When it comes to life insurance, it is quite difficult to estimate the exact need of insurance and most of the people who turn out to sell us insurance plans are found fumbling if asked about the exact insurance need and its rationale. Although the insurance companies are trying to educate their agents/advisors about the basics of insurance the situation is far from desirable.
We have to understand the reason for taking any insurance and also to calculate the appropriate quantum of insurance. Insurance is an arrangement where a number of persons pay a small amount each to an insurance company which in turn assures to pay a specific amount if a particular event occurs and which results in a financial loss to the person who had bought the insurance. So if we have to get our car insured, we will pay the premium which will be around 3-4% of the value of the new car and the insurance company is bound to compensate for any financial loss to the insured article, in this case, the car. Once the contract period of one year is over and if there has been no loss to the insured article, the insurance company is not bound to pay any thing to the person who had taken the insurance. Now in the above example, we do not have to think much about the amount of insurance since it is already on records. A new car is insured depending on the price paid for it to the company and an old car is depreciated for every year of use.
But the problem in life insurance is: ‘how to determine the value of a human being?’.
This problem has a solution which is called “Human Life Value” and it is a calculation which is used world wide for determining how much insurance should be taken for any human being. Since the logic of buying insurance is compensation in case of a monetary loss, the insurance company can only compensate for a financial loss that arises because of the death of the person whose life is insured. The loss which arises upon the death of a person can be of two types, financial and personal (emotional). The life insurance policies can only compensate for a financial loss which is calculated before issuing the policy and it is done by using a “Human Life Value Calculator”. The financial loss in case of the death of a working person is the loss of all his future earnings till the age of retirement minus the expenses he would have made on himself. The logic behind this is that if the person is not alive any more, the actual earning loss is of the money he would bring in after deducting his personal expenses.
Now if the person is 28 years of age and wishes to retire at 60, the financial loss in case of his death would be 32 years of earning, and the simple way of calculating his human life value would be the total of all his future salaries. Let us assume his monthly salary is Rs 20,000 so a simple calculation would come to Rs 2,40,000 for every year of earning left i.e., 32 years and the total comes to Rs 76,80,000. But then we have to calculate not the absolute value of future earnings but the present value of future earnings. Present value of any money is less than the actual amount received in future since the value of money is decreasing every year due to the prices of all items going up gradually, a phenomenon called inflation. So assuming that the inflation is 5% per year (meaning thereby that the overall price increase is 5% in one year) if I am expecting to get Rs 1 Lakh next year, its present value is close to only Rs 95,000 and 1 Lakhs received two years from now will be worth only Rs 90,700. Applying the same logic to the above example, the present value of all his future earnings i.e his “Human Life Value” is Rs 38.43 Lakhs which is just half of his total future earnings.
So not only calculate your human life value now, but do it every time you get that coveted increment in salary.
Insurance calculator: Expense protection method
Insurance calculator: Human Life Value method
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