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Risk Management and Insurance Needs Analysis

This document provides an example of calculating life insurance needs for a working individual using different methods. It calculates the needs using: 1) The multiple of earnings method, finding needs of $500,000 and $1,000,000 using 5x and 10x the individual's $100,000 income. 2) The actual need method, calculating nominal and present value amounts of living expenses and resources from other sources over two periods. The nominal calculation finds a need of $658,200 while the present value calculation finds a lower need of $411,811. 3) It explains that the present value calculation assumes proceeds can earn interest to fund some needs, requiring less insurance, but depends on investment returns

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20 views2 pages

Risk Management and Insurance Needs Analysis

This document provides an example of calculating life insurance needs for a working individual using different methods. It calculates the needs using: 1) The multiple of earnings method, finding needs of $500,000 and $1,000,000 using 5x and 10x the individual's $100,000 income. 2) The actual need method, calculating nominal and present value amounts of living expenses and resources from other sources over two periods. The nominal calculation finds a need of $658,200 while the present value calculation finds a lower need of $411,811. 3) It explains that the present value calculation assumes proceeds can earn interest to fund some needs, requiring less insurance, but depends on investment returns

Uploaded by

Encik Hazreen
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOC, PDF, TXT or read online on Scribd

Lecture 8 Example Answers

Example 1. Applying the Risk Management Framework. The party animal suddenly gets wise about the many liabilities that might be associated with the keggers he likes to host around the pool at his apartment complex. What can he do about them? Apply all 4 risk management strategies. Avoid: Stop hosting parties Reduce: Probability: Party away from the pool Magnitude: Hire a sober life guard Retain/assume: Be prepared to compensate damages Insure: Obtain an umbrella liability policy Example 1. Insurance Need Analysis How much life insurance is needed a working individual whose spouse is employable but not working? There are no other dependents. Assume current household income is $100,000. Calculate life insurance need using, respectively, (i) the multiple of earnings method and (ii) the actual need method. For the actual need method, calculate need in both nominal and present value amounts. For the PV calculations, assume APR=5%. Explain why the latter two calculations differ and which one makes more sense to you. [Hint: For the present value of the actual need calculations, use a PVA calculation within each period, then use a PV calculation to discount period 2 (years 13-30) back to t=0.] (a) Estimated future need
Years, by period 1-12 13-30 Immediate Need Living Expenses Number of years Nominal Need PV Need (t=0, i=5%) Total Nominal Need Total PV Need $270,000 $62,000/yr 12 $1,014,000 $819,522 $1,914,000 $1,144,982 -$50,000/yr 18 $900,000 $325,460*

(b) Resources from other sources (for dependents)


Years, by period 1-12 13-30 Income Liquid Assets Number of years Nominal Resources $38,400 $165,000 12 $625,800.00 $35,000 18 $630,000.00

PV Resources (t=0, i=5%) Total Nominal Resources Total PV Resources

$505,348.86

$227,821.98*

$1,255,800 $733,171

Solution: Insurance needed (i) Multiple of income method (see completed worksheet below): 5 x $100,000 = $500,000 10 x $100,000 = $1,000,000 (ii) Actual need method: Using nominal calculation: $1,914,000 - $1,255,800 = $658,200 Using present value calculation: $1,144,982 - $733,171 = $411,811 Nominal need calculation makes no assumption about earnings on the insurance proceeds. PV calculation assumes proceeds could be placed into an annuity that earns interest, so some need can be funded out of earnings. Latter approach requires less insurance but depends on investment returns and is less forgiving of higher inflation.

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