Life Insurance Quiz Insurance, insurance, average, initial, demand

Chuckrox8

Tucker is 35, has average initial wealth, and has labor income that is highly correlated with the stock market.

Max is 35, has average initial wealth, and has labor income that has very low correlation with the stock market.

All else being equal, who has the greater optimal demand for life insurance, Tucker or Max?

former

Max. Low correlation with the market means it is more reliable, which makes the PV of future eanings greater

bpdulog

It is Max. High correlation to stock market means earnings more volatile, so PV of human capital is less . Hence less insurance is needed

Windjammer

wrong response... More volatility in HC - less need for Life insurance... So Max needs the Life Insurance more -- since his entire life is planned around getting that much needed money in on a regular basis.

HC and Life Insurance are negatively correlated.

CP

skycfa

Where do they come up with this nonsense?

nannan66

The right answer, the wrong answer, the CFA answer.

lcai

Max for the win

jmh530

I guess answer depends on what OP meant by Optimal? More or less???

CP

susana

Well put darlia. Don't try to find a justification, just use the PV approach. You could argue that both Tucker and Max need enough life insurance to meet their minimum expenses. Max has high earnings volatility, which means his family has the ability to live on low earnings. Tucker has lower earnings volatility, so his family is used to getting the same (median amount) of earnings. Therefore their minimum standard of living is higher. By that logic, he needs more life insurance for them to live normally.

It's a flawed argument, but it's the best I can do. Hence, just stick with the PV approach with a higher discount rate.



Edited 1 time(s). Last edit at Monday, May 16, 2011 at 11:42PM by sbmarti2.

pennyless

Max is the correct answer.

Check out Vol 2, p340.

re: CP, I hear where you're coming from on the terminology, but that's what the CFAI uses.