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How To Become Your Own Financial Planner?

An exclusive Program To Develop The Skills To Manage Your Personal Finance

Module III: The Right Approach To Insurance Planning

In this module on "Insurance Planning", we'll be touching upon a very important aspect of financial planning. Spread across 4 sessions we'll be covering...

Are you adequately insured?

Should you club your insurance and investment needs?

Simple tips to buy a life insurance policy

Factors to consider while buying a health insurance policy

Let's take the first one:

Session 6: Are You Adequately Insured?

The only thing predictable about Life is that it is full of uncertainties. We don't know what's in store. And sometimes, an untoward event takes place, when its least expected. Hence, you ought to safeguard the interest of your loved ones who are largely dependent on you. Life insurance, the purpose of which is indemnification of risk to life, is a must!

But merely buying any insurance policy is not enough.

You ought to have optimal life insurance coverage, plus an appropriate life insurance policy. This will ensure the financial wellbeing of your dependents when you depart this life. Today, as you leverage to meet so many aspirations, it's best not to take chances, or the liabilities would pass on to your dependents. It's important to adequately insure risk to life. In fact, insurance is one of the primary aspects, you should address in a financial plan.

So in this session, let's discuss how to go about ascertaining insurance requirement while indemnifying risk to your life...

There are many ways to determine life insurance requirement, but according to PersonalFN the best and the most effective way of calculating insurance requirement is through the Human Life Value (HLV) - Expense method.

HLV provides a value - in terms of money - required to sustain the same standard of living by the family / dependents, in case something happens to you, the bread earner of the family.

HLV takes into account:

  • Life expectancy of your spouse

  • Number of children

  • How old the children are, and how many years they'll be dependent on you

  • The financial goals you're addressing for the dependents

  • Your monthly household expenses (excluding your personal expenses)

  • Lifestyle expenses

  • Contingency reserve (if any)

  • Assets

  • Current insurance (if any)

  • Outstanding loans

  • Cost of inflation

...amongst a host of others.

How to calculate HLV (using the expense method)?

The first step to calculate HLV (using expenses method) is: to take a count of your net annual income and then deduct expenses for your personal use. The remainder gives the amount that you can afford for your family annually.

Let us understand it with the help of an example of Mr Saxena:

Mr. Saxena, aged 40 years, earns Rs 15,00,000 per annum and spends Rs 6,36,000 per annum on his family as monthly household and lifestyle expenses.

The assumed inflation rate is 8% p.a., while the risk-free investment rate is assumed at 7.3% p.a.

The calculation will also include specific goal related expenditure...

Mr Saxena wants to provide for his wife Radhika during the retirement phase and take care of the education and marriage expenses of his children-Vaibhav and Vibha. Vaibhav, his eldest son, is 9 years old and Vibha is 6 years old.

Family’s monthly expenditure (per month) (Rs)

35,000

Family’s annual lifestyle expenditure (Rs)

2,16,000

Percentage of monthly household expenses on Mr Saxena (% per month)

15

Percentage of annual lifestyle expenses on Mr Saxena (% per year)

25

Expected inflation on household expenses (%) (assumed)

8

Expected return on risk free securities (%) (assumed)

7.3

Number of financial dependents

3

Dependent 1: Spouse

 

Spouse’s (Radhika) current age

36

Number of years Radhika will be dependent on Mr Saxena

44

Percentage of monthly expense spent on Radhika (%)

25

Percentage of annual lifestyle expense spent on Radhika (%)

25

Provision for retirement planning for Radhika (Rs) (rounded off) (present value)

25,56,325

Total monthly expense on Radhika (Rs)

13,250

Financial Value of Mr Saxena’s life to Radhika (Rs) (rounded off)

1,06,29,532

Dependent 2: Son

 

Son’s (Vaibhav’s) current age

9

Number of years Vaibhav will be dependent on Mr Saxena

19

Percentage of monthly expense spent on Vaibhav (%)

25

Percentage of annual lifestyle expense spent on Vaibhav (%)

25

Provision for graduation for Vaibhav (Rs) (rounded off) (present value)

10,81,156

Provision for post-graduation for Vaibhav (Rs) (present value)

16,64,469

Provision for marriage expenditure for Vaibhav (Rs) (present value)

11,31,505

Total monthly expense on Vaibhav (Rs)

13,250

Financial Value of Mr Saxena’s life to Vaibhav (Rs)

70,82,236

Dependent 3: Daughter

 

Daughter’s (Vibha’s) current age

6

Number of years Vibha’s will be dependent on Mr Saxena

22

Percentage of monthly expense spent on Vibha (%)

25

Percentage of annual lifestyle expense spent on Vibha (%)

25

Provision for graduation for Vibha (Rs) (rounded off) (present value)

11,02,454

Post-graduation expenditure for Vibha (Rs) (rounded off) (present value)

16,97,258

Marriage expenditure for Vibha (Rs) (rounded off) (present value)

13,75,580

Total monthly expense on Vibha (Rs)

13,250

Financial Value of Mr Saxena’s life to Vibha (Rs) (rounded off)

79,23,655

Other Areas

 

Outstanding loans (Rs)

45,00,000

Other liabilities (Rs)

0

Contingency fund that will be required by the family (Rs)

10,00,000

Current life insurance that the client already has (Rs)

50,00,000

Assets that the family will be able to financially use in case of Mr Saxena’s demise (Rs)

12,00,000

Total insurance requirement (Rs)

2,49,35,423

(For illustration purpose only)
(Source: PersonalFN Research)

Mr. Saxena, spends Rs 6,36,000 per annum on his family as monthly household and lifestyle expenses.

Mr Saxena's provision towards retirement for wife, Radhika is approx. Rs 25 Lakh, While the financial value of his life to Radhika is about Rs 1.06 crore.

The Financial Value of Mr Saxena's life to Vaibhav is about Rs 71 Lakhs, if provided for Vaibhav's...

Graduation;

Post-graduation; and

Marriage expenses.

According to Mr Saxena's calculation, he is keen to provide Rs 41.74 lakh for Vibha's education and marriage (in present value terms). The Financial Value of Mr Saxena's life to Vaibhav is around Rs 79 Lakh.

Mr Saxena has loans outstanding to the tune of Rs 45 lakh, which has to be taken into account for calculating the insurance requirement.

He has also accounted for a contingency reserve of Rs 10 lakh and has existing life insurance coverage of only Rs 50 lakh.

With these vital assessment and input, it is clear that Mr Saxena needs an additional insurance of Rs 2.50 crore.
Note that the motive of having adequate insurance should be to avoid any financial burden on the family members in your absence.

Therefore quantifying your human life using the scientific approach called HLV, would help you optimally insure yourself and protect the financial interest of your loved ones.

Once you've determined the optimal insurance coverage, go ahead and choose an appropriate insurance product. You see, there are a number of insurance products available in the market today - from term plans to ULIPs to endowment plans, money back policies and so on. But it's important to evaluate them prudently so as to strike a fair cost-to-benefit ratio and select the right insurance policy for your needs. We will talk about this in length in the ensuing sessions of this module.

Finally, here are a few...

Points to Remember

  • Holding an optimal insurance coverage is a critical aspect of insurance planning

  • An optimal insurance cover can help you address the financial security of your family / dependents after you.

  • Life insurance refers to indemnification of risk to life

  • It is important to quantify the value of the bread earner of the family, so as to determine a fair estimate of the amount of insurance coverage.

  • There are various ways to determine life insurance requirement, but the most scientific and comprehensive is Human Life Value (HLV) - expense method

  • Don't forget to take into account the vital ingredients viz. number of dependents, the age of your children, expenses, contingency reserve, asset owned, inflation, amongst a host of other facets to prudently determine the life insurance cover you should have.

Thank You For Participating!

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