Tan Kin Lian's Blog: How much life insurance to own?

Wednesday, December 02, 2009

How much life insurance to own?

One method that can be used is called the "human life value" approach. This is calculated as the present value of the family's share of the deceased breadwinner's future earnings. It is calculated as follows:

a) Estimate the individual's average annual earnings over his or her productive lifetime
b) Deduct taxes, insurance premiums and the cost of self-maintenance; the remainder is used to support the family
c) Determine the number of years from the present age to the retirement age
d) Use a reasonable discount rate the determine the present value

For example:
present age: 30
retirement age 65
annual earnings $50,000
self maintenance: $20,000
support family: $30,000
present value for 35 years at 4% discount: 19.41
amount to insurance needed: $582,000

This is slightly more than 10 years. For such a large sum, it is necessary to buy decreasing term insurance.

If the period is taken as 25 years (i.e. the children would have grown up), the factor is 16.24. The amount of insurance needed is $487,000. This is close to my rule of thumb of 10 years.

9 comments:

Different said...: I have a different approach.

My insurance coverage does not cover my potential earnings. It covers only 2-3 years of expenses for the family in the event of my passing.
That should be sufficient time for grief and cost of funeral, and loss of income for 1 year.

I encourage my survivors to get up and earn an income. No free lunch.
No reason why anyone should have a windfall of 1 million on account of my death!

Many agents do not seem to understand my view, and are insistent on selling me policies that pay out huge sums, based on future earnings.

I would like to know the views of others in this blog.
Thank you Mr Tan.; December 02, 2009 10:26 AM
Anonymous said...: Where can we buy decreasing term?; December 02, 2009 11:22 AM
Anonymous said...: To "Different": don't worry about your survivors "grieving" over your passing on. They will be very happy you left them some money to celebrate.; December 02, 2009 12:21 PM
Anonymous said...: I faced a similar situation with a reputable insurance agent.He told me that the sum of monies that I was insured are insufficient for my two kids education should something badly befall on me.I told him that as long as the sum is enough for them to live through and have formal education,the rest will be up to them to think of ways to further their education should I died.They will have to work for it if they think they want to persue a degree etc.The present is more important then planning for the future as my salary is quite small.

Ice-cream man; December 02, 2009 3:32 PM
Anonymous said...: The other common method is the liabilities or expenses method which involves figuring out the annual amount of $$$ to support your dependents X the number of years needed X factor for inflation, say 3%. In a way, the rule of thumb of 10 yrs of annual income falls into this category.

For liabilities like mortgages or car loans, get a reducing term insurance. And don't forget the cheap home insurance too.

What you must have, and what everyone of your loved ones must have, is H&S insurance.

Anon 10:26am --
It depends also on how much your income/earning power contributes to the lifestyle or wellbeing of your dependents. If your family doesn't need your income, or you don't really have dependents, then actually you don't really need insurance, except for H&S.

In above case, a big lump sum insurance is more of a "gift" or "legacy" to your family, as many agents would say to create the emotional warm fuzzy feeling.

Ex-Con; December 02, 2009 5:48 PM
Anonymous said...: I forgot to mention above. If scared jobless due to CI or some serious disability, and still need to support yourself and/or dependents, then maybe consider CI term or DI.

Unfortunately, most CI and DI are expensive even though term. You can look around for Group Term types which shld be cheaper. E.g. Aviva SAF DI and SAFRA CI / HomeTeam CI. Also LUV plan for union members.

Can also consider Aviva SAF CI, but this one must buy on top of Aviva SAF Term.

Sorry, don't know any cheap group DI for non-SAF. If your spouse is SAF (incl. reservist) then he/she can buy for you too.

Ex-Con; December 03, 2009 2:18 AM
LWL said...: Every person that owns a HDB flat already subscribes to a decreasing term policy that covers their outstanding mortgage by way of the HPS.

The premium is deducted from the CPF Ordinary Account. It therefore makes sense for all joint owners to individually insure themselves for 100% of the outstanding loan (although at present, it is only compulsory one owner to be covered at 100%)

In addition, most CPF members (unless they have opted out) also subscribe to the DPS (a fixed term policy) which pays out about $48 000 upon death. Again the annual premium comes from the CPF Ordinary Account.

Therefore, based on the above, it would be, in my view, not necessary for a very high term coverage, over and on top of the HPS and DPS.

THe HPS takes care of housing, while the DPS will provide for expenses for the initial year. Additional term coverage should therefore just need to take care of food and other necessities.

In fact, if one already owns a 5-room or larger HDB, then, really, in the event of death of breadwinner, it would be logical to sell the existing flat and downgrade. The proceeds can then be used to supplement any other term policy payout for the benefit of the dependents.

Based on the example provided in the article, I would therefore conclude that an amount of about $300000 term (assuming a outstanding loan of $150000 and the $48000 DPS payout) would be more than sufficient.; December 03, 2009 11:17 AM
Different said...: Hello LWL,
Thank you for your comments.
It validates my views:

There is no argument in buying huge coverage except for basic needs.In fact, if you have sufficient funds, there is no need for insurance, even for hospitalisation & surgery.

Think for a moment. If you needed 1 million to perform brain surgery, and not knowing if the surgery will be successful, would you proceed? and after you did it, would the insurance company resume
covering you?

Save the premiums and go for a relaxing holiday... that is a better return.!!; December 04, 2009 9:18 AM
Anonymous said...: Like that no business for the insurance agents ,leh..you spoiled their plans.
So nicely, they make sure their customers ALWAYS not enough so that they can review the insurance of their customers to see, (no need see they already know) if there is short fall.Put it in another way to see if they have money to buy limited pay wholelife or if no money ask their customers to APL their existing policy and buy a limited whole life living policy, hor. Pay 10 years and insured for life and no need pay any more, good or not?
Very clever...now customers got many living polices...insured by many living policies..Goooooooooooood; December 04, 2009 1:52 PM