05/08/2016
How much Insurance Cover You should Buy
Most people believe they have saved enough to take care of their family. But problems arise when an unforeseen event such as an accident or a disease threatens to erode their savings. This is where insurance plays an important role.
The first insurance you must buy is a life cover. This will make sure that your family does not suffer financially in case you die. It is important to ask yourself: What if something happens to me? Will my family be able to pay off the home loan? What about the education of my children? Do I have enough savings to replace future income? Life insurance takes care of these concerns.
Most people understand the need for a life cover. In spite of that, India is grossly under-insured with life insurance pe*******on of just 2.6 per cent (2014). In Hong Kong and the UK, which have a much better social security system, it is as high as 13 per cent and 8 per cent, respectively.
The next important layer of protection is health insurance as hospitalisation can drain your savings. Likewise, you need adequate home insurance, too. Also, when you go abroad on a holiday or for a business trip, travel insurance will come to your rescue if you fall ill (medical costs abroad can be prohibitive), lose your baggage or face any other exigency. While one must buy these covers, it is equally important to ensure that the cover amount is adequate for your needs. Here is a guide to help you calculate how much cover you must have - be it life, health, home or travel insurance.
LIFE INSURANCE
How much is your life worth? It is important to answer this question if you want to decide how much life cover you must buy. Should it be measured by how much you have invested? Should it be a few years of your annual salary? Putting a monetary value to life is not easy. Several factors go into the calculation. The figure not only depends on your current investments but also on your future liabilities.
Getting this right is important so that your dreams for your family do not remain unfulfilled if something happens to you. For instance, your child should not compromise on his/her ambitions just because you are not around. Your spouse should not have to struggle to meet the daily needs of the family because you are not there to support it. The amount of cover should be enough to take care of your loans, your children's education as well as your family's daily expenses. Here are some methods used to calculate how much life cover one should buy.
Human Life Value: It is the most commonly-used method. It is defined as the present value of all your future income, less personal expenses, life insurance premiums and taxes. It does not take into account your liabilities and future goals. Here is an example. Suppose you are 35 years old. You are expected to work for another 25 years. What happens if you die today? Will your family be able to live on your savings for another 25 years? Maybe not. To know how much money your family will need, subtract expenses from income. Assuming that your total income is Rs 15 lakh, and personal expenses, taxes and life insurance premium come to Rs 5 lakh, your family will need Rs 10 lakh a year for the next 25 years. In order to earn Rs 10 lakh interest every year, it will need a corpus of Rs 1.15 crore, assuming an interest rate of 8 per cent. But this is without factoring in inflation. Throw in inflation and they will require almost Rs 2 crore, as the real rate of return falls from 8 per cent to 1.8 per cent if we assume inflation at 6 per cent.comprehensive way to calculate the cover. This is because apart from the annual expenses, it takes into account your loans as well as money required to send children to college, among other things. This is important as our loved ones can go through a harrowing time in repaying our loans if they do not have a source of income. So, after calculating the present value of future household expenses, experts add the value of outstanding loans and the amount required to meet the college/marriage expenses of children while arriving at a figure for how much life cover you require.
Bimal Samal, Director, Sales & Marketing, Ideal Insurance Brokers, says, "One should always do a need analysis before buying a cover. A large part of the process of choosing a life insurance policy involves determining how much money your dependents will need in case of your death."
So, assume that the person in the human life value example has a loan liability too. He also wants to save for future goals. Suppose he or she has a loan of Rs 20 lakh and wants to save another 20 lakh (inflation adjusted) for his child. In that case, one must add another Rs 40 lakh to the Rs 2 crore cover. However, don't forget to subtract from the figure of Rs 2.4 crore your existing investments and life insurance covers to arrive at the cover required.
There is another important point. Under need-based insurance, it is important to revise the cover whenever your situation changes.
For example, you must increase the cover on birth of your child as your expenses will rise after this. "It is advisable to get life insurance irrespective of the age and premium charged as liabilities and responsibilities increase with age," says Abhijit Gulanikar, Chief Officer, Business Strategy, SBI Life Insurance.
Income replacement method: This method is based on your current annual income. Under it, you simply multiply your annual income with the number of years left to retire. Deepak Mittal, MD & CEO, Edelweiss Tokio Life Insurance, says, "The cover should be enough to substitute all net future income (netted for personal consumption and use). The amount of life cover depends on the life stage a person is in and the liabilities (and related assets) he has. As a thumb rule, one should have a cover of 10-20 times the annual income."
Continuing with the above example, a 35-year-old person with annual income of Rs 15 lakh will require an insurance cover of Rs 15,00,000 * 25 = Rs 3.75 crore. Experts say need-based method is the best as it ensures that you are neither under-insured nor over-insured. One should not forget to take into account one's loans and future goals while doing the math. Ashish Vohra, Senior Director and Chief Distribution Officer, Max Life Insurance, says, "Life Insurance needs may differ on an individual basis. Therefore, proper need-analysis must be done with the financial planner to arrive at your exact protection need."
