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Deciding how much Life Insurance cover to take is not a lucky dip, but a practical calculation that ensures your family can handle their life without sliding financially into the future. Apart from enjoying a good premium amount, look at the momentous obligations, loans taken, family expenditure, education expenses of the children and your family’s expenses for five years. Take into account funeral expenses, current investments made, anticipated inflation line, and other financial goals to be achieved in case you are not around. The aim is to enable families to live comfortably and accomplish the family milestones without financial stress. Use a simple calculation formula as a reference, and adapt it for mortgage payments, business debts and family requirements. Do not get lured into taking cover at a high premium based on flashy sales talk, when the actual number doesn’t match up to yours; review from time to time, and take cover from a well-known insurer. The essence is to take Insurance as the means rather than the end. Review your insurance cover whenever there is a change in circumstances or income.
What The Sum Assured Must Cover & Why It Matters:
The sum assured is the lump sum your dependants will receive when the life insured stops (or in some cases, at maturity). It has to be sufficient to:
a. settle immediate liabilities (mortgage, credit card, personal loan, overdraft),
b. maintain the family’s income for a given number of years,
c. meet new financial goals (settling children through university, marriage),
d. cover unforeseen contingencies (medical or relocation costs), and
e. offset current assets (savings, investments, employer insurance) that ease the financial strain.
A sum assured that is inadequate makes you underinsured, the most mundane and widespread mistake. Conversely, excessive sums ensure unnecessary premiums that you won’t need. The best coverage is an ideal balance of both.
Pro-Tip: Don’t make the sum assured your “family charter.” It should be your family insurance bank that grants them time and choices.
A Brief Overview of Popular Methods (So You Recognise Your Options):
There are various straightforward ways people use to arrive at an estimate of the sum assured. I will mention those that are easy to remember, explain them, mention some advantages/disadvantages, and there will be a numerical example at the end so that you can see how the numbers work out.
1. Income multiple rule (a quick ‘rule of thumb’ in the industry): multiple annual income by some multiple (often 1020x).
Advantages: quick.
Disadvantages: takes no account of liabilities, existing assets, future goals or inflation; just an approximate number.
2. Needs-based (DIME/detailed needs analysis) sum of D, L + I +M +E (and adjusts these for inflation), subtract liquid assets.
Advantages: practical, comprehensive and customised.
Disadvantages: requires attention to be paid to detail and realistic assumptions.
3. Human Life Value/PV of future income: estimate the PV of the sum of streams of income (which you don’t want to earn anymore) you need to replace.
Advantages: economically justified, lower estimate possible.
Disadvantages: rate assumptions used, technical.
4. Combination approach: start with a baseline approach (needs or HLV) and check that against a multiple rule and add a margin.
The needs-based approach (which is operational) is my suggestion for the majority of Indian earners, and I would also double-check the HLV result for a sanity test. The income multiple is a useful quick check.
Needs-Based Calculation in Detail (a Useful Template You Can Use):
Follow this checklist and plug in your numbers:
1. List any immediately serious financial drains (D). Home loan outstanding, personal loans, and credit card balances are sums that need paying upon death.
2. Decide income replacement period (N years). For how many years do you want your family to receive income replacement? For example: 10-20 years, up to retirement…
3. Estimate annual family income needed (I). What is needed by your family on an annual basis (conceivably after you die, after adjusting for any spouse/other income)?
4. Income replacement amount = I x N (or use a present value method if you prefer the HLV method).
5. Future goals (G) added to include children’s education fund, marriage, and other one-offs (present value, if you want).
6. Emergency/contingency buffer (B): an additional safety buffer (for example, an emergency buffer of 6-12 months of expenses or a flat buffer).
7. Add all up: Gross Cover required= D+(I x N) +G+B.
8. Subtract current assets & covers: liquid savings, current life covers, employer group cover (if it’s safe to do so), investments you could actually release.
9. Result = Net Sum Assured required.
That’s your target. Add on inflation, then add on some margin of safety if you want a more conservative hedge.
Pro-Tip: Go with realistic Monthly budgets for me, most others inflate the numbers to avoid the math and end up underinsuring. Keep yourself honest: list out actual Monthly bills.
Worked Example (Numbers Displayed Clearly for Replication):
Let’s take an example to walk through for an Indian earner (numbers are rounded for simplicity of understanding). These are example numbers; replace your own.
a. Annual net income 12,00,000 (take home or gross? Maybe the gross if you are including a salary taxed as well):
b. Outstanding loans 30,00,000 + 2,00,000 (personal loan? whatever you have):
c. Future goals for family 20,00,000 (child’s education), 5,00,000 (child’s marriage):
d. Emergency fund 3,00,000 (around 3 months’ worth of living, or whatever you think is required):
e. Existing family savings/investment: 5,00,000
f. Incomes Replacement Period Desired: 20 Years (conservative plan)
Method A: Income Multiple/Check:
1. A quick and easy way of estimating your required cover is using a rule of thumb (15 x your annual income):
2. 15 x ₹12,00,000 = ₹1,80,00,000 (₹1.8 Crore)
Method B: Simple needs (DIME style, pragmatic):
1. Income replacement: 20 x 12, 00,000= 2, 40, 00, 000 (2.4 crore)
2. Add debts and goals and buffer: 2,40,00,000 + 32,00,000 + 20,00,000+5,00,000 + 3,00,000= 3,00,00,000 (3 crore)
3. Less existing assets 5,00,000> Net required 2,95,00,000(2.95 crore).
Method C: Present value (financial HLV sketch):
1. If you assume future income has the present value of a fixed level annuity and use an acceptable discount rate (for example, 6% real/nominal), the net present value of ₹12,00,000 for 20 years is approximately equal to ₹1.38 crore (around ₹1,37,63,905).
2. Add Debt, Goals and Buffer and Remove Savings: PV income replacement (approximately ₹1,376 crore) + ₹32,00,000 + ₹20,00,000 + ₹5,00,000 + ₹3,00,000 – ₹5,00,000 = Estimated Net Requirement of Approximately ₹1.93 crore (around ₹1,92,63,905).
These different calculations give different numbers:
Quick multiple > 1.8 crore
Needs approach > 2.95 crore
PV/HLV approach > 1.93 crore
Which is correct? Each shows a different wisdom: the needs approach being the most conservative (it assumes income continues for 20 years), the HLV approach discounts future income in a logical way (and gives you a lower figure), and the multiple is a handy back-of-the-envelope figure. I would use the needs approach as an initial target figure, and then verify this by calculation against the PV/HLV number: if they are close, you’re happy; if the needs figure is essentially more expensive, go back and reexamine the various assumptions (approximate years of replacement, anticipated future goals, potential assets on hand).
Pro-Tip: If the amount looks unachievable, prioritise core liabilities +5-10 years’ income replacement and then plan to supplement this in the future as savings build up. Term insurance can be amortised.
Interpreting the Findings: Tenure, Type of Policy & Useful Decisions
After selecting a target sum assured, you’ve got to decide the policy form.
Term insurance vs. other products:
1. Term insurance (Pure protection): Cheapest per sum assured. For a large sum assured, they are the best value. So opt for a term to cover the net sum required over the period in which it will be needed (e.g., for example until children are independent and paying their own way or home loan repaid).
2. Endowment/ULIP/moneyback: a savings and cover plan combined. Often expensive (c.f. term + separate investments). More often than not, for pure protection, a separate investment plus a term cover plan works out cheaper.
3. Decreasing term cover is often used in harmony with a mortgage decreasing balance; cheaper than level cover but only appropriate where the need decreases over time (e.g., mortgage only focus).
Selection of a tenure:
a. Until retirement: if there is a need for income to support your family up until the point at which you could have been earning.
b. If that’s the main goal, then education would end after children have been educated and married.
c. Mortgage term: if mortgage protection is the primary objective, then it should be set to match the remaining length of the home loan.
Riders and add-ons:
1. Accidental death benefit (ADB): cheap and provides additional cover if death occurs by accident.
2. Critical illness/disabling illness riders: pay lump sums on diagnosis; of some value but costly, consider a standalone critical illness plan if appropriate.
3. Waiver of premium assists you if you’re disabled and not able to make premium payments; however, check the age restrictions and T&Cs.
Pro-Tip: Purchase base term insurance sufficiently big to satisfy the most pressing core needs, but apply riders sparingly to fill in potential risk gaps (for example, due to a family history of a particular disease).
Avoiding Frequent Risks, or the Mistakes People Make:
1. Overreliance on employer/group cover. While helpful, employer cover is generally limited and goes out of the window when you change jobs; treat it as an add-on.
2. Ignoring inflation. When you take a lump sum, a fixed star in the sands approach causes the amount to fall with inflation. Either start with a fairly cautious assumption of the future value, or take a larger sum and monitor the level over time.
3. Single income assumption. Couple with others, or reassess your needs if you get married, have children, set up a business, or acquire a mortgage.
4. Forgetting tax, probate, and transfer costs. Nominee arrangements and legal frictions delay access to funds, so keep documentation and nominees informed. Use structured payments if appropriate.
5. Using linked investment-insurance policies for lump sum protection. Term insurance is way cheaper as protection, whilst savings/investments are best all by themselves for goal building.
Pro-Tip: Re-calculate on an annual or every other year basis, or after a household change.
Ways to Finance a Substantial Amount: Realistic Approaches to Pay for the Cover
If the sum assured in your needs calculation is large and your budget for premiums is limited, then consider:
1. Buy term insurance with long-term: lower premium rate for each unit of cover.
2. Split policy cover: buy a big term policy and a smaller, cheaper bare bones policy; top up later.
3. Stagger purchases: buy core cover now & increase (via top-up policies) as income increases.
4. Mix level and decreasing policies aimed to focus on mortgage + wide family needs.
5. Make use of Riders in an economical, astute manner instead of purchasing loads of secondary policies with other coverage.
Pro-Tip: Never cut core cover too much, as you will get a premium rise you can’t afford; cut down on tenure or riders.
FAQs:
1. Can we trust the rule of thumb that if you get offered “10-15x annual income,” then it is seriously beneficial?
It’s a quick sanity test and OK for a very rough starting point: take your annual income, times by 1020 depending on dependants and liabilities. It’s a blunt instrument, though it makes no allowance for debts or future goals. Use it to get a quick idea of scale, then use the needs-based calculation for a more responsible target.
2. When calculating sum assured, should I add my employer/group life cover?
Yes, count employer/group cover as additional, not main. While it does help reduce the shortfall to an extent, it shouldn’t be relied upon as a substitute for personal term cover, as it usually ceases upon leaving your job or retiring.
3. How many times should I increase my sum assured?
Do the needs analysis again when something big happens, marriage, children, mortgage, new job, at least every 23 years. Push it up when your salary and dependents grow. Smaller, more regular top-ups are less painful financially than one large one.