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 buying 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

  1. 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.

  1. 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