Most of us have seen banners, hoardings, advertisements in newspapers, television and the internet saying, ‘Secure your family’s future with Rs 1 crore life cover at just Rs x per month’.
Well, it does sound like a great opportunity to get life cover at nominal prices. But is Rs 1 crore life cover sufficient?
Coming across such term insurance ads promoting the magical number of Rs 1 crore, we may think that it is wonderful. A large financial cover that takes care of the family at such a nominal amount, the premium amount turns out to be what we normally spend on tea/coffee every month, does seem exciting.
However, before you buy that Rs 1 crore life cover, stop and consider this: Is a cover of Rs 1 crore really enough for me?
On paper, this figure does sound huge, but in reality, will this amount be good enough to help your family live comfortably for a long time? Let us find out whether this popular number is decent enough to cater to your family’s needs in your absence.
How to find the right amount of life cover?
A large number of people are mentally comfortable with Rs 1 crore life cover in term insurance. But the outcome of buying a life cover without calculating the financial damage an early death can cause to the lives of the dependents can be catastrophic. It will hinder life goals like your child’s education, child’s marriage and a comfortable retirement for your spouse. All of these will then go for a toss in your absence.
Also, your lifestyle is definitely going to change in the coming years with an increase in your salary. There could also be an addition of new family members which could result in an increase in your liabilities. Hence, the easiest way of arriving at the required life cover amount is through this simple formula:
Multiplication of annual income
This is one of the easy ways of arriving at a sufficient amount of life coverage amount. It works on a simple basic multiplication which requires just two factors – your annual income and the multiple factor.
A multiplying factor is required because it would be more than just one, two or three years’ salaries that would not come to the family if the breadwinner dies. The entire future income will get impacted.
The multiplying factor takes care of future income flows as well, based on the current income of the insured, because it takes into account what the breadwinner (insured) would have earned in future as well.
As a thumb rule, one should choose the multiple factor of 20 on the higher side and 15 on the lower side. The answer to this simple multiplication will provide you with an appropriate life cover amount.
So, if a person has an annual income of Rs 8 lakh, the ideal life cover amount for him will be 8,00,000 x 20 = 1,60,00,000 i.e. Rs 1.60 crore.
Another way by which we can determine the required life cover amount is:
Human Life Value (HLV) calculator
A Human Life Value (HLV) calculator helps to compute the total income a person would earn during his active working life. One can also take into account the expected inflation rate and outstanding debt.
At the same time, it subtracts the existing life insurance cover, current savings, and other investments to show the final value of that human life.
Accordingly, a person’s financial value and his life cover should be equal to this value. Today, all insurance companies and brokers have developed their own online variants of the HLV calculator helps in easily calculating the correct life insurance coverage amount.
You can calculate it manually using the following formula: Life Cover = [Family’s Living Expenses + Life Goal Expenses + Outstanding Debts] – [Current Total Life Insurance Cover + Money in Hand]
To determine your family’s living expenses, you will have to take into account your annual living expenses and multiply it with a defined number of years. The idea being, the considered amount will last until a period of time when another member of the family is ready to take up the role of being the bread earner.
Here, the defined number of years can be arrived at by taking your current age and deducting this figure from your determined retirement age. Suppose, your age is 30 years and the current annual living expense is Rs 3 lakh and you plan on retiring at the age of 60, the defined number of years would be 60 less 30 i.e. 30 years. This brings your family’s living expenses to Rs 90 lakh (Rs 3 lakh per year x 30 years).
Next, add other major planned future expenses like child’s education, outstanding loans like home loans, personal loans or car/bike loans to it. These could be Rs 50 lakh for the child’s future education and a home loan of Rs 50 lakh, bringing the total to Rs 1.90 crore (Rs 90 lakh + Rs 50 lakh + Rs 50 lakh)
Next, subtract the life insurance cover that you currently have, along with the financial funds you hold. Say, you have Rs 15 lakh of life insurance cover and Rs 15 lakh combined in various savings, fixed deposits, mutual funds, totalling Rs 30 lakh.
The resulting answer will show the required life cover amount = Rs 1.60 crore (Rs 90 lakh + Rs 50 lakh + Rs 50 lakh) – (Rs 15 lakh + Rs 15 Lakh).
Simple and easy, isn’t it?
Note that we talking about the said life cover in the above calculation. This is to suggest that if your current life cover is insufficient then the new result is the additional life cover you would need to buy.
One must also remember that a plain vanilla term plan will not be able to provide full protection until riders are attached to it. Riders like double accident cover or critical illness riders can help customise the ordinary term plan into a comprehensive solution for you.
Of course, academically standalone products in an accident and critical illness field/covers are specialised and more comprehensive. However, the reality is that not many people are able to actually plan, research and buy such specialised products.
Riders may not be as comprehensive as standalone products, but the buying process is simple and instant, which makes sense to a lot of people who may be too busy to research and buy the specialised product.
Remember, in life insurance, there is no ‘one size fits all’ formula. People differ from each other, so do their needs and the needs of their dependents. The best way of achieving complete peace of mind with regards to your family is having an adequate life insurance coverage for yourself and not jumping blindly on to the Rs 1 crore life cover bandwagon.
Hence, it is also very important to review your cover at five-year intervals to ensure that you have made adequate arrangements for your loved ones in your absence.