INSURANCE - Part 2

Hi, we meet again.

The article preciding this one had given an insight to most of us if not all, the 2 methods a potential insured person could choose from prior to buying a policy. In this article i shall bring to surface the correct method of determining how much one should be insured. For me to do so, i need to borrow the case studied previously about John and Alice. As you would have known in that case study they do not have any kind of insurance coverage; neither for them nor for their child.

In this article let us assume that John and Alice would now have decided to purchase a policy but do not know how much they should buy to cover themselves. So, they approached me!

As a certified financial planner, i have agreed to help them.

First and foremost, i called both of them and requested them to provide me their monthly HOUSEHOLD CASH FLOW STATEMENT. With a gawping look, they admitted that they do not know how to prepare the cash flow statement. "It's okay", i said in a soft tone. The next few minutes or so i spent some time to guide them in how to preparing a cash flow statement. John and Alice drafted their own cash flow statement and below is what they submitted to me. Let us look at it now.

The cells on the right hand side represents their expenditures, while their income is shown on the left half of the statement. Look at the expenses side (cash out flow) and you will see some figures which are delibrately circled. These are figures which either John or Alice had spent for common expenses towards maintaining their familyhood. All those none circled items are figures incurred as a result of either one's individual expenditures and not directly contributing towards common expenditures.

Let us focus on John's portion of expenses that goes towards maintaining his family instituition.

You need to add all those items that are tagged with "John" mark. The gross total shall come to RM 2880.70. Alice's expenditures shall come to RM 704.00 but we are not going to focus on hers at present, not untill we finished with John.

In order for Alice to live with the same comfort her present lifestyle prevails, she need RM 2880.70 to be pumped into her comfort zone she enjoys now and that is being supported by her husband, John. If this monetary support is deprived off from her, she would find herself in a spiral of various problem that would definitely jeopardize her comfort zone. Therfore, Alice would adamantly want to persuade John to take up an insurance policy on him with she as the beneficiary, should any misfortune strikes him in any part of his life. The risk that John is comfronting can easily be transfered to any Insurance provider who can accept the risk with an exchange of a premium.

So if some misfortune strikes John and John loses his economic viability, the insurer would compensate Alice. Thus, Alice would be continuing her comfort zone same as the one she enjoyed prior to the misfortune that attacked John. With an insurance, Alice would still enjoy RM 2880.70 coming in from the Insurer. This is an important function of an Insurance, therefore should not be taken very light!

Okay, so much for that! Now just how much John has to be covered?

RM 2880.70 X 12 months = RM 34,568.40

If a misfortune striked John this year, Alice would need RM 34568.40 to compensate her the next 12 months.

As given, Alice is 32 years old an she anticipated to live until the age of 76.

She have 44 years ahead of her and that amounted to,

44 years x RM34568.40 = RM 1,521,009.60. This is the amount John has to be covered!!

You have noticed that in the gross expenditure of John, i have included Credit card balances, Mortgage loan payment and Car instalment payments. I have assumed that there is no MRT on the house. I have also assumed that Alice wants to keep John's car and his credit card. What if Alice doesn't want John's car and credit card. What if the house has got a MRT? Let us calculate now!

The total gross expenditure of John now shall be RM 808.70. Multiply this with 12 months and 44 years, you will get a sum of RM 426,993.60. This is the amount John has to be covered!!

Remember, down the road if no misfortune strikes him (i hope not), his total coverage would be different. A point to be highlighted here is, an insurance policy should not be out of the monitoring radar of the insured. The insured should constantly review his coverage over time and adjust his coverage to reflect the true needs.

Now that you know how to calculate John's coverage, can you decide how much Alice is needed to be covered?? Good Luck!