You are on page 1of 5


These questions have been drafted with the intention of stimulating and perhaps guiding your thinking into
ways of understanding the issues in this chapter. The issues include real life problems that have not fully been
fully solved, and are likely to play a role in both your professional and personal lives. You will get the most
benefit if you approach the issues independently.

Do not merely look at the spreadsheets – create your own, play with the assumptions and think about
how to lay them out for ease of future understanding. I have used mine for 20 years to plot my
financial approach to retirement.
Draw mind maps to relate the issues to each other for the answers that do not require a spreadsheet.
Where you are asked to research answers, make a note of the sources of information in a place where
you can find them again and add important websites to your favorites.
Questions like 4.4(b) could be asked in various forms in exams and provide background for many
(government) policy issues that you may face in your working life. If you are working with another
student, do a mind map and then write a short (500 words or so) answer to practice your written
communication. When you have finished, ask yourself the question: what do I want to say about this
subject? Then, see whether you have said it and your study partner agrees!

(a) Develop a simple human capital model of income progression from ages 25 to 65 on a spreadsheet.
Assume that 25 percent of income is “invested” in accumulating human capital. Assume that it yields a
return of 5% per annum that is added to salary. Accumulate the investment but depreciate it
(declining balance method) at 5% per annum. See if this corresponds with any examples of income
progression over the lifetime that you can find.
(b) How do you expect your own financial life cycle to work out? Develop a workbook of spreadsheets that
allows you to experiment with different scenarios of income, expenses and savings. Make plausible
assumptions about the unknown.
• The spreadsheet should give details, by year, of income and expenses broken down into
regular and irregular spending. It should separately consider at least housing, transport, rates
and taxes, recreation, medical costs and schooling. Include borrowing, saving and the
accumulation of assets and liabilities.
• Graph the results showing income, expenses, assets and liabilities from age 20 through to 90.
(c) What income do you think you would need in a comfortable retirement? Think about the expenses you
will no longer incur – and the extra expenses you may incur – when you are no longer working. Using
your spreadsheet, see how much you have to save to provide this retirement income.
(d) How might the spreadsheet change for someone earning a very low wage?
(e) From your spreadsheet, do you look as if you will be liquidity constrained at first? Test this by setting
your expenditure so that your assets are more or less exhausted by age 90. You probably will find that
your spreadsheet tells you that you would have to go into more debt at younger ages than a bank is
likely to lend you. Does this mean you should borrow more? See what happens if you are retrenched
and take early retirement at 50.
See Workbooks:
4.1a Income progression
4.1b Financial lifecycle.

See also draft “Spreadsheet standards”, on which this workbook was based

experiment with income. but if you add these to your portfolio. nuclear family unit. (b) List the different insurance cover you want at different times of your life. political and cultural environments. If you expect to be liquidityconstrained at some point. to cover household expenses and pay for the sort of assistance a spouse might otherwise provide.EXERCISE 4. (4) Google company. and from different professionals. what insurance would a bank want before it lent money to ease your constraints? (c) We have mainly considered a middle class. different family structures (divorced. (c) You can think of different income levels. Give some other examples. corporation. You could do this by simulating a few investment scenarios. for example.3. A single person with no dependants. Why? I do not know – it is a puzzle to me too. limited company. Consider how the income and expense risks may vary for people in other situations.3 (a) Can you list the types of business form that exist in your country? (b) “Tax planning is made possible because governments want to encourage certain business practices. reducing tax through legal means may take up a major part of management time. You may find that a bank will ask for life insurance but not for disability insurance. think about when they might apply to you and how they might be insured. EXERCISE 4. (3) Look at the stationery of some commercial companies. They are likely to have registration numbers of some sort. (2) Ask a lawyer. returns could be as low as the yield on inflation linked stock – if it is available to you. remarried. extended). or someone in a legal firm. This is a really challenging question that will elicit different responses in different business. higher expenses or different investment returns. At other times and . The Corporations or Companies Act may well define some types of business. Many people of course do not live this way. you will have to take the risk of losing money into account. Higher returns are of course available on more risky assets. Some thoughts to incorporate into your answers: (a) Investment returns may be very low for money that you might have to keep in a bank to meet your liquidity needs. For the rest. and can be the main reason why life insurance products are bought. There may also be an expectation of support from other members of the community/tribe/clan or from the state.2 (a) Using the workbook you created earlier. partnership etc. (b) You may want cover for each of the risks discussed in 4. does not need life insurance but may have greater need for disability insurance.” Would you say that this statement was true? What might it be missing? (a) (b) Some ways of finding out what types of businesses are permitted: (1) Look at the law. In some countries at some times.

but the reinsurers are more likely to have the ability to evaluate the risks. You can only claim to understand this question when you discover that designing fair and efficient tax rules is almost impossible! EXERCISE 4. In some countries there is a separate agency responsible for payment. avoiding tax can be socially unacceptable exercise. (b) In future. where the owners of the capital are prepared to take the risks? The international investment markets may have more capital. See if you can match them to the descriptions in Section 4. While there are investors. the first chief actuary I worked for was repelled by the idea. run to achieve a profit. Speak if possible to a lawyer or accountant who specializes in tax matters to understand their views. or better than. who are prepared to buy assets they have not evaluated on the assumption that the market prices are correct.5. You want particularly to ask them about different ways of taxing capital gains. Are there particular issues of anti-selection and moral hazard? What are the relative costs. (a) This is probably available from the government department’s website. the recent financial crisis suggests that this is unwise. (d) “Individual choice is to be preferred notwithstanding the cost savings available from group contracts. (c) Do you think that businesses. is the role of the family in the provision of social security likely to be greater or smaller? Give reasons. (b) Find out what products are sold by a few of the financial institutions known to you.5 which are not widely available in your country? Why do you think that they are not available? Hint: Is there a need? Is it met in some other way? Is there another reason? (d) Give some examples of when you would think it would be appropriate to use derivative instruments rather than insurance or a replicating portfolio of the underlying assets. If you have not done so previously.3 with the products set out in Section 4. government? Give reasons. and the rules that are used for determining who is entitled to what – especially any means tests.5. including brokerage and transaction taxes? The costs will also relate to the level of competition in the different markets.” Discuss.2 and 4. EXERCISE 4.places. (c) Can you identify any products in Section 4. which perhaps make up the most difficult actuarial problems.5 (a) Find out what social assistance is offered by the government in your country or state.4 (a) Draw up a table that links the needs and risks set out in Sections 4. which may in turn be the result of regulations. can provide social security as well as. go . (c) The essential points to mention are probably: • • • Is there a shortage of capital.

can there be a move back to more extended families? Cultural differences also have a role. cross subsidies and equity. Outsourcing of government functions to the private sector is another model. and those that live longer provide examples. so private sector motivation can make up for the economies of scale enjoyed by government organizations.along to the closest office and preferably ask for the forms for one or other benefit for which you or one of your family might conceivably qualify. Large national schemes can be more efficient. and will encourage governments to transfer responsibility to families. Governments can offer significantly more security than private funds. On the other hand. higher incomes have encouraged nuclear families to be more independent. some developed countries. lobbying by more vocal groups can lead to subsidies being regressive. and the absence of market disciplines can mean that some groups are subsidized by others. In more developed economies. where the market was not able to restrain cross subsidies. o Governments should – all other things being equal – give people as much freedom as possible. Apart from some of the points from (c). (c) Some of the issues to consider: • • • (d) Financial strength. etc. as the relevant Minister/Secretary tends to have power over both. you could explore whether people would voluntarily relinquish their freedom for mutual benefits. In a democracy. If the group cannot .) Governance and motivational issues. real options. You may well be part of an institution that creates the regulations and forms. and it would be helpful to know what it feels on the other side. or the opportunity to move away from the organization. Government schemes generally tend to take investment and mortality risks. The subsidies that defined benefit (DB) schemes give to those whose salaries rise at a greater rate than average. o Voice or exit. have preserved a great deal of the extended family. people should be either be given a say over the governance of the organizations that impact their lives. who will be less able to provide care. The objective is to get some understanding of how potential beneficiaries feel and how easy it is for them to get their entitlements. o Private arrangements are certainly more likely to experiment with alternative products and processes. compulsion. (b) The growth in the proportion of elderly people will put greater strain on the state. like Italy. lower population growth has come from smaller families. There is presumably a trade-off involving costs. and how voluntary groups can maintain their identity by applying various pressures to their members to ensure that they do not “defect”. On the other hand. the desire to tailor benefits to particular needs. It is difficult for government bodies to find independent oversight. While careful management can ensure that the subsidies are progressive (from rich to poor). Private enterprise with government regulation is a model that appears to work well. mandatory systems where everyone has to belong. You might also consider the question of “free riders”. o Proper governance requires proper and independent oversight. Freedom vs. o People are likely to be more motivated to look after their own money. then marketing and underwriting costs can be significantly reduced if not eliminated. (Of course DB schemes have also been provided by private companies.

then should one argue for government intervention? This also has its maintained voluntarily. .