Final answer:
Indexed life insurance policies provide a hedge against the effects of inflation by allowing the cash value of the policy to grow based on the performance of an underlying index. This ensures that the policy's value keeps pace with inflation, providing a hedge against rising prices.
Step-by-step explanation:
The life policy that is designed to provide the policyowner a hedge against the effects of inflation is called an indexed life insurance policy. Indexed life insurance policies allow the cash value of the policy to grow based on the performance of an underlying index, such as the S&P 500. This ensures that the policy's value keeps pace with inflation, providing a hedge against rising prices.
For example, if the underlying index has a return of 8% and the inflation rate is 3%, the cash value of the policy will increase by 8% minus 3%, resulting in a net increase of 5%.
Indexed life insurance policies are a popular choice for individuals who want to protect their savings from the erosive effects of inflation over the long term.