A Term Insurance Plan protects the dependents of a householder against the financial distress that may be caused upon the death (or critical illness) of the householder, due to the loss of a source of income to sustain them. Therefore it is very important to decide upon the right quantum and the right duration of the protection: the umbrella should be of the right size – neither too big, nor too small; and needs to be carried only as long as there is a possibility of rain, not any longer. The “quantum of protection” we call SA (Sum Assured) of the plan and the “duration of protection” we call the Term of the plan.
It is obvious that the protection is required only till the dependents “require” this source of income; the need for protection ceases the moment the dependents are able to work and earn for themselves. The term of the plan therefore should be only up to this point of time. For instance let us suppose the householder has a son and a daughter aged 6 and 7 respectively; they are likely to be fit to work and earn for themselves (for simplicity let us suppose the householder’s wife is employed and therefore can sustain herself) by the time they are of age 25. Which means the protection is required for about 19 years; so the term of the plan should be 19 years.
The SA of the plan should be such that it forms a corpus from where the dependents can draw their sustenance up to the point of time when they are able to work and earn for themselves.
How do we calculate the quantum of the corpus required? The quantum of corpus required will depend upon the quantum of monthly sustenance desired, for what period and the rate of return on the corpus when it is invested pending use.
Now, how do you arrive at this figure of corpus desired, given the quantum of monthly sustenance desired, the period for which it is desired and the rate of return?
Given the quantum of monthly sustenance desired, the period and the expected rate of return, the quantum of corpus is given by the formula:
Corpus = Monthly sustenance X [{(1+i)n -1} / { i (1+i)n}]
Where i = expected rate of interest / rate of return per month
n = number of months for which sustenance is desired.
Let us solve an example to understand this. Let us suppose Anil’s dependents need a monthly sustenance of `11,011 for twenty years. How much corpus will he need to create ? Assume an interest rate of 12%.
Well, you must have been troubled by the fact that the calculation above is rather a hard nut to crack. You don’t have to really. Just use an excel sheet. Let us see now how to do it.
Open an Excel sheet. I would suggest you put on your PC/laptop and open MS Excel; so that you can easily follow the instructions given here; just go on and you will see how simple it is. In the Excel sheet click and open the drop down Formulas menu in the top bar; it is usually the fifth item in the top bar. Click the Financial Functions; which is usually the third group of functions (after the Ʃ and ‘Recently Used’ functions); a list of functions will drop down, arranged alphabetically. Choose the function PV. A box as shown below will appear. Fill in the function arguments (values).
Rate is the rate of interest; in the example above it will be 0.12/12. Now let me explain that. The rate of interest we have supposed is 12% that is 0.12; this annual rate of interest. We divide that by 12 to arrive at the monthly rate of interest. You need not do the division and enter in the box; just enter 0.12/12. Nper is the period; here it is 20 years, that is 20X12=240 months.
So in the Nper space enter 240. Pmt is the withdrawal that the dependents wish to make every month; in our example it is `11,011. In the Pmt space enter -11011; yes, minus11011; because the withdrawal of monthly sustenance is a debit to the corpus. Leave the next two spaces (Fv and Type) blank. And there you have : in front of the Formula result = at the base of the box you will get 1000012.593. That is the corpus you need : `10,00,000. Kids’ play, right ? Try it again for another example.
Once you are comfortable with the Excel sheet, you can simply type = PV (rate, nper, pmt) in a cell of the Excel sheet. Note that you should not type “rate, nper, pmt”, but type the values of these variables. So, in the example we have taken you will type = PV (0.01,240,-11011).
This way you can buy the right quantum and the right duration of protection with a Term Insurance Plan. Little effort that it takes is worth it. Because then will neither buy too little of protection not will you buy too much of it; too little is useless; too much is a waste of money. In a market that is infested with insurance sharks competing for your wallet, you need to be a smart buyer. And this is how you can.
