If client adds a ten year period certain option to her annuity, her income yield would be reduced when compared to not having the option. – correct Income yield would be reduced by greater amount the longer she waits to buy the annuity – this is wrong in my opinion, CFA answer says it is correct. Any reason ??
I’m not sure about the context of the question, but a 10-year period certain annuity would indeed provide a lower income yield relative to a single life annuity over a normal life expectancy.
A 10-year period certain annuity guarantees payments for 10 years, even if the owner/annuitant dies prior to those 10 years passing. To obtain this, the owner accepts a lower lifetime annual payment from the insurance company (lower income yield). If for example, the owner dies after 1 year of payments, their beneficiary would receive a payment (or continue to receive annual payments) equivalent to the remaining 9 years. With a single lifetime annuity, payments would stop. But say 10 years passes and the owner is still alive. Those lower income payments continue for life, which would have been higher if the owner elected a single life vs. the 10-year period certain.
Waiting to purchase the annuity has nothing to do with it unless there’s some context to the question I’m missing.
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Thank you taking time to write the explanation. The details of the question is in 2017 mock exam am, boylan case, question 18.
Oh I see. So, if she waits to buy the annuity, she is older, life expectancy is shorter, and she is more likely to die within the 10-year period than if she bought the annuity at an earlier age. Thus the period certain payments are adjusted lower as she gets older.
I like to think of a period certain annuity as an insurance policy on annuity income. You pay a premium (lower lifetime annual payments) for the insurance. Just like with life insurance, the older you are, the more likely your beneficiary will receive a payoff, thus the premiums are higher. In the case of a period certain annuity, those higher premiums are in the form of lower income payments. You are more likely to die during the payoff period so the income is adjusted lower.
I hope that makes sense.
Check out Exhibit 7 on page 425 of Reading 12 and the couple of paragraphs below it. Should clear this concept up for you.
Got it. Thank you very much.
“If she adds a 10 year certain option to her annuity, income yield would be reduced when compared to not having the option, but income would be reduced by greater amount the longer she waits to buy the annuity”
The CFA wording is not clear. It is poor wording. Here it means the longer she waits to buy the annuity with 10 year certain option, the greater the amount of income yield reduction.