Question

Howard and Millie, 28 and 26 respectively, is a young family without children. Howard works as an engineer for a medium size manufacturing company, earning $70,000 per year. Millie works part-time at a doctor's office, earning $20,000 per year. They expect that their income will keep pace with inflation, which is expected to be 2% per year.

Millie does all the housework, such as cooking meals and cleaning the house. She estimates that it would cost $18,000 to hire somebody to do (all) the housework that she is doing.

They are free spenders; they spend all their income every month, so that they have no savings. Although they want to save, they don't want to change their life style. If one of them dies; the remaining person would still need 90% of their current spending. You can ignore taxes in this question.

Howard has good benefits from his work, including group life insurance that provides a lump sum equal to three times his salary if he dies. They plan to work until age 65.

Assumptions:

- Use real dollars in your answer.

- The nominal rate of interest is 6%.

- Cash flows are at the end of the year.

- Ignore taxes.

Required:

(a) Using the Income Approach, how much life insurance does the family need?

(b) Using the Expense Approach, how much life insurance does the family need?

Answer 1

Answer :

(1). Income Approach

Particulars	Howard ($)	Millie ($)
Retirement age	65	65
Present age	28	26
Remaining age	37	39
Yearly salary	70000	20000
Opportunity salary	0	18000
Annualy salary	70000	38000
Infliation % per year	2%	2%
Insurance needed using	-	-
Income approach	37,82,398	22,13,015

Hence insurance needed to the family using income approach is $ 59,95,413 (37,82,398 + 22,13,015)

(2). Expensea Approach

Total income of the family	90,000	(70000 + 20000)
Total Expenses they required	90,000	-
Expenses required if one dies	81,000	-
Average age remaining for retirement	38	(37+39)/2
Nominal rate of interest	6%	-
Insurance needed	1,10,08,241	-