L3 2022: Reading 23 EOC question 17 - Needs Analysis question

CFA Level III Portfolio Management
#1

Page 438, item set on Adrian and Olivia Barksdale

Smith is also concerned about the Barksdales’ existing life insurance coverage. Currently, the Barksdales have a term life policy insuring Adrian with a death benefit of A$100,000. Smith assesses the family’s insurance needs in the event Adrian were to die this year. To do so, Smith uses the needs analysis method based on the financial data presented in Exhibit 1 and the following assumptions:

The discount rate is 6.0%, and the tax rate is 30%.

Salary and living expenses grow at 3.5% annually.

Salary and living expenses occur at the beginning of each year.

The following assumptions apply in the event of Adrian’s death:

  • Olivia will continue to work until retirement;
  • Family living expenses will decline by $30,000 per year;
  • Olivia’s projected living expense will be $50,000 per year for 44 years; and
  • The children’s projected living expenses will be $15,000 per year for 6 years.

Why isn’t reduction in family expenses (bolded above) factored into the needs analysis calculation as shown in the answer on Page 443? Should it be deducted, similar to income?

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#2

It is.

Look carefully at the expense calculations.

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#3

Ok - so Olivia’s living expenses will be 50,000 and that of the two children are 15,000; total 65,000, which is 30,000 lower than 95,000 total living expenses set out in the first para of the item set.

Think I got it.

Thanks again…

#4

My pleasure.

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