CMFAS M9 Risk & Life Insurance Fundamentals question: capital-retention (income) approach

CMFAS M9Risk & Life Insurance Fundamentals

An adviser wants the death benefit for Mdm Selva's family to generate S$42,000 a year of income WITHOUT ever eroding the capital, so a legacy remains for her children. He assumes the invested proceeds will earn a net 3.5% a year. Under this capital-retention (income) approach, what lump sum is required?

A S$1,470,000
B S$840,000
C S$1,200,000
D S$147,000

Show the answer and explanation

Answer: C. S$1,200,000

Under capital retention the capital is preserved and only the investment return funds the income, so required capital = annual income need / assumed return = 42,000 / 0.035 = S$1,200,000. Using 5% (S$840,000) understates the need, and multiplying income by 3.5 (S$147,000) mis-applies the method — the fund must throw off S$42,000 indefinitely at 3.5%.

Common mistake

Capital retention capitalises the income need at the return rate (income / rate); it does not multiply income by a number of years.

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