Archive / Investment Adviser (Level 2) / Life Insurance Products

nism-series-xb-charu-income-replacement-hlv-additional-cover[ INVESTMENT ADVISER (LEVEL 2) ]

Charu earns Rs. 50,000 monthly (Rs. 6,00,000 p.a.) and is 35 years old, expecting to work until age 60 (25 years). Expected inflation is 6% p.a. and long-term investment return is 10% p.a., giving an inflation-adjusted return of 3.77% p.a. She currently holds Rs. 40 Lakhs of life insurance. How much ADDITIONAL life insurance cover does Charu require using the income replacement method?

[ A ]Rs. 47 Lakhs

[ B ]Rs. 64 Lakhs

[ C ]Rs. 56 Lakhs[ CORRECT ]

[ D ]Rs. 72 Lakhs

Takeaway

Charu's Gross Human Life Value discounted at the real rate of 3.7736% over 25 years is about Rs. 96.02 Lakhs, and netting off her existing Rs. 40 Lakhs cover leaves an additional requirement of Rs. 56 Lakhs, so option C is correct.

Derivation

Real discount rate = ((1.10)/(1.06)) - 1 = 3.7736%. Gross HLV = PV(3.7736%, 25, -6,00,000) = Rs. 96,01,652. Additional cover required = Gross HLV (Rs. 96.02L) - existing cover (Rs. 40.00L) = Rs. 56,01,652, rounding to Rs. 56 Lakhs. This question tests the income-replacement variant of the needs analysis, where the correct real discount rate (nominal return net of salary growth, not net of price inflation alone) and the correct 25-year working horizon must both be applied before the existing cover is deducted.

Why the others fail

A — Rs. 47 Lakhs

Results from discounting at an unadjusted nominal 10% rate without factoring in the 6% assumed salary growth, understating the true HLV and hence the additional cover.

B — Rs. 64 Lakhs

Results from using a 20-year working horizon instead of the stated 25 years to retirement, understating both the HLV and the additional cover required.

D — Rs. 72 Lakhs

Assumes the existing Rs. 40 Lakhs cover is never deducted from the gross HLV, overstating the additional insurance requirement.