With IRDA’s new standard proposal form coming in to effect from October 15, 2013, it will be compulsory for insurance agents, advisers and brokers to carry out a proper need analysis of policy holders. So, what is insurance need analysis?
Simply put, it is nothing but a method of determining the right product for policy holders and amount of life insurance which their dependents need in case of death of the policy holder.
To determine the right product for an individual, you need to factor in age, marital status, number of dependent members, expense, debt, child education and so on. However, determining an accurate expense after loss of the bread winner of a family is more complex. Here are some pointers which will help you to overcome this problem.
Rule of thumb: It is the simplest way of determining an insurance need of an individual. There are three different methods:
Income Rule: In this method insurance need can be calculated simply by multiplying the current annual income by 6-8. Let us say, a person earns Rs 2 lakh per annum; according to income rule his insurance need would be Rs 12 lakh to Rs 16 lakh.
Income plus expenses: Advisers need to find out the liability of policy holders based on his existing debt, mortgage, college expense of children, children marriage etc. Taking the example given above, let us assume that the person has total liability of Rs 5 lakh. Now this liability is added to the earlier insurance need or Rs 12/16 lakh plus liability i.e. equal to Rs 17/21 lakh.
Evaluation of premium: Under this method, the yearly premium is calculated by allocating 6 percent of annual income of an individual and 1 percent in case of dependent members. Staying with our earlier example where the client has an annual income of Rs. 2 lakh and assuming he has three dependent members, his annual contribution to insurance would be Rs 18,000 (Rs 12,000 for individual plus Rs 6000 for the three dependent members).
Human Life Value: The basic principal of this method is to provide same lifestyle to the dependent members as they are maintaining today. The amount of life insurance needed is calculated in multiples of current earning by the remaining number of years for retirement. In this method, advisers need to find out individual’s annual income from present age to age of retirement, annual expenses/commitments and tax-liability. For example: a 35 year old person earns Rs 3 lakh and his yearly personal expense along with income tax liability is Rs 60000. Now net disposable income is Rs 2, 40,000 (Rs 3, 00,000 – Rs 60,000). If the current interest rate is 8 percent and his retirement age is 65 than net present value (PV) would be nearly Rs 27 lakh. (The PV can be easily calculated in financial calculator or Excel sheet through PV function)
Human Life value with real rate of return- This method is the same as above but the only thing added here is consideration of inflation rate. Let us assume that the average inflation for 30 years is 6 percent. After factoring in inflation, the new PV would be Rs 54 lakh.
Family Need Approach - The Family need approach is based on two points.
Immediate needs at death (cash needs) - The immediate cash needs like final medical treatment costs, funeral and burial costs, estate settlement cost, debt settlement, emergency fund, etc.
Ongoing family needs (net income needs) - This is drawn by keeping in mind four phases of life i.e. readjustment period (2 years), dependency period (1 year), blackout period (10 years) and retirement period (5 years).
Adding immediate needs at death and ongoing need gives the total requirement of the family. To find out the life insurance need we have to subtract total requirement of the family from family’s other available assets that could be used to meet up some of the expenses.
Simply put, life insurance to meet family needs= (immediate needs at death+ present value of ongoing family needs) – available assets.
Here available asset is investments in mutual funds, savings, retirement assets etc.