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As the year 2021 comes with new hopes and aspirations, we must not forget the learnings from 2020. It definitely taught us to build our safety net and made us realize that we must be prepared for anything uncertain - in both sicknesses and in health. 2020 has driven home the point that taking life insurance is one of the most important financial decisions that one can make. When it comes to life insurance, term covers are the most efficient as they give maximum cover at the lowest cost possible. Term covers are the simplest form of life insurance that pays out the sum assured if the insured dies during the term of the policy. There is no payment in case the insured person survives the term.

However, just buying life insurance is not enough. The key is to get the adequate sum assured to take care of your family’s needs. 

Your life insurance must replace you financially.

But how much is enough? “Insurance protects you against the unforeseen demise of the bread-earner so that the future lifestyle or goals of the family do not get disrupted. The cover is just not dependent on the present income, it is dependent on the future value of the goals that you have decided for your family.

Underwriter’s rule

The minimum cover should be at least 15-20 times your annual income. This amount will ensure you have enough cover based on your income.

For instance, where your annual income is 10 lakhs, 15 times that is 1.5 crores. The reasoning behind this 15 times is that when your beneficiary family members receive this amount, they would invest it in debt investments generating a return of 8% i.e. 12 lakhs per annum or 1 lakh per month. These 12 lakh returns from your investments would replace your annual income of 10 lakhs financially.  

The only drawback is that this method does not consider your changing/increasing income and other needs and you would have to get more cover every few years with this method.

Income replacement

Under this method, it is assumed that life insurance should replace the lost earnings of the breadwinner. One of the simplest ways to calculate your income replacement value is insurance cover = current annual income x years left to retirement.

For example, if you are 35 years old, your yearly salary is ₹7 lakh and you plan to retire at the age of 60 years, the cover you will need is ₹1.75 crores ( ₹7 lakh x 35).

One of the drawbacks of this method is that it can suggest a very high cover by considering future income.

Expense replacement

Under this method, which is recommended by financial planners, individuals need to calculate their day-to-day household expenses, loans, and goals such as children’s education, as well as providing financially dependant parents for their entire lives. The figure you reach is the total money that your family will need.

The next step is to deduct the present value of your investments and the life cover you already have. While calculating the value of your investments, excluding assets such as the house you live in, and car, as your family members are likely to continue using them. The figure you get by deducting investments and insurance cover from expenses and goals will give you an idea of how much cover you need.

This method gives you a more accurate number on how you can compute your insurance cover by considering your lifestyle needs and the assets you already have.

Human life value

This method considers the economic value or human life value (HLV) of a person to the family. The concept primarily considers the value of future income, expenses, liabilities, and investments.

Under the HLV method, you need to consider your income, expenses, expected future responsibilities, and goals to determine the insurance need. This method is suggested as this gives better clarity keeping in mind the inflation as well.  Where your goal is to sustain the present lifestyle of your family in the future, then determine how much it costs in today’s rupee value. This will help decide the amount of coverage that you should take.

This method is recommended by most insurance companies, and many insurers have an HLV calculator on their websites. You can use the calculator to know your cover.

Your life insurance needs and cover would change over time as your income changes, goals are revised and other financial needs arise. In such a case, you can either increase the sum assured of your current policy (where you have that option) or go for a different policy. Yes, this would come with an added cost to you as the premium would increase. Being adequately covered is the key to life insurance, otherwise, there is not much difference between having one and not having one.

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Did you check our course NAmaste Money, in the course's Module 4 - session 4 - Life Insurance session, we discuss everything about term plans, share a tool to compute your insurance needs and also, discuss endowment plans and how you can invest using insurance.

Check out the course now - register here and get 20% off using code SAVE20

Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision.