What are the data points in term insurance calculation
A term plan gives the policy holder an opportunity to get the protection of life insurance cover for his family at minimal costs. However, if the insured person survives the policy term he would not be eligible to receive any amount.
Estimating the Life Insurance Cover required while b
uying Term insurance is an important part of financial planning. Enlisted are the most important data points considered by insurance companies while calculating insurance :
Present age of the insured in years
A major factor behind term insurance cover calculation is the age of the policyholder.
Mortality Rates
Mortality rates offered by insurance companies are an acturial calculation which determines the premium to be charged for a policy. Premium is based on the claim ratio success the company is able to handle. Higher the claim ratio higher the premium and vice versa
Gender of the insured
Next to age, gender is the biggest determinant of pricing. Insurance carriers use statistical models to approximate how long someone with a specific profile will be around. It is a well-documented fact that women live longer than men. Thus insuring the life of a woman is less of a risk than insuring a man’s as per the insurer. Women usually pay premiums for a longer period of time than males, and thus enjoy slightly lower rates.
Existing Savings
The existing savings include the money kept in the bank account, Fixed Deposit accounts, Recurring Deposit account, shares etc.
Current monthly expenses
This includes the actual expenses per month excluding investments and savings.
Existing Liabilities
Such liabilities include existing outstanding loans. Car loans, Student loans and other debts should be taken into account in life insurance planning.
Inflation
It is important to note the exact percentage of inflation while calculating the term cover.
What is not included in the calculation of term insurance
The factors that are not considered while calculating the term insurance cover are
- Fixed Assets and long-term savings such as house, car, land, jewellery etc.
- Post retirement expenses.
Need Based Analysis Method of Insurance Calculation
Need Based Analysis method is the most accurate way to calculate the life insurance needs since it considers the expenses the survivor would need to consider in the absence of the main life insured, until the survivor’s life expectancy.
Here, irrespective of the income of the person, one needs to determine the Present value of all the needs/expenses one has to fulfill, which is the required corpus.
Data points considered for calculation of Insurance under Need Analysis Method
- Expenses
The Needs based approach thus concentrates on expenses. Expense is the main data point to be considered under this approach. The main expenses to be considered are ennumerated below.
- Immediate needs that arise just before or after the death of the person like medical costs or funeral costs. These can go to a large extent in few cases.
- All the loans that the insured person took are taken into account as those need to be cleared as well.
- Expenses that are needed to maintain lifestyle expenses for the spouse till his/her expected life period or at least till any child supports him/her.
- Lump sum expenses needed to provide for goals of financial planning like marriage and education of children are also accounted for.
Once all the above expenses are summed up, the figure arrived at is what the family needs today in case of the unfortunate event of death of the insured ie the Total Life Insurance Requirement.
- Existing Life Insurance and Liquidable Assets
The existing life insurance one already has plus all the liquidable assets as on date , (excluding car, residence and other personal assets), are deducted from Total Life Insurance Requirement to arrive at the Desired cover needed.
As is evident from above, Need Analysis Method is indeed a very detailed and accurate way of assessing one’s life insurance requirement . It ensures that one is neither under-insured nor over-insured.
Example of calculating term insurance cover under Need Analysis Method
Mentioned here under is an example to understand how insurance calculation happens under Need Analysis Method
| Total Outstanding Loan Amount – A | Nil |
| Present cost of Child Education (Goal year 2020-2024) | Rs 5,00,000 |
| Years to Goal | 4 |
| Expected Inflation Rate | 10% |
| Future cost | Rs 7,32,050 |
| Expected return on current savings | 8% |
| Number of years of Goal | 4 |
| Net future cost to be provided for | Rs 29,68,743 |
| Assuming return of | 9% |
| Fresh amount required for Child Education in present day terms- 1 | Rs 21,03,133 |
| Present cost of Marriage of child (Goal year 2020-2024) | Rs 7,00,000 |
| Years to Goal | 9 |
| Expected Inflation Rate | 7% |
| Future cost | Rs 12,86,921 |
| Current savings for the goal, if any | – |
| Expected return on current savings | 8% |
| Number of years of Goal | NA |
| Net future cost to be provided for | Rs 12,86,921 |
| Assuming return of | 9% |
| Fresh amount required for Child’s Marriage in present day terms- 2 | 5,92,534 |
| Immediate/Funeral Expenses – 3 | 50,000 |
| Fresh amount to be provided through life insurance proceeds -(1+2+3)= B |
27,45,667 |
| Monthly Expenses | 1,00,000 |
| Expected Inflation Rate for Monthly Expense | 8% |
| Number of Years to Support Monthly Expense (80-42) | 38 |
| Expected Return on Funds | 9% |
| Amount needed in present day terms for expenses – C | 3,86,48,262 |
| Total life insurance requirement (A+B+C) | 4,13,93,929 |
| Existing life insurance coverage (include money back, endowment, term plans etc) |
Rs. 2,37,00,000 |
| Liquidable Assets | Rs. 1,37,08,000 |
| Fresh insurance requirement (D) | Rs. 39,85,929 |
| Fresh life insurance requirement (120% of D) | Rs. 47,83,115 |
Debalina Roy Chowdhury
Dilzer Consultants
Sources
https://www.bankbazaar.com/insurance/term-insurance/term-insurance-life-cover-calculation.html
http://www.rediff.com/money/2008/jul/18perfin.htm
16 June 2017