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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