Risk management for Individual, CFAI Practice problem. Q15

Hi everyone, not sure if you have completed this part of the questions. If you do and understand, can you share some insights?

The solution calculates FV of Annual premium (12,000 a year) in 20 years as well as the dividends. My question is, why the Cash value projected at the end of 20 years is not in the calculation?

I posted reading and problem below for your quick reference.


Henri Blanc is a nancial adviser serving high-net-worth individuals in the United States. Alphonse Perrin, age 55, meets with Blanc for advice about coordinating his employee bene ts with his investment and retirement planning strategies.

Perrin has adopted a life-cycle portfolio strategy and plans to retire in 10 years. Recently, he received a promotion and $50,000 salary increase to manage a regional distribution center for a national retail rm. Perrin’s spending needs are currently less than his annual income, and he has no debt. His investment assets consist of $2,000,000 in marketable securities (90% equity/10% xed income) and a vineyard with winery valued at $1,500,000.

Blanc leads Perrin through a discussion of the di erences between his nancial capital and his human capital, as well as between his traditional balance sheet and his economic balance sheet. Perrin is vested in a de ned bene t pension plan based

on years of service and prior salary levels. Future bene ts will vest annually based on his new salary. Perrin makes the following statements regarding his understanding of pension bene ts.

Statement 1 Unvested pension bene ts should be classi ed as human capital.

Statement 2 Vested pension bene ts should not be classi ed as nancial capi- tal until payments begin.

Perrin asks Blanc to compare his traditional and economic balance sheets. Blanc calculates that the sum of the present values of Perrin’s consumption goals and bequests exceeds that of his unvested pension bene ts and future earnings.

Perrin tells Blanc that he expects a slower rate of growth in the US economy. Perrin expresses the following concerns to Blanc.

Concern 1 Holding all else equal, I wonder what the e ect will be on my human capital if the nominal risk-free rate declines?

Concern 2 My employer projects a slower rate of sales growth in my region; there- fore, I am anxious about losing my job.

Perrin is a widower with three adult children who live independently. Perrin’s oldest son wishes to inherit the vineyard; the two other children do not want to be involved. Perrin would like to accommodate his children’s wishes; however, he wants each child to inherit equal value from his estate. Blanc explains potential uses of life insurance to Perrin and suggests that one of these uses best meets Perrin’s immediate needs.

Perrin expresses a preference for a life insurance policy that provides a range of investment options. Perrin selects a policy and asks Blanc to calculate the net payment cost index (per $1,000 of face value, per year), using a life expectancy of 20 years and a discount rate of 5%. Table 1 provides information about Perrin’s policy.

Table 1 Perrin’s Life Insurance Policy

Face value $500,000 Annual premium (paid at beginning of the year) $12,000 Policy dividends anticipated per year (paid at end of the year) $2,000

Cash value projected at the end of 20 years $47,000

Question 15:

The net payment cost index that Blanc should calculate is closest to:

A $17.48. B $20.00. C $20.19.

Anyone please help?

cash value gets used in surrender value calculation - not for net payment cost index

Bang on. Cash value is used in calculating net surrender index, exclude it when calculating net payment cost index.

yup you got it. rest everything stays the same between the two

@indigonation5 @pachstar

Thank you guys. I don’t recall there is a surrender cost index, thanks for reminding!

Check out the supplemental questions for reading 12 that CFA posted to the site - there is a calc for both formulas on that.


I am hung up on Q 17 of the rd 12 Eoc’s:

MY q is why the discount rate comes in the picture here ?

Why are we dividing by 500 at the end of problem 15 instead of the stated 1000 that’s in the question and in the white text example?