An individual is considering the purchase of life insurance

An individual is considering the purchase of life insurance that would provide $50,000 of benefits. Two policies providing the same coverage have been proposed that have different payment plans. Policy A requires end-of-year premiums of $280 for 25 years. (No premiums are paid after 25 years). Beginning one year after the last payment, the policy will pay the policyholder five equal payments, each of which is 20% of the total amount paid in premiums. Thus with policy A, the policyholder will receive in return all that was paid if he lives for 30 years. Policy B requires $200 in end-of-year premiums for 30 years. With this policy a cash value will be accumulated so that the policyholder could withdraw $2000 at the end of 30 years. After 30 years no payments are made on either policy and the coverage will remain in effect. The policyholder believes the market interest rate and the inflation rate will average 9% and 4% respectively, over the next 30 years. If the policyholder assumes that he will live more than 30 years, which policy should be selected?

Solution

policy B is to be selected because it has more benefits than policy A