Calculating Insurance Needs

How does one calculate these parameters? If choosing the right insurance for you is hard, imagine having to calculate how much you need to buy!

There are 2 ways to calculate life insurance cover requirements: Expense Protection and Human Life Value approach. While the former considers your expenses, the latter considers your future income. Human Life Value is the economic value of an individual; the present value of all his future income. Setting aside the part of income one spends on himself, the protection required through Human Life Value calculates today’s value of his income for the years till his retirement. Expense protection, on the other hand, calculates the corpus required to take care of the family’s future expenses and goals. Inflation diminishes the value of money and hence expenses need to be adjusted to inflation for calculation of protection required.

For what term do you need this cover? Ideally insurance must be taken to cover the working period in one’s life. You take insurance to protect your dependents from the loss of your income; using the same logic, you take insurance for the time that the dependents are being supported by your income. Hence, it is advisable to take insurance till one’s retirement. However, when insurance is taken for protecting and saving towards specific goals, then the tenure of the plan should match the years left for meeting the goal.

What type of products suit you? Choosing a product will depend on the specific need and the life stage one is in. What is the final product you will choose? When there are multiple choices that match the need, it is the affordability that makes the final choice. Most importantly, individuals must be educated. They must know that life insurance products for investment and savings are structured for the long term and meant for someone who is earning and whose earnings are supporting his/her dependant/dependants. We have seen clients who have 17 insurance policies. We have seen clients who bought insurance policies for their non-working mothers as a gift, not realizing that a non-working member of the household with no young children does not need to have insurance purchased in her name. Better to have bought insurance on the Father who is supporting the mother, so that she can get some financial help when he is no longer there.

To demonstrate the importance of adequate insurance and planning, we’ll take an example of a 35 year old married man with 2 children. He earns Rs. 5 lakhs per annum, spends Rs. 3 lakhs to run the household and is the only earning member in the family. He has an existing term plan with risk cover of Rs. 15 lakhs which he took when his second child was born. In March 2009 he invests Rs. 10,000 in a pension plan to make up the shortfall in the income tax deductions allowed for him. As far as he is concerned he is well insured and set for the future. Let’s see what happens if he were to die tomorrow. The family will receive Rs. 15 lakhs as claim settlement from the insurance company. Assuming that they invest the entire corpus in an FD at 10% interest per annum, their annual income would be Rs. 150,000. The shortfall in this case, to meet the household expenses, will be an additional Rs. 150,000 every year. To meet the shortfall, they will have to dig into the accumulated corpus, which in turn will diminish to nothing in just 7 years. What will happen to his family post that? Who will provide for his children’s education, marriage, his wife’s retired life and all such important aspects that should have been planned for? Let’s now assume that he survives till his retirement. Assuming his retirement age to be 60 years and the return on his pension investment of Rs. 10,000 per annum to be 8%, the accumulated corpus at his retirement would be Rs. 7.9 lakhs (the value of which today is Rs. 1.15 lakhs). Will that suffice to take care of him and his wife for their retired life?

Some points to consider:

• It is very important that you are adequately covered as inadequate cover is equal to No cover at all.
• Insurance planning is the first step towards financial planning and financial planning should be the first step towards purchasing insurance. To advise an individual  on his insurance needs, it is important to get a holistic view of the present and the future.
• Insurance requirement must be reviewed every 2 years or when there is a change in the family scenario example: addition of dependants.
• The insurance requirement changes with every change in your life - income, expenses, life style, members, liabilities and assets.

Financial Planning and its role in selecting insurance: To be able to prescribe the best insurance products for an individual or family, a financial plan is necessary. An advisor needs an in-depth knowledge and understanding and proper prioritization of all aspects of the client’s life. The probable duration of life, amount of security needed, present and future needs / shortfalls and post retirement requirements are also essential pieces of information to be collected. Knowledge of the “markets” / mutual funds and economic climate coupled with comprehension and application of HLV (Human Life Value), Expense Protection, and Corpus requirements for retirement help in prescribing an effective solution. With the awareness of a need for proper financial planning on the rise, coupled with the plethora of insurance products available, it is imperative that a “consultant” now needs to upgrade his skills as a financial advisor.

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