• Rule of thumb
Most people rely on the rules of thumb since it is a simple to calculate and easy to understand that helps to calculate a basic amount of insurance coverage. Mostly common rule of thumb is used as “Income rule” which provides a guideline to assess the insurance need of an earning individual. It uses a basic multiple of income as always heard that 10-15 times of yearly income should be covered. Though the rules of thumb method is quite simple, it does not factor the needs and circumstances of each family and you could end up overinsured or underinsured.
• Human Life Value(HLV) Approach
The Human Life Value or income replacement approach or the Capital Needs Analysis is a method to determine an estimation of person’s human life value. The income replacement calculation is based on the theory that the purpose of insurance is to replace the loss of earning when a person dies. Simple put HLV is calculated based on the individual’s income earning ability.
Steps to calculate Human Life Value
Step 1: Find the current income of bread earner
Step 2: Deduct his personal expenses, income tax, and life insurance premium
Step 3: Find the earning life of the bread earner from current age
Step 4: Find out the present value of required income stream by using inflation adjust return
• Need Approach
It is based on the assumption that the goal of life insurance is to cover the surviving family members’ immediate expense after the insured family member’s death as well as their ongoing expenses into the future. While HLV focuses on the income that would be lost, the needs approach attempts to identify the allocation of that income and to determine the purposes to which it would have been put.
Need analysis has general equation is:
Life Insurance = Cash needs + Present value of Net income needs – Expected available assets
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