What are the data points in term insurance calculation
A term insurance plan provides policyholders with an opportunity to secure life insurance coverage for their families at minimal costs. However, if the insured person survives the policy term, they won't receive any payout.
Determining the required life insurance coverage when purchasing term insurance is a crucial aspect of financial planning. The most vital factors that insurance companies consider when calculating insurance coverage are as follows:
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- Age of the insured: The policyholder's age is a significant factor in calculating the term insurance coverage.
- Mortality Rates: Insurance companies use actuarial calculations to determine mortality rates, which, in turn, affect the premiums. A higher claim ratio leads to higher premiums, and vice versa.
- Gender of the insured: Gender, after age, is a major determinant of insurance pricing. Women typically enjoy slightly lower rates due to their longer life expectancy.
- Existing Savings: Existing savings include money in bank accounts, fixed deposit accounts, recurring deposit accounts, shares, and other investments.
- Current Monthly Expenses: This encompasses the regular monthly expenses, excluding savings and investments.
- Existing Liabilities: Outstanding loans, such as car loans and student loans, should be considered in life insurance planning.
- Inflation: It's essential to factor in the inflation rate while calculating the required term insurance coverage.
What's Not Included in Term Insurance Calculation:
Certain factors are not considered when calculating term insurance coverage, including fixed assets like houses, cars, land, jewelry, and post-retirement expenses.
Need-Based Analysis Method of Insurance Calculation:
The need-based analysis method is the most accurate way to determine life insurance needs. It focuses on the expenses survivors would need to cover in the absence of the primary insured person until their life expectancy. The key data points considered in this approach include:
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- Immediate needs: Expenses arising just before or after the death of the insured, such as medical or funeral costs.
- Outstanding loans: All loans taken by the insured should be cleared.
- Lifestyle expenses: Expenses required to maintain the spouse's lifestyle until their expected life period or until any child supports them.
- Lump sum expenses: Amounts needed to achieve financial goals, such as a child's education or marriage.
By totaling these expenses, you arrive at the family's current needs in case of the unfortunate event of the insured's death, which is the Total Life Insurance Requirement. Deducting existing life insurance and liquidable assets from this requirement ensures you have the desired cover needed.
The need-based analysis method is a comprehensive way to assess life insurance requirements, preventing under-insurance or over-insurance.
Example of Calculating Term Insurance Cover Using the Need Analysis Method:
Here's an example to illustrate how to calculate insurance coverage under the Need Analysis Method:
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- Total Outstanding Loan Amount: 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: Rs 29,68,743
- Fresh Amount Required for Child Education: Rs 21,03,133
(And similar calculations for other goals)
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- Total Life Insurance Requirement: Rs 4,13,93,929
- Deduct Existing Life Insurance and Liquidable Assets
- Fresh Insurance Requirement: Rs 39,85,929
- Fresh Life Insurance Requirement (120% of D): Rs 47,83,115
In conclusion, the Need Analysis Method offers a thorough and accurate way to assess your life insurance needs, ensuring you have the right coverage."
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