Life is full of uncertainties. The onus of protecting ourselves and our families lies with each one of us. Hence it’s no surprise that more and more people are opting for insurance covers to seek protection from the vagaries of life.
Insurance provides a financial cushion that makes it easier to tackle these uncertainties. However, we often wonder how much insurance is enough for our protection. Truth be told, there’s no method or rule to arrive at the best possible cover for one’s needs. One has to pick a cover and periodically assess it in order to increase or decrease it. But here are some thumb rules to help you close in on the best possible cover for you.
1) The 10x-15x rule
A thumb rule many insurance seekers apply is to opt for a cover that is 10 to 15 times their current annual income. So if you are earning Rs 10 lakh annually, your sum assured should be in the range of Rs 1 crore to Rs 1.5 crore.
This is an easy-to-apply rule. But consider its potential downsides as well. Financial experts suggest this method may not ascertain if the best possible cover to meet the future financial goals of your family. This is particularly true if the calculation is based on your earnings near the start of your career when your annual income has a long way to grow.
Each individual’s needs and goals are unique, and therefore the potential costs of achieving those goals must be ascertained before fixing an insurance cover. As such, the typical term insurance plan may provide 20 times the value of you annual income.
2) Financial need analysis approach
The basic objective of the financial need analysis method is to ensure the insurance cover is sufficient to take care of dependents as well as all financial liabilities of the individual’s family. Liabilities may include home loan, car loan, and funds required for children's education and marriage.
For example, assume an individual earns Rs 50,000 per month and his family’s needs come to Rs 25,000. Assuming the individual has a home loan of Rs 25 lakh and a car loan of Rs 5 lakh, the insurance cover should be an amount that can ensure a payment of Rs 25,000 per month to the family after taking care of the liabilities.
3) Human Life Value methodology
The Human Life Value (HLV) methodology works on the principle that one should buy life insurance equal to his economic value or human life value. The human life value here is calculated as a sum total of earnings you will be making for the rest of your working life.
For example, assuming you are 35 years old, earn Rs 12 lakh per annum, and expect to retire at 55 years of age, you have another 20 productive years ahead of you.
If the expected average annual return on investment is taken at 12 per cent along with an 8 per cent average rate of inflation, your estimated human life value would come close to Rs 167 lakh. Reducing your outstanding loans and liabilities will then give you the net insurance cover you may need.
4) Underwriters thumb rule methodology
In the underwriters thumb rule methodology, your age is seen as an important yardstick to calculate your overall insurance need. Under this methodology, if you are between 20 and 30 years of age, you should have life insurance worth 15 times your annual income.
The multiple is reduced to 14 times if you are in 30-40 age bracket, 12 times for 41-45, 10 times for 46-50, eight times for 51-55, and six times for individuals above 56 years of age.
Whatever be your preferred methodology, consider this: you have the responsibility to provide for your dependents. If you are a young person with dependents, you have long-term responsibilities such as providing for your spouse and ageing parents, putting your kids through school and college, repaying your loans, and somehow still saving enough for retirement. And this is why, it is absolutely important for you to get yourself the best possible life insurance cover that would help your family meet all those above-mentioned requirements in case you were to meet an untimely end.
(The writer is the CEO of BankBazaar.com)
