How much life insurance do you need?

Adverse impact on physical health of many owing to COVID has proved the point that life is filled with uncertainties and thus opting for a life cover in the form of insurance is one of the most crucial financial decisions to make. Last year, following the outbreak of pandemic, demands for life insurance schemes spiked. However, as there are many types of life insurance schemes in the market like ULIPs (Unit Linked Plans), traditional endowment plans, whole life traditional endowment insurance plan etc, you should evaluate each and every scheme to choose the one as per your preference and suitability.

Note that, when it is about opting for a life cover scheme, availing term insurance plan is one of the most efficient because it endows maximum cover at the lowest cost. Term insurance plan is the simplest type of life insurance designed to pay out the promised assured amount to the insured’s dependents in case of insured’s death during the term of the insurance policy. If the insured survives the policy term, there is no payment of the assured amount.

However, purchasing any term insurance policy is not enough. Major key is to opt for an adequate sum assured, which can help mitigate all your family requirements. But the question arises how much sum assured is sufficient? Insurance is a protection against unforeseen death of the breadwinner so that the financial goals and lifestyle of the family dependents do not get hampered. The life insurance cover is not dependent on current income, it is based on the future value of expenditures and financial goals that your family dependents would require meeting. Here we will look at 4 important methods that can assist you to calculate the life cover you would require – human life value, expense replacement method, income replacement value and underwriter’s thumb rule.

Human life value (HLV)

As per this method, the life cover that one should purchase is directly proportional to economic value, also called HLV. It is the capitalized value of an earner for the rest of his life, which is determined based on the current inflation. HLV gets calculated based on 3 factors namely – age, present and future expenditures, and present and future earnings.

Note that one can easily calculate their life cover requirement by using the HLV life insurance calculator available online in most insurers’ websites.

Expense replacement

As per this concept, earners require calculating their daily household expenditures, debts and financial goal corpus requirement for wards’ higher education/marriage, to provide financial assistance to dependent parents etc. The figure you get is the total fund your family would require.

Next you need to deduct the life cover and present investment value you already hold. When calculating your investment value, omit assets like house you reside in, car etc as your family dependents would continue to use them in your absence. The figure you reach by deducting your insurance cover and investments from your goals and expenses would endow you with an idea of the cover you would require.

Income replacement

This method calculates your life insurance cover basis your annual income. The formula for this method is : insurance cover = present annual income X years remaining for retirement

For instance, if you are 30 years of age and your salary is Rs 12 lakh and you aim to retire at 60 years of age, then your life cover you would require is Rs 3.60 crore (Rs 12 lakh X 30).

Underwriter’s rule

As per this method, the required sum assured must be in multiples of income earned per annum based on the earner’s age. For example, individuals with age ranging anywhere between 20 and 30 years should usually have an insurance cover equaling 25 times of their annual income. However, those with an age of over 40 to 50 years usually should have a life insurance cover equaling 20 times of their annual income.

Bottom line

As life insurance cover requirement with time may change  due to inclusion of new goals, obligations etc, thus it is crucial to periodically review your insurance needs as per your change in expenses. 

Note that the above listed methods only gives you an indicative value. Final insurance portfolio must be decided according to your financial standing.