CALCULATING LIFE INSURANCE NEEDS
Rule of Thumb
1. Spend annually a sum equal to 6 % of breadwinners gross income plus 1 % for each dependant
2. Coverage should be 7 - 10 times the annual income
3. 5 % of take home pay as annual premium
Two approaches used to determine Insurance Needs
1. HUMAN LIFE VALUE APPROACH
Example:
Annual salary Rs 70000
Work for next 30 years
Discount rate is 6% pa.
If he dies today
Insurance Policy Amount = PV of Annuity = Annuity * (PVAF)
963538.2
or Rs 10 lakh policy
Out of this annual salary Rs 20000 is spend on earning member personal expenses.
688241.55757447 Rs 7 lakh insurance policy
Current annual salary is Rs 70000 and will grow @ 3% pa.
Adjust the nominal discount rate with growth rate
Real Rate = ((1 + NR)/(1 + GR))-1
0.029126 2.91%
PVAF 19.83 19.825290904444
Insuarnce Policy Amount 1388100
Drawback of Human Value Approach
2. CAPITAL NEED ANALYSIS APPROACH
First step is to determine Cash Inflow and Cash Outflow
Cash Inflow = 1. Income from Assets Cash Outflow
2. Salary of spouse I. Regular Expenses
i) Current living expenses
ii) School fees
iii) Insurance Policy Premium
iv) Medical expenses
v) Rent
II. One-Time Expenses (liability)
Loans
III. Future Goal Expense
i) Children higher education
ii) Children Marriage
iii) Spouse retirement corpus
iv) Own House
Second Step is to calculate the PV and GAP respectively
1. Calculate PV of regular expenses
2. PV of future financial goals
3. GAP = (1. + 2. + One time expense - PV of regular income)
Third Step Gross Insurance Needed = GAP - Existing Assets
Last step is to claculate the Net Insurance Required
Gross Insurance - Existing Insurance Policy
Rohit wants to secure the future of his wife, who is 32 years old and is expected to live up to 80 years, by taking a lif
i) Rental income Rs.2,40,000 p.a.
ii) Living expenses Rs.12,10,000 p.a.
iii) School fees of his daughter is Rs 50,000 p.a., expected to increase @ 3% p.a. for next 10 yea
iv) Wife endowment life insurance policy premium Rs. 60,000 p.a. payable for next 10 years
v) Current marriage expense is Rs.20,00,000 and will increase @ 3% p.a.. He plans to get her da
vi) Other expense Rs.3,00,000 p.a.
vii) Property loan outstanding Rs.12,00,000
viii) Gratuity Rs. 1,80,000
ix) EPF Rs.2,50,000
x) Shares and debentures Rs.12,00,000
xi) Property Rs.90,00,000
xii) Existing life insurance policy Rs.20,00,000
Estimate life insurance cover for Rohit if the expected inflation for the remaining expenses is 5 percent p.a. and retu
SOLUTION:
1. Calculate PV of Cash Inflow
PV of Annuity = 240000*(PVAFn,i)
n = 48
I = 9%
PVAF 10.933575455
Hence PV of A 2624058.1092
2. Calculate PV of Cash Outflow
i) PV of Regular Expenses Current
a) Living Expenses grow @ 5% for 48 years 1210000
b) Other Expenses grow @ 5% for 48 years 300000
c) School Fees grow @ 3% for 10 years 50000
d) Insurance Premium n= 10 years 60000
PV of Living Expenses Annuity * (PVAFn,i)
26481625.804
PV of Other Expenses Annuity * (PVAFn,i)
6565692.3481
PV of School Fees Annuity * (PVAFn,i)
371070.54478
PV of Insurance Premium Annuity * (PVAFn,i)
385059.46207
ii) PV of Future one time expenses
Current 2000000
g 3%
n 15
FV of Marriage PV*(1+i)^n OR Adjust DR for GR
3115934.8332 855442.64596646
PV of Marriage Expense 855442.64597
iii) PV of current one time expense 1200000
Total PV of Cash Outflow 35858890.805
3. Calculate GAP
PV of Cash Outflow - PV of Cashinflow
GAP 33234832.7
4. Gross Insurance
GAP - Existing Assets
GI 22604832.7
Hence net Insurance cover needed is 20604832.696 or Rs 2 crore
Annuity * (PVAF) PVAF = ((1-1/(1+i)^n)/i
13.764831151489
or Rs 10 lakh policy
nal expenses.
Rs 7 lakh insurance policy
Rs 14 lakh
nses (liability)
up to 80 years, by taking a life insurance policy. The details of his income, expenses, assets and liabilities are given below:
se @ 3% p.a. for next 10 years
ayable for next 10 years
% p.a.. He plans to get her daughter married after 15 years.
ses is 5 percent p.a. and return on investment is 9 percent p.a.
Adjust the discount rate for the growth rate
RR 0.0380952380952
Adjust the discount rate for the growth rate
RR 0.0582524271845
s are given below:
