How to calculate your life insurance coverage

All of us know that life cover is the first step to financial planning, but the right quantum of life cover is something that seems to elude most. The calculation of Human Life Value (HLV) helps avail the right amount of cover. The right assessment of life risk and sufficient life cover is something we owe to our near and dear ones who depend on us for financial support.

Importance and evaluation

Today buying life insurance has been reduced to almost an afterthought because most of us are uncomfortable with facing our own mortality. Life insurance should be purchased so that loved ones are not left with your unpaid bills and are able to take care of their living expenses. The starting point of your evaluation therefore should be -- how much will your loved ones need in case of such an eventuality?

The most common way to evaluate HLV is to multiply the annual income by 7 or 10 and appropriately take the required cover. For example, if someone aged 37 years, has an annual income of Rs 10 lakh (Rs 10 lakh = Rs one million), then one could avail a cover to the extent of Rs 60 lakh to Rs 85 lakh. The premium would amount to Rs 15,000 to Rs 21,000.

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Another common method of enumerating HLV involves estimation of corpus required to meet your household requirement, in case of eventuality, as of today. This corpus should be evaluated after inclusion of inflation and other expenses that one can anticipate in the long term.

Post this, add the corpus required for your key financial goals -- children's education, marriage etc., and add the outstanding loan liabilities. From the net amount reduce your existing cover and your current net worth. The balance amount is the cover required.

Here is a simple example: Rahul Karnik, aged 30, and who has a household expense totaling to Rs 70,000 per month (excluding EMI / investment commitments). He has a child aged 2 years, for whom he has adjudged a requirement of Rs 8 lakh as of date for his education and Rs 3 lakh for marriage.

The outstanding loan liability is at Rs 15 lakh (home loan) and his current value of investments includes Rs 10 lakh. He also has his own home where he stays and hence cannot be sold to generate liquidity. Further, his current insurance cover is at Rs 12 lakh. The life cover requirement is calculated as below:

The above example assumes an inflation of 6 per cent, life expectancy of 100 years and returns of 7.5 per cent.

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Now that one has evaluated the amount of life cover, it is time to deduce on how to go about acquiring adequate life cover

Plain vanilla term plans

An oft-repeated phrase -- term plans are the cheapest form of life insurance -- is simply true because term plans insure human life and do not provide any return. The plan is also called as 'Pure risk cover'.

There are plenty of term plans available in the market with most features being common across policies. The easiest way to evaluate a term plan is to go for the cheapest one. Here are few other important considerations while evaluating term plans:

Longer term: Investors should opt for a term plan at the earliest (younger age) and simultaneously select a longer term. Normally term plans cover risk till the age of 60 to 65 years and you may be required to look at a whole life endowment plan (non-pure risk plan) if you would like cover beyond this age. The premiums are even throughout the policy's tenure, hence, the earlier you start lower will be the premium.

Lower premium: It is important to compare the term plan offerings from various insurers before deducing the one that you want to avail. One can avoid add-on features like return of premium etc. However, you may opt for certain riders which are offered along with the base life cover. Some of the commonly offered riders are: accident disability /death rider, critical illness rider.

You can take the help of a qualified and competent financial planner who can help in evaluation of HLV and choosing the right plan. You can also choose to evaluate other modes of availing life cover such as Unit linked insurance plans or traditional insurance plans that are aligned with your long term financial goals.

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Conclusion

HLV is absolutely vital and it should be the starting point of your holistic financial planning. The premiums paid towards any life insurance policy offers the benefit of deduction u/s 80C.

HLV should not be seen as a one-time exercise. Standard of living and lifestyle are moving targets and hence HLV also will change proportionately. It is thus vital to review HLV on a regular basis and add to life cover, if need be.

Evaluate various term plans across various insurance companies; choose the cheapest premium and the longest term. Term plans work best if you are starting early on hedging your life cover, you can look at other options of availing life cover as your age advances and certain key financial goals crop up.