Needs-based approach

How much life cover does a person actually need? One common shortcut multiplies income by a number and stops there. The workbook offers a better method: the needs-based approach.

It starts from the assumption that insurance exists to meet specific needs after death: the family's ongoing expenses, outstanding debts, and future goals such as a child's education. Add those up, subtract what is already available, and the answer is exactly the number of rupees still needed, not an arbitrary multiple of income.

The calculation runs in layers:

1. Corpus to replace regular expenses for the number of years the family needs support, adjusted for inflation and discounted at an investment return, computed using the PV function in Excel.
2. Add outstanding debts the family should not be left carrying, such as a home loan.
3. Add lump sums for specific future goals, such as a child's corpus.
4. Subtract existing life insurance cover already in force.

The result is the additional life insurance required, not the total ideal cover. A needs-based calculation is always run net of what already exists, because the question being answered is how much more, not how much in total.

One constraint the workbook flags directly: overall expenditure cannot exceed income. A needs-based number that implies the family would need to spend more than the household actually earns is not internally consistent, and the calculation should be checked against that ceiling.

Adil wants his spouse to have Rs 25,000 a month of household expenses covered for 30 years, plus a Rs 10,00,000 corpus for his child, and wants his Rs 30,00,000 home loan cleared. He assumes 6% inflation and 8% investment returns, and already holds Rs 50,00,000 of life cover.

Annual expense (25,000 x 12)                       Rs   3,00,000
Inflation-adjusted return [(1.08/1.06)-1]                  1.89%
Corpus for expenses, PV(1.89%, 30, -3,00,000)     Rs  68,24,712
Loan outstanding                                   Rs  30,00,000
Child's corpus                                     Rs  10,00,000
Total need                                         Rs 1,08,24,712
Less existing cover                                Rs  50,00,000
Additional cover required                          Rs  58,24,712

Adil needs roughly Rs 58 lakh more cover, not Rs 1.08 crore, because the needs-based method nets off what he already holds.

Chapter 2 (Features of Life Insurance Products) introduces the needs-based approach as an alternative to income-multiple methods, and sets the 'expenditure cannot exceed income' constraint as a check on the answer. Chapter 20's case studies, Adil and Charu, apply it directly with the PV function. Expect a full worked calculation, using the same structure as the example above.

• Always net off existing cover at the end. The workbook's own sample question turns on candidates forgetting this step and answering with the gross need instead of the additional cover required.
• The discounting rate is the inflation-adjusted return, computed as (1 plus investment return) divided by (1 plus inflation) minus 1, not the raw investment return.
• Debts and specific goals are added as lump sums, separate from the present value of ongoing expenses. Do not fold a home loan into the annuity calculation.
• The 'expenditure cannot exceed income' rule is a sanity check, not a step in the arithmetic. Use it to flag an answer that looks too large relative to the family's actual earnings.