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in BUS 3024S - Contingencies by (1.1k points)

Hi


Why is the claim cost not multiplied by a factor of (1.04)^0.5, since the death benefit is payable immediately?


Thanks



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by (1.6k points)
If you write it out by first principles you will see that the v and 1.04 increase cancel out. Remember that when the person dies (assuming half way through the year), the increase amount would have been by half a year. 
by (1.1k points)
Oh okay I see, thanks!!

1 Answer

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by (2.9k points)
The other thing to keep in mind is that the question stated that 315 was the amount from the onset of the policy, meaning that even though the person may be assumed to die halfway through the year (since it is paid on death exactly), the amount of 315 would need to be inflated to halfway to the year and then discounted. (As you can see, phrasing and the information in the question is vitally important so make sure you look for phrases like this and spend a little extra time in a test/exam fully understanding what is meant! I like to draw timelines when I see things like this to make sure I understand how this cashflow is meant to work).

And as Matt correctly stated, as the inflation rate is equal to the rate of interest, they cancel each other out resulting in the expression seen in the memo.

Also, small tip (and I'm sure you know this) but make sure you break up expenses and all the different components into separate calculations. The memo combines everything and it's easy to get lost in all of it. So to bank marks and reduce errors, separate all these components and combine them at the end.
by (1.1k points)
Thank you Murray!
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