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How much life cover do you need? Individual Insurance Planning by Cornerstone Wealth Management in India |
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Rattan Chugh
ExpressMoney
Tuesday , March 27, 2007 at 1006 IST
How much life cover do you need?
How much life insurance you buy shouldn't be an arbitrary amount. It sholud be determined by numbers derived from your personal circumstances. |
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The primary purpose of life insurance is to provide risk cover that offers financial protection to a policyholder’s dependents in the event of the policyholder’s death. One needs to have enough life insurance so that his or her family can continue with their current lifestyle even if the breadwinner passes away. |
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Like every financial decision, life insurance shouldn’t be and needn’t be arbitrary. There is such a thing as ‘the right amount of cover’, which assumes greater significance in light of the fact that there’s a price to pay for buying grossly less or grossly more. If you under-insure, you risk causing financial hardship to your dependents; if you over-insure, you waste money paying for something you don’t need. |
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The amount of insurance you need depends on your personal circumstances, which comprises of many variables. The most important of these is dependents. If you don’t have dependents (say, you are not married and your parents are financially self-sufficient), you don’t need life insurance at all. Likewise, if your spouse is working and can live comfortably without your income, you don’t need cover. However, if the two of you have taken loans, then you need to provide a back-up for those loans. And if you have young children, you will need to provide for expenses to raise them and support their higher education. |
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| Therefore, to answer the question of how much cover, answer the question: how much capital does your family need, both in the short-term and in the long-term? The answer can be derived in three steps. |
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| Step 1: work out your expenses |
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Living expenses. These include day-to-day expenses such as food and utilities, and non-recurring expenses your family may have. Your current annual expenses, exclude your own, can be a good indicator. If you have young children, chances are, their expenses will increase with age. Work out their expenses till they become financially independent that period should determine the tenure of your cover. |
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Current liabilities. This is the principal amount outstanding in your various loans (for example, house, car, personal loans or credit card outstanding). |
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Future expenses. The major expenses expected in the future like higher education of children and their wedding expenses. Consider the time horizon and the impact of inflation on these expenses. |
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Step 2: determine your assets
Salary. If your spouse is earning, some of the day-to-day expenses can be supported from that salary.
Current assets. Value of investments like mutual funds, shares, real estate, bonds, and post office savings. Don’t include the house you live in, as your family will still need to live in it.
Other payouts. Your pension and insurance plans. This includes pension or superannuation plans offered by your employer, employee provident fund and life cover from your existing insurance plans. Many employers provide life cover to their employees through a group insurance plan. Typically, the cover is a multiplier of the base salary. Check whether you are covered by such a plan, and add it to the existing cover. |
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Step 3: Calculate your life cover
Through the example of the Sharma family, the worksheet (See table: Do you have sufficient cover?) takes you through the steps to calculate the right insurance cover for you. First, we determine the capital required to earn a return that can support the annual expenses of the Sharmas. Their annual expense is Rs 3 lakh and Mrs Sharma earns Rs 1.2 lakh a year.
That leaves a shortfall of Rs 1.8 lakh. Now, because of inflation, this amount will increase every year. Assuming the cost of living increases by 4 per cent a year and their corpus earns 10 per cent a year (post-tax), the effective rate of return is 6 per cent. In order to earn Rs 1.8 lakh at that rate, the Sharmas will need a capital of Rs 30 lakh. |
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To this, we add their current liabilities and future expenses. That’s what the Sharmas need to cover for. Next, we work out how much of this they can meet by what they have, namely their current assets and existing life cover. The balance is the additional life cover they need to get. |
If you under-insure, you may leave your dependents with little; if you over-insure, you pay for something you don’t need |
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Once you have calculated the life cover, get a life insurance product that suits your need. Term plans are the cheapest and most effective. However, they don’t provide any returns, which is not a bad thing. It is advisable not to mix insurance and investment, as such products are not the most efficient. The one exception to this rule is a children’s plan in which the insurer pays the sum assured in case of the insured parents’ death, as well as continues to pay the future premium to ensure the fund accumulation for children’s education continues as planned by the parent. Lastly, assess your insurance need every three years or when there is a change in your family situation for example, marriage, birth of a child, spouse discontinuing career. |
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