Financial Markets and Institutions (2-downloads)

11. What is the purpose behind reinsurance?

12. Distinguish between defined-benefit and defined-

contribution pension plans.

13. Why have private pension plans grown rapidly in

recent years?

14. What is a pay-as-you-go pension plan?

15. Why is Social Security in danger of eventually going

bankrupt?

Q U A N T I TAT I V E   P R O B L E M S

1. Research indicates that the 1,000,000 cars in your city

experience unrecoverable losses of $250,000,000 per

year from theft, collisions, and so on. If 30% of pre-

miums are used to cover expenses, what premium

must be charged to car owners?

2. Assume that life expectancy in the United States is

normally distributed with a mean of 73 years and a

standard deviation of 9 years. What is the probabil-

ity that you will live to be over 100 years old?

3. Your rich uncle dies, leaving you a life insurance pol-

icy worth $100,000. The insurance company also

offers you an option to receive $8,225 per year for

20 years, with the first payment due today. Which

option should you use?

4. A home products manufacturer estimates that the

probability of being sued for product defects is 1% per

year per product manufactured. If the firm currently

manufactures 20 products, what is the probability that

the firm will experience no lawsuits in a given year?

5. Kio Outfitters estimated the following losses and

probabilities from past experience:

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542

Part 6 The Financial Institutions Industry

What is the probability Kio will experience a loss of

$5,000 or greater? If an insurance company offers a

loss policy with a $1,500 deductible, what is the most

Kio will pay?

6. A client needs assistance with retirement planning.

Here are the facts:

•  The client, Dave, is 21 years old. He wants to retire

at 65.

•  Dave has disposable income of $2,000 per month.

•  The IRA Dave has chosen has an average annual

return of 8%.

If Dave contributes half of his disposable income to

the account, what will it be worth at 65? How much

would he need to contribute to have $5,000,000 at 65?

7. When opening an IRA account, investors have two

options. With a regular IRA account, funds added are

not taxed initially, but are taxed when withdrawn.

With a Roth IRA, the funds are taxed initially, but not

when withdrawn. If an investor wants to contribute

$15,000 before taxes to an IRA, what will be the dif-

ference after 30 years between the two options?

Assume that the investor is currently in the 25% tax

bracket, and that the IRA will earn 6% per year.

8. An employee contributes $200 a year (at the end of

the year) to her pension plan. What would be the total

contributions and value of the account after five

years? Assume that the plan earns 15% per year over

the period.

9. Paul’s car slid off the icy road, causing $2,500 in dam-

age to his car. He was also treated for minor injuries,

costing $1,300. His car insurance has a $500 deductible,

after which the full loss is paid. His health insurance 

has a $100 deductible and covers 75% of medical 

cost (total). What were Paul’s out-of-pocket costs from

the incident?

W E B   E X E R C I S E S

Insurance Companies and Pension Funds

1. There are many sites on the Web to help you compute

whether you are properly preparing for your retire-

ment. One of the better is offered by Quicken. You will

find it at