Life insurance is the most important and least cared for by an individual.
A spike in mis-selling, poor returns, and heavy commission to agents in the first year have not only made the movement of the financial instrument difficult but also neglected in an individual portfolio. Another reason for its poor demand is the need to arise only post some unfortunate events like death, disability, or disease.
These events either put you out of the scope of insurance or make you bolder to consider such an event would not occur resulting in poor demand.
Death is certain and everybody has to accept this at some point in time. It’s only at that time you start looking for what all insurance is there. Insurance is something, whose need is known only when you hear some unfortunate news. It’s the best financial tool to save the family post unfortunate event.
When purchasing life insurance, the question really isn’t how much you need, but how much capital your family would need when you cease to exist, which primarily depends on two variables.
Two Variables of Life Insurance
A) How much money would be needed at death to meet immediate obligations?
This amount takes account of all final expenses: uncovered medical bills, funeral, and estate-settling costs, outstanding debts, mortgage balance likewise other planned unplanned expenditures.
B) How much income is required to maintain the lifestyle?
This is the money that is required to maintain the present living standard. Also, any future plans which the family has planned like child education / Marriage etc.
How Much Life Insurance is required
The question arises on how much life insurance is actually good to meet the mentioned expenses during the unfortunate event. It’s possible that you have a couple of insurance plans with you, but the question is are you sufficiently insured.
Having insurance and having proper risk cover are two different things.
The hard fact is majority of Indians are still either uninsured or underinsured. As per the data, 75% of Indians are not covered by any insurance and only 8% are covered properly. 75% of 138 crores is a scary number.
Underinsurance results in financial instability in the family, over insurance, which will result in higher premium outgo which would affect other lifestyle expenditures. So, the calculation of the correct number is of paramount importance to do justice to both the present and future.
Methods to Calculate Right Cover
There are two methods to calculate life insurance need used widely: –
1) Thumb Rule (Advocated by insurance agents)
The thumb rule simply says an individual should have insurance of 10 times of yearly income. It’s simple to calculate and give a basic idea of the required insurance need. It does have its drawback as it doesn’t look for the goals, assets, and liabilities of an individual.
2) Need-based / Goal-based method (Correct & Scientific method).
Need-based insurance is calculated on the basis of family’s expense and standard of living.
Though the thumb rule method is fast and easy to calculate it has its own share of drawbacks. It’s prudent to use a need-based calculator while assessing human life value as the same is going to affect your family posts your departure.
The calculation should be perfect and no goals should be compromised for the want of money.
Wrong Life Insured
You would need insurance when somebody would be financially dependent on you. Accordingly, there is no need for insurance for single/ unmarried having no dependent. Many individuals are lured to buy life insurance policies for their wife, even when she is a pure homemaker on the pretext of saving tax or returns. They are also induced to buy insurance for children. They would emotionally blackmail for their children’s education/marriage without understanding the cost involved in such plans. This is the wrong wealth management practice and would not add any benefit.
Mr. Rohit Khanna, 33 yrs. (Not real) employed in a software company having annual compensation of 12 lacs. He is married to Rita, 30 yrs and is blessed with son Shashank (5yrs) and daughter Suhani (1 yrs). He lives in Gurgaon (Delhi NCR). They live in a flat they bought last year for 50 lacs. To facilitate purchase they took a loan from ICICI Bank of 40 Lacs and paying 35000 as EMI.
The outstanding loan balance currently is Rs. 35 lacs. Other Investments of Rohit are EPF (6Lacs), Mutual Fund (10 Lacs), FD (2 Lacs), and Savings bank account (1 Lacs). The total investment in various assets is Rs. 19Lacs.
His fix monthly expenses include conveyance (10,000 Rs), Children Education (22000 Rs), Life Style Expenses (Entertainment, Travelling -Rs. 18,000), LIC Premium (endowment plans of sum assured of Rs. 10lakh each) 30, 000 yearly.
He is also having some future commitments Higher education of both the Kids (30 Lacs), Marriage (50 Lacs). He is also having health insurance cover provided by the employer ( Floater, 5 Lacs).
Now we need to calculate his life insurance requirement
So, he opened excel, selected formulas then insert function and clicked at PV i.e. present value. The present value function will give you a present value of all the future outflow for his household expenses if anything happens to him today.
Let us calculate and understand the same in detail.
1) Rate –Inflation-adjusted return ( 9% assumption)
2) Nper – Number of years till life expectancy of the spouse i.e. assumed at 80 years.
3) PMT – Present yearly expenses of the family.
Present Value – Calculation based on variables mentioned in point1-3, Rs. 56,92, 400.This is the amount that the family needs in case of any unfortunate event to the earning member. We need to adjust accumulated assets as well as planned liabilities. The same has been calculated in below :
|Life Insurance Need Calculator of Rohit.|
|PV of House hold expenses today||5,745,600|
|Add: 1) Home Loan Liability||3,500,000|
|2) Education Goal||6,000,000|
|3) Marriage Goal||10,000,000|
|Less: 1) Investment Assets||1,900,000|
|2) Life Insurance Cover||1,000,000||2,900,000|
|Actual Life Insurance required||Rs. 22,345,600|
On the contrary, a simple thumb rule approach (10 times of income) would suggest 1.20cr only. Resulting in underinsurance.
In the right terms, Rohit requires an insurance cover of a minimum of 2.23 Crores. This should be assessed yearly and be increased based on lifestyle and added liabilities.
So, what’s your need ?? do you have enough?? Calculate …. Think…. make the right choice.
Must Read: 11 Commandments of Term Insurance