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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

(a) Using the workbook you created earlier, experiment with income, higher expenses or different
investment returns.
(b) List the different insurance cover you want at different times of your life. If you expect to be liquidityconstrained at some point, what insurance would a bank want before it lent money to ease your
(c) We have mainly considered a middle class, nuclear family unit. Many people of course do not live this
way. Consider how the income and expense risks may vary for people in other situations. A single
person with no dependants, for example, does not need life insurance but may have greater need for
disability insurance, to cover household expenses and pay for the sort of assistance a spouse might
otherwise provide. Give some other examples.
Some thoughts to incorporate into your answers:

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, returns could be as low as the yield on inflation
linked stock if it is available to you.
Higher returns are of course available on more risky assets, but if you add these to your
portfolio, you will have to take the risk of losing money into account. You could do this by
simulating a few investment scenarios.


You may want cover for each of the risks discussed in 4.3; think about when they might apply
to you and how they might be insured. You may find that a bank will ask for life insurance
but not for disability insurance. Why? I do not know it is a puzzle to me too.


You can think of different income levels, different family structures (divorced, remarried,
extended). There may also be an expectation of support from other members of the
community/tribe/clan or from the state.

(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.
Would you say that this statement was true? What might it be missing?


Some ways of finding out what types of businesses are permitted:


Look at the law. The Corporations or Companies Act may well define some types of


Ask a lawyer, or someone in a legal firm.


Look at the stationery of some commercial companies. They are likely to have
registration numbers of some sort.


Google company, corporation, limited company, partnership etc.

This is a really challenging question that will elicit different responses in different business,
political and cultural environments, and from different professionals. In some countries at
some times, reducing tax through legal means may take up a major part of management
time, and can be the main reason why life insurance products are bought. At other times and

places, avoiding tax can be socially unacceptable exercise; the first chief actuary I worked for
was repelled by the idea.
Speak if possible to a lawyer or accountant who specializes in tax matters to understand their
views. You want particularly to ask them about different ways of taxing capital gains, which
perhaps make up the most difficult actuarial problems.
You can only claim to understand this question when you discover that designing fair and
efficient tax rules is almost impossible!

(a) Draw up a table that links the needs and risks set out in Sections 4.2 and 4.3 with the products set out
in Section 4.5.
(b) Find out what products are sold by a few of the financial institutions known to you. See if you can
match them to the descriptions in Section 4.5.
(c) Can you identify any products in Section 4.5 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.

The essential points to mention are probably:

Is there a shortage of capital, where the owners of the capital are prepared to take the
risks? The international investment markets may have more capital, but the reinsurers
are more likely to have the ability to evaluate the risks. While there are investors, who
are prepared to buy assets they have not evaluated on the assumption that the market
prices are correct, the recent financial crisis suggests that this is unwise.
Are there particular issues of anti-selection and moral hazard?
What are the relative costs, including brokerage and transaction taxes? The costs will
also relate to the level of competition in the different markets, which may in turn be the
result of regulations.

(a) Find out what social assistance is offered by the government in your country or state, and the rules
that are used for determining who is entitled to what especially any means tests.
(b) In future, is the role of the family in the provision of social security likely to be greater or smaller? Give
(c) Do you think that businesses, run to achieve a profit, can provide social security as well as, or better
than, government? Give reasons.
(d) Individual choice is to be preferred notwithstanding the cost savings available from group contracts.

This is probably available from the government departments website. In some countries
there is a separate agency responsible for payment. If you have not done so previously, go

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. The objective is to get some
understanding of how potential beneficiaries feel and how easy it is for them to get their
entitlements. 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.

The growth in the proportion of elderly people will put greater strain on the state, and will
encourage governments to transfer responsibility to families. On the other hand, lower
population growth has come from smaller families, who will be less able to provide care. In
more developed economies, higher incomes have encouraged nuclear families to be more
independent; can there be a move back to more extended families? Cultural differences also
have a role; some developed countries, like Italy, have preserved a great deal of the
extended family.


Some of the issues to consider:


Financial strength, cross subsidies and equity. Governments can offer significantly more
security than private funds. Government schemes generally tend to take investment and
mortality risks, and the absence of market disciplines can mean that some groups are
subsidized by others. While careful management can ensure that the subsidies are
progressive (from rich to poor), lobbying by more vocal groups can lead to subsidies
being regressive. The subsidies that defined benefit (DB) schemes give to those whose
salaries rise at a greater rate than average, and those that live longer provide examples.
(Of course DB schemes have also been provided by private companies, where the
market was not able to restrain cross subsidies.)
Governance and motivational issues.
o People are likely to be more motivated to look after their own money, so
private sector motivation can make up for the economies of scale enjoyed by
government organizations.
o Private arrangements are certainly more likely to experiment with alternative
products and processes.
o Proper governance requires proper and independent oversight. Private
enterprise with government regulation is a model that appears to work well. It
is difficult for government bodies to find independent oversight, as the relevant
Minister/Secretary tends to have power over both. Outsourcing of government
functions to the private sector is another model.
Freedom vs. compulsion.
o Governments should all other things being equal give people as much
freedom as possible. On the other hand, mandatory systems where everyone
has to belong, then marketing and underwriting costs can be significantly
reduced if not eliminated. Large national schemes can be more efficient.
o Voice or exit. In a democracy, people should be either be given a say over the
governance of the organizations that impact their lives, or the opportunity to
move away from the organization.

Apart from some of the points from (c), you could explore whether people would voluntarily
relinquish their freedom for mutual benefits. There is presumably a trade-off involving costs,
real options, the desire to tailor benefits to particular needs, etc. You might also consider the
question of free riders, and how voluntary groups can maintain their identity by applying
various pressures to their members to ensure that they do not defect. If the group cannot

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