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How much cover do I need?
Karthikeyan Jawahar Sunday, 10 August , 2008, 10:46

Do you need Life Insurance? In the Financial Planning that I do for my clients, this is usually my first question. The right question that we need to ask ourselves is — Do I need to protect my family even if I am not around? The answer is ‘Yes’. Education loans may come with life cover The next question that I ask my clients is: How much of life insurance do you need on yourself to protect your family’s lifestyle, if you are not there? Educational loans now come with insurance cover The answer that usually comes back to me is — “I have lots of insurance policies – I am sure I have enough”. Yes, most of us have a number of life insurance plans. But do we have enough life cover to protect our families? How do we find whether we have enough life cover in our insurance plans? More India business stories Methods to find insurance requirement There are a number of methods to calculate the need for insurance. All these are based on finding an economic value (called Human Life Value) of the bread-winner of the family. Then insurance should be equal to Human Life Value. The first method is the Income Replacement Method. Technically, this method defines human life value as the present value of all future incomes. The logic is that the family of the deceased should have the benefit of getting all the salaries/incomes that the deceased would have brought home otherwise. The other method is the Need-Based Approach. Here the present value of different milestones/goals/dreams in life, that the bread winner has planned for the family are added. To this the present liabilities are also added to calculate the insurance requirement. In other words, the present value of all milestones planned and liabilities held is calculated. Let us illustrate these concepts with some examples: Income Replacement Method Amar, 30, plans to retire by 58. His current salary is Rs 10,000 per month. He expects his salary to increase by 15 per cent annually. Inflation decreases his earnings by 6 per cent on an average.

From the above, we can do our calculation as in Table 1. The insurance need for Amar based on the above calculation is nearly Rs 97 lakh, even though he earns only Rs 10,000 per month today. Calculation Insurance requirement based on Needs Approach Akbar, 30, lives in a rented house with wife and son. He plans to buy a car worth Rs 3 lakh after two years. His dream house is to

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be ready at an expense of Rs 20 lakh after seven years. He plans to educate his son, who is 10 years old, with an engineering degree, which today costs a total of Rs 4 lakh for the four years. He plans to gift his wife a diamond necklace worth Rs 5 lakh on their Silver Jubilee Marriage Anniversary in 15 years’ time. He plans to retire at 58 with Rs 1 crore in his bank account. The average expected inflation is 6 per cent and average investment returns is 12 per cent. His dream car would be worth Rs 3.37 lakh after two years, factoring inflation. Similarly, the house will cost Rs 30 lakh, the college education would cost Rs 16 lakh, the diamond necklace would cost Rs 12 lakh and the retirement fund would need to be Rs 5 crore, after we factor in inflation. Next, we can calculate the present value of each of his goals and sum them up. To protect his dreams and goals of his family, Akbar should have about Rs 46.5 lakh as his life insurance. Simplified income replacement method The above illustrations are highly mathematical and will require a good calculator or a spread sheet on computer to calculate. Is there a simplified way to find my life insurance need? Yes, help is on the way. A simplified and uncomplicated way is to use what I call the Simplified Income Replacement Method. This gives the bare minimum of the life insurance that anyone should have. The limitation is that this method does not consider the effects of inflation. Here is our example: Anthony, 30, earns a salary of Rs 10, 000. He earns Rs 1,000 every month from tuitions. His personal expenses Rs 2,000 per month. He is currently saving Rs 500 in a mutual fund. The balance of the money he gives to his wife for running the household. Thus, for a person earning a salary of Rs 10,000, and without any lavish expenses, a minimum life insurance of Rs 12 lakh is required. Are we sufficiently insured? Based on the calculations above, please calculate the life insurance you would need. Are you sufficiently insured? Most of us do not have enough life insurance. What prevents us from having enough life insurance? The Cost of Insurance This is the answer I get from practically all of my clients. “How can I afford to pay premiums if I were to have Rs 12 lakh as insurance at a salary of Rs 10,000 per month?

“One of my insurance agents says it will cost me Rs 25,000 per year for Rs 5 lakh insurance. The other one says that if I pay Rs 10,000 per year I can, at the maximum, get Rs 4 lakh as insurance. How can I insure myself for Rs 12 lakh,” — This is what one of my clients asked. The problem here is with the choice of insurance plans. In the above two types, one is an endowment plan and the other is a ULIP. The issue with the above plans is that they combine savings and investment respectively, with insurance. Hence they are bound to be costly. The most elementary and basic of all insurance plans is the Term Insurance Plan, which is least costly. This is also the reason most insurance agents do not sell these plans — their income is also going to be lesser. Life Insurance is not costly! For Anthony the cost of a term plan will be only Rs 3,600 per year for Rs 12, 00,000. Now is that affordable? Yes it is. In fact the cost of the term insurance, is many fold lesser than most of the comparative vehicle insurance. For example the insurance for a car worth Rs 12 lakh will be Rs 36,000. More India business stories

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In fact, since insurance is basically to preserve the life style of our family and not for ourselves, then we can infer that we don’t need any insurance other than term Insurance. All the other plans are optional, for specific purposes, which can be taken up only if we have a surplus. (The author is Director – Research & Consulting, Finerva Financial Solutions Pvt Ltd.)