We believe that insurance is a function of your financial liability. If you have adequate assets to take care of your liabilities, then you don’t need to spend on life insurance. Now, the question here is how do you determine your financial liabilities? Well, you need to take a stock of what kind of financial goals & financial responsibilities your family will have, in your absence. The areas like children education & marriage, 1st or 2nd Home etc. are easy to estimate. The difficult part may be in arriving at a value for income replacement. This is simply a sum total of all money that your spouse will need for monthly household expenses between today and end of his or her life, adjusted for inflation and expected return, net of tax. We normally recommend a life expectancy of 85 years. You can use present value formulas in excel for such calculations or ask your Financial Planner.
Now, you know how much money your family will need if you are not around today. So let’s look at how much money your family will get if anything happens to your family today. So total up the sum assured in your insurance policies and also see if your Employer has any life cover for you.
Suraj and his Wife Chanda have an 8 year Son, Joy. So here is how Suraj calculated his Life insurance corpus need:
Education Corpus for Joy: Rs. 13 Lakhs
Marriage Corpus for Joy: Rs. 5 Lakhs
Income Replacement: Rs. 82 Lakhs
Total Needed [A] = Rs. 100 Lakhs
Sum Assured total of all Insurance Policies: Rs. 25 Lakhs
Value of Financial Assets: Rs. 42 Lakhs
Current Liabilities: Rs. 7 Lakhs
Net Financial Assets: Rs. 35 Lakhs
Total Available [B] = Rs. 60 Lakhs
Insurance Corpus Gap [A-B] = Rs. 40 Lakhs
Suraj can buy an online term plan for Rs. 40 Lakhs to bridge the current gap in his Insurance Corpus. Kindly note that this is a simplified illustration and you may have other factors to be considered. There are alternate methods to calculate your life insurance need. As an example, say 10 times your current annual income or corpus taking your future income in account.
Key factors to keep in mind:
- Don’t forget to include the investments that you may have made (e.g. ULIP Policy)
- Consider your spouse’s profile as the money will have to be managed by her / him as you will not be around
- Involve your spouse as you work on your insurance corpus
- Balance between the need to cover the financial risk V/s. the cost of insurance
- If your insurance corpus works out very high, then revisit the outflow in each of the goal and see if you can optimize. See if your spouse can partly work & see if a higher ROI can be assumed in the insurance corpus.
- It may help to take a psychometric test to know risk tolerance for your spouse and yourself
- Take a tenor that goes up to around your retirement age. As your financial liabilities will be fulfilled and financial assets will grow, the need of insurance will go down drastically.
- This article has been originally written for Dainik Bhaskar and published on 22-Nov-2013. A copy of the published article is available here.
- There can be differences in both the versions due to translation