Do You Know How Much Life Insurance You Need?

By | March 22, 2017

Do You Know How Much Life Insurance You Need?

What sum assured do you feel is enough when buying a Life Insurance policy? Do you choose the sum assured based on your requirements or the premium amount of the policy?

When we buy Life Insurance, especially a Term Insurance plan, we often settle on low coverage despite cheap premiums. Often, it is due to our lack of knowledge about an optimal sum assured that we settle on an amount lower than our needs. So how do we determine what’s an optimal Life Insurance coverage amount?

Additional Reading: The Definitive Guide To Buying Term Life Insurance

Here are a few common and popular techniques to figure out your Life Insurance requirements:

Income Multiplier Technique

If you fear mathematics and long calculations, this is the most rudimentary of all techniques. It states that you should have a coverage that is 10 to 12 times your annual income. So if your annual income is Rs. 10 lakh today, your coverage should be Rs.1 crore to Rs. 1.2 crore. If you’re a 30-year-old salaried male with no tobacco habit, earning Rs. 10 lakh annually, you can avail a cover of Rs. 1 crore for 20 years for monthly premiums starting from Rs. 552.

 Underwriters’ Thumb Rule Technique

This is a similar technique to the above where a multiple of your annual income is considered as the optimal cover. The difference here is that the income multiplier depends on the age of the individual. At lower ages, the multiplier is high, spelling the need for higher coverage, whereas at higher ages, the factor reduces as the requirement of coverage also reduces. Here are the different multiplier factors based on age.

Age bracket Multiplicative factor
20-30 years 15
31-40 years 14
41-45 years 12
46-50 years 10
51-56 years 8
56 years and above 6

Income Replacement Method

This method aims to replace your expected income with the policy proceeds in case of premature death. The method takes into account your present age, your expected working tenure and the annual income. It excludes inflation, any increase in income, and voluntary retirement sought before the expected retirement age. Here’s how it works:

Current age 35 years
Expected retirement age 65 years
Active working tenure left 30 years
Current annual income Rs.5 lakh
Expected income over the remaining active working life Rs.5 lakh x 30 = Rs.1.5 crore

Your family expects you to contribute an aggregate of Rs.1.5 crore in the years that you would be employed. In case of your premature death, your family would lose out on this income. Thus, you should buy a cover of Rs.1.5 crore ideally, which would replace your expected income.

Human Life Value Method

A popular method, the Human Life Value (HLV) method, also follows the above principle albeit with a difference. Instead of replacing the expected income, it aims to create a corpus which, when invested, would yield the current level of income every year for the family. Suppose your annual income is Rs. 5 lakh. You should create a corpus which, when invested in a no-risk investment instrument, yields a return of Rs. 5 lakh annually to enable your family to replicate your contribution to your family. Assuming the rate of return to be 8%, the corpus should be (5 lakh/0.08) = Rs. 62.5 lakh. You should add to this your existing liabilities and deduct any existing assets to arrive at the ideal sum assured.

Need Analysis Technique

This technique is a more theoretical one rather a numerical one. It considers the life stage you are in, your financial goals, your annual expenses and savings, your existing liabilities and assets, etc. After these aspects are considered, the ideal sum assured is calculated.

What Should You Do?

You can bring the wisdom of all these techniques together and compute the sum assured best suited to your family’s needs. Don’t forget to factor in the inflation rate, your liabilities, goals and also any contingencies (like health emergencies). Only after a detailed analysis should you buy a Life Insurance plan.

Many online insurance aggregators provide Life Insurance calculators where, when you input the required information, you can compute your ideal sum assured. You can use such calculators or do the calculations yourself too.

A Life Insurance policy gives you and your family financial security and this security is possible only if you choose the correct sum assured. So, whatever you do, ensure that your sum assured is ample before you buy a policy.

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About Adhil Shetty

Adhil Shetty is the Founder and serves as the Chief Executive Officer of Adhil has a Master’s degree in International Relations with a specialization in International Finance and Business from Columbia University in the City of New York, and a Bachelor’s degree in Engineering from the College of Engineering Guindy, Anna University. Adhil is an expert in Personal Finance (Car loan/Home loan and personal loan) and he majorly consults on investment and spends rationalization for the Indian loan borrowers. His guidance is number based with real time interest rate calculations and hence useful for consumer’s real time query.

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