Case 042Goal and retirement planningCore
A sole earner on Rs 45 lakh a year has a Rs 70 lakh home loan, Rs 1.2 crore of children's goals and Rs 60 lakh of existing cover. Using the needs method, how much more life cover does the family need?
1The situation
Prakash Iyengar-Nair, 42, is the only earner in a family of four in Chennai, on Rs 45 lakh a year. His wife is 40 and their children are 9 and 6. The family owes Rs 70 lakh on the home loan. You have costed the children's education goals at Rs 1.2 crore in today's money.
Without Prakash, the family would need about Rs 18 lakh a year to live on, excluding the EMI and his own spending, until his wife is about 65. They hold Rs 1.4 crore of investments outside the house and his retirement accounts, and he has Rs 60 lakh of term cover. Assume the payout earns 2% a year above inflation.
2Your task
Build the needs calculation and give the extra cover required. Say which numbers you would challenge and how sensitive the answer is.
Quick check
Which part of the need is largest?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
The family needs about Rs 3.5 crore more cover. The need is the Rs 70 lakh loan, Rs 1.2 crore of goals, Rs 3.51 crore to replace Rs 18 lakh a year for 25 years, and Rs 10 lakh of final costs: Rs 5.51 crore. Less Rs 1.4 crore of investments and Rs 60 lakh of existing cover, the gap is Rs 3.51 crore. The income line drives the answer, so its assumptions deserve the most scrutiny.
Step 1What does the needs method ask?
If a family's only boat sank, you would ask what it carried every day and for how long, not what the boat cost. The needs method sizes cover to what the family would lose: debts to clear, goals to fund and years of living costs to replace, less what it already holds. It is slower than a rule of thumb such as ten times income, but every line can be checked with the client, which is exactly what makes the number defensible.
Step 2How do you turn a yearly need into a lump sum?
Ask what sum, invested, would pay Rs 18 lakh a year for 25 years with the payments rising with inflation. Discounting at the return above inflation handles the rising payments in one step: at 2%, each rupee of yearly need costs about 19.5 rupees today. So Rs 18 lakh a year needs about Rs 3.51 crore. The loan and goals are added as they stand, since the goals are already in today's money.
| 18 | yearly living costs to replace, Rs lakh |
| 0.02 | the return the payout earns above inflation |
| 25 | years until his wife is about 65 |
Step 3How sensitive is the answer, and what would you challenge?
Change the real return and watch the gap move. At 0% above inflation the gap is about Rs 4.5 crore; at 4% it is about Rs 2.8 crore. Then challenge the inputs: the Rs 18 lakh may fall once the children leave home, and the Rs 1.4 crore of investments should count only what the family could actually use. Recommending about Rs 3.5 crore, in one or two policies ending when the need falls away, is a defensible answer.
| Return above inflation | Rupees today per rupee a year | Income need, Rs crore | Gap, Rs crore |
|---|---|---|---|
| 0% | 25.0 | 4.50 | 4.50 |
| 2% | 19.5 | 3.51 | 3.51 |
| 4% | 15.6 | 2.81 | 2.81 |
Where candidates lose it
The most common error is adding Rs 18 lakh times 25 years, Rs 4.5 crore, without discounting. It overstates the need by nearly a crore and suggests the candidate has never valued a stream of payments.
The second is counting the family home as an asset to offset the need. The family lives in it; selling it to fund living costs defeats the point of the cover.
What the interviewer asks next
- His wife starts earning Rs 8 lakh a year. How does the gap change?
- Should the new cover run to his age 65 or be split into two policies with different terms?
- How does the human life value method differ, and when would it give a bigger number?
Company names and figures are illustrative.