Question

a. Jasmine, age 42, is a single parent with an eight-year-old daughter. She earns $600,000 annually as a marketing manager in a software house. As part of her remuneration package, Jasmine’s employer also provides her with a group life insurance protection in the amount of $1,000,000.

Jasmine has decided to purchase additional life insurance so that her daughter will be financially protected if she suffers from premature death.

Currently, Jasmine has the following financial needs for her family if she should die:

Income support for her daughter -$23,000 monthly
Establish an education fund for her daughter - $2,200,000

Pay off mortgage loan on home -$2,500,000
Pay off credit card debts -$70,000
Pay off auto loan -$100,000
Pay off funeral costs and other final expenses -$150,000

Jasmine does not have much cash savings but she owns several mutual funds and blue chips shares with a current market value of $1,500,000. Also, she has bought an individual life insurance policy for herself with a sum insured of $2,000,000. Further, Jasmine has participated in her employer’s retirement scheme with an account balance of $500,000.

1. Based on the ‘needs approach’, how much additional life insurance should Jasmine purchase to fulfill her financial goals. It is assumed that the rate of return earned on the policy proceeds is equal to the rate of inflation and social security benefits are not available for Jasmine’s daughter. 9 marks

2. In the above question a(i), how much additional life insurance should Jasmine purchase if social security benefits in the amount of $7,000 monthly are payable until her daughter attains age 18? 4 marks

2. Examine the usefulness of the ‘needs approach’ as a method of determining the amount of life insurance to purchase. 4 marks

3. Explain how the level-premium method can provide the insured with lifetime protection.

Answer 1

The needs approach for determining the amount of life insurance needed has a different goal than the earnings multiple approach. The goal of the needs approach is meeting the total needs of the household after the death of a breadwinner, both at the time of the death and in the future. To calculate the amount of necessary life insurance according to this approach, add up all of your funding needs to determine the total needs of your beneficiaries. Include immediate needs, debt elimination, transitional funds, dependency funds, spousal life income funds, spousal education funds, children’s education funds, and retirement income funds. Subtract current insurance coverage and other available assets from this total.

Solution to Part 1- Calculation of additional life insurance to be purchased by Jasmine on the basis of 'Needs Appproach' where no social security benefits are available to Jasmine's daughter

Particulars

Income support for her daughter - $23,000 monthly $276,000
Establish an education fund for her daughter - $2,200,000

Pay off mortgage loan on home - $2,500,000
Pay off credit card debts - $70,000
Pay off auto loan - $100,000
Pay off funeral costs and other final expenses - $150,000

Total Funding Needs (A) 5296000

mutual funds and blue chips shares $1,500,000

individual life insurance policy $2,000,000

group life insurance protection   $1,000,000

Salary    $600,000

Total Assets (B) $5100000

Additional life insurance to be purchased by Jasmine is (A)-(B) =$196000

Solution to Part 2- Additional Life Insurance Policy to be purchased by Jasmine is social security benefit is available to daughter will be $112000 i.e $196000 less $84000($7000*12)

Solution to part 3

Usefulness of Needs Approach

• The needs approach to life insurance planning is used to estimate the amount of insurance coverage an individual needs.
• The needs approach considers the amount of money needed to cover burial expenses as well as debts and obligations such as mortgages or college expenses.
• This approach is in contrast with the human-life approach, which is more comprehensive in determining the value of an individual's employment potential.

Solution to part 4

Usefulness of Level Premium Method for the insured

• Level-Premium Insurance is a type of life insurance in which premiums stay the same price throughout the term, while the amount of coverage offered increases.
• Premium payments often start at a higher level than policies with similar coverage but are ultimately worth more than competitors as policyholders experience increased coverage over time at no additional expense.
• Terms are usually 10, 15, 20 and 30 years, based on what the policyholder requires.

If the primary purpose of the death benefit is to provide income to support very young children and fund college expenses, a 20-year level-premium might be appropriate. However, if these children are already in their early teens, a 10-year level-premium may be sufficient.