduction…*In general, viatical settlements are ethical. In the case of a viatical settlement, it is simply an exchange of cash today for payment in the future, although the payment depends on the death of the seller. The purchaser of the life insurance policy is bearing the risk that the insured individual will live longer than expected. Although viatical settlements are ethical, they may not be the best choice for an individual. In a Business Week article (October 31, 2005), options were examined for a 72 year old male with a life expectancy of 8 years and a $1 million dollar life insurance policy with an annual premium of $37,000. The four options were: 1) Cash the policy today for $100,000. 2) Sell the policy in a viatical settlement for $275,000. 3) Reduce the death benefit to $375,000, which would keep the policy in force for 12 years without premium payments. 4) Stop paying premiums and don’t reduce the death benefit. This will run the cash value of the policy to zero in 5 years, but the viatical settlement would be worth $475,000 at that time. If he died within 5 years, the beneficiaries would receive $1 million. Ultimately, the decision rests on the individual on what they perceive as best for themselves. The values that will affect the value of the viatical settlement are the discount rate, the face value of the policy, and the health of the individual selling the policy.

Solutions to Questions and Problems

NOTE: All end of chapter problems were solved using a spreadsheet.

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This problem requires us to find the FVA. The equation to find the FVA is:

FVA = C{[(1 + r)t – 1] / r}

FVA = $300[{[1 + (.10/12) ]360 – 1} / (.10/12)] = $678,146.38

CHAPTER 6 B-20

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25. In the previous problem, the cash flows are monthly and the compounding period is monthly. This assumption still holds. Since the cash flows are annual, we need to use the EAR to calculate the future value of annual cash flows. It is important to remember that you have to make sure the compounding periods of the interest rate is the same as the timing of the cash flows. In this case, we have annual cash flows, so we need the EAR since it is the true annual interest rate you will earn. So, finding the EAR:

EAR = [1 + (APR / m)]m – 1

EAR = [1 + (.10/12)]12 – 1 = .1047 or 10.47%

Using the FVA equation, we get:

FVA = C{[(1 + r)t – 1] / r}

FVA = $3,600[(1.104730 – 1) / .1047] = $647,623.45

26. The cash flows are simply an annuity with four payments per year for four years, or 16 payments. We can use the PVA equation:

PVA = C({1 – [1/(1 + r)]t } / r)

PVA = $2,300{[1 – (1/1.0065)16] / .0065} =