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    How big should your life insurance cover be? These factors will help you decide

    Synopsis

    A Rs 1 cr life insurance cover might seem sufficient now, but it won’t sustain your expenses in a few years.

    cover-coverThinkStock Photos
    Is Rs 1 crore insurance cover sufficient to take care of your family's financial goals in case something untoward happens to you?
    When Prasad Patil bought a term insurance cover of Rs 1 crore, he was single and had no dependents. Now married, he feels the Rs 1 crore cover won’t be enough to sustain his family’s needs and cover his goals 10 years down the line. “It may be adequate now, but I have to plan for a situation where we will have kids. Also, my income will rise significantly later. To cover that loss perhaps a higher cover might be required,” says the Mumbai-based self-employed professional.

    Policyholders like Patil are a rare breed. To most others, a Rs 1 crore insurance cover seems sufficiently large to take care of all their financial goals and sustain their family’s expenses in case something untoward happened to them. “We are seeing many people buying a cover that they are mentally comfortable with, and Rs 1 crore is a popular number. But many buy without doing the basic math,” says Mahavir Chopra, Director, Health, Life and Strategic Initiatives, Coverfox.com.

    To be fair, the eight figure sum certainly seems very large. If a family puts Rs 1 crore in a bank deposit that earns 7% interest, it will get a monthly income of Rs 58,333. That money can sustain the expenses of an average middle class Indian household.

    Or can it? This calculation seems fine on paper, but won’t work when you take into account the outstanding loans taken by the policyholder, the relentless march of inflation and the impact of income tax. Also, one needs to put aside a corpus for certain one-time expenses, such as children’s education and marriage and the retirement needs of the spouse. Our calculations show that if the individual has a home loan and two children, the Rs 1 crore received as insurance money will not sustain the family for more than 12-13 years.

    Untitled-1
    In pic: Prasad Patil, 33, Mumbai
    Annual income: Rs 12 lakh (approx.)
    Dependents: Father (61), mother (53), wife (31)
    Living expenses: Rs 4.8 lakh (per year)
    His expenses: Rs 96,000
    Corpus required (25 years): Rs 96 lakh
    Outstanding loans: Nil
    Future kids’ expenses: Rs 35 lakh
    Contingency corpus for wife: Rs 10 lakh
    Corpus required: Rs 45 lakh
    Less existing investments: Rs 25 lakh
    Total required cover
    : Rs 1.16 crore
    Existing insurance cover: Rs 1 crore
    Deficit: Rs 16 lakh
    *Future expenses are estimates
    Our Assessment

    His insurance cover might fall marginally short of the required amount. However, since his wife also works, there is no pressing need to buy additional cover right away. He can wait a few years (till 36-37) to buy more insurance.


    How much insurance do you need
    The person in the example below needs a life cover of Rs 1.97 crore. Use this worksheet to calculate your insurance needs.

    cs-23-im-3ET Bureau

    *Policyholder’s personal expenses are assumed to be 20% of the household expenses and are to be deducted
    **Does not include place of residence as it cannot be liquidated to meet family’s needs
    cs-23-im-4ET Bureau

    Not surprisingly, many Indians are underinsured. Though pure protection term plans have become popular in recent years with the advent of online policies, the average Indian household is very vulnerable to financial disruption in case the breadwinner dies. A Swiss Re study conducted in 2014 found the shortfall in mortality protection in India to be as high as 92%. In other words, the average Indian was insured for Rs 8 lakh though he required an insurance cover of Rs 1 crore. This can be attributed to poor awareness about insurance as well as the general fixation with insurance-cum-investment products.

    Calculating insurance needs How big should be your insurance cover?

    Some experts suggest that the cover should be based on the life stage of the individual. “An earning individual up to the age of 40 should purchase a term plan with a life cover of approximately 20 times the annual income, a person in his 40s should buy a cover 10-20 times, and an individual in his 50s should opt for a life cover of 5-10 times the annual income. The term insurance plan should continue till retirement age,” says Puneet Nanda, Deputy Managing Director, ICICI Prudential Life Insurance. Expenses, too, can form the basis of sum assured estimation. “Your term cover should be 12-15 times your dependent family’s annual expenses,” says Prerana Salaskar-Apte, financial planner and Partner, The Tipping Point.

    Yet another thumb rule says it should be at least 8-10 times your annual income. But all these are rudimentary calculations, and do not take into account the liabilities of the individual, his existing investments and the needs of the family. In reality, the financial situation of every individual is unique and a one-size-fits all approach may not yield an accurate result. Experts recommend a thorough analysis of one’s expenses, liabilities, investments and requirement while arriving at the ideal cover amount. Use the worksheet on Page 3 to calculate your insurance needs.

    The calculation takes into account the number of years your dependents will need a monthly income, your outstanding loans and the one-time expenses you have planned in the coming years. “Your insurance should always be linked to your requirements and not a figure like Rs 1 crore, no matter how big it seems,” says Pankaj Mathpal, CEO, Optima Money Managers. While emotional loss cannot be compensated in case of the life assured’s death, the term cover will ensure that his dependents do not have to deal with financial stress. This should be an eye opener for those with large home loans. The lender will not give your family a grace period to start repaying the EMIs after you are gone. “If you have a home loan of Rs 50 lakh, that amount will straightaway get deducted. The balance amount, even if invested prudently, will not be able to take care of your family over a long period of time, which is the objective of your life cover,” says Mathpal.

    Retirement kitty for spouse
    The insurance cover should also cover your spouse’s future requirement, particularly if she is not earning. “Your cover must be capable of protecting your spouse’s old age requirements to enable a life of dignity and comfort. Consider the potential medical, living and help-related expenses,” says Rishi Mathur, Head, Products and Strategy, Canara HSBC Oriental Bank of Commerce Life Insurance. Delhi-based IT professional Sahil Sighat wants a Rs 1 crore retirement kitty for his wife. He has a term plan of Rs 2 crore but will need additional insurance to cover all his goals.

    However, every individual and family’s needs are unique. “If the only dependent is a wife, for instance, a term cover of Rs 1 crore may be sufficient. If two children are dependents as well, it is possible that a larger sum may be required. Buyers should take a milestone-based approach to looking at your cover,” says Vineet Arora, MD and CEO, Aegon Life.

    Untitled-2
    In pic: Sahil Sighat, 41, Delhi
    Annual income: Rs 40 lakh
    Dependents: Mother (74), wife (39), sons (aged 17 and 7)
    Living expenses: Rs 14.4 lakh (per year)
    His expenses: Rs 2.88 lakh
    Corpus required (18 years): Rs 2.07 crore
    Outstanding loans: Rs 1.1 lakh
    Children’s expenses: Rs 1.25 crore
    Wife’s retirement corpus: Rs 1 crore
    Corpus required: Rs 2.26 crore
    Less existing investments: Rs 30 lakh
    Total required cover: Rs 4.33 crore
    Existing insurance cover: Rs 2 crore
    Deficit: Rs 2.33 crore
    Our assessment
    Though he has bought a large term cover, it is not adequate to cover all his goals. He should consider buying an additional cover or scale down some of his goals.


    Human life value
    Thumb rules can act as a simple guide, but for a robust protection portfolio, a deeper dive is needed. The concept of human life value (HLV) calculates the total income that the individual is expected to earn over the rest of his working life and discounts that future income by the expected inflation rate. In other words, the future income of that person is given at today’s prices. The expenses incurred on the individual are subtracted from this value to show how much is the monetary value of the individual for the household. For instance, a 35-year-old woman, who has a 30% share in household expenses and 50% in home loan EMI, will have to factor in the annual cost of replacing these contributions. In addition, her life insurance policy should cover the present value of her contribution towards the child’s education corpus. This will give the inflation-adjusted total cost that needs to be replaced in the period of financial dependence of her child.

    Accounting for inflation Don’t forget inflation when calculating future costs. Your family’s needs will grow as prices keep rising. If your family needs Rs 50,000 a month in 2018, even a nominal 7% inflation will push up that figure to Rs 70,000 a month in five years. By 2028, the monthly household expenses would be Rs 1 lakh. The insurance cover should factor in this rise. Experts say one must review one’s insurance cover every five years, particularly during critical milestones such as marriage and birth of children. Some policies have in-built features like increasing sum assured or life-stage linked enhancement. This does away with the need to buy additional cover periodically.

    “For beating inflation, increasing sum assured feature is a wiser option,” says Karthik Raman, CMO and Head – Products and Strategy, IDBI Federal Life Insurance. It eliminates the procedural hassles, including medical check-ups, that fresh covers invariably entail. It helps your family members avoid a situation where the sum assured loses value over time. Policyholders like Patil are likely to find such covers useful.

    Of course, not everybody needs a big term insurance cover. “It is meant purely to protect the financial needs of one’s dependents. If one has no dependents and doesn’t plan to have any, then a term plan can be avoided,” says Salaskar-Apte. Pant’s mother draws a pension and he has no other dependents. “He doesn’t need life insurance at the moment,” notes Mathpal. Yet, Pant has taken a Rs 1 crore cover factoring in future responsibilities.

    Untitled-3
    In pic: Tanay Pant, 29, Mumbai
    Annual income: Rs 6.5 lakh
    Outstanding loans: Nil
    Dependents: None
    Required cover: Nil
    Insurance cover: Rs 1 crore
    Annual premium: Rs 11,000
    Our assessment
    Though he doesn’t require insurance right now, Pant has done well to lock into an insurance plan before 30 when premiums are very low. The cover will be big enough for a few years, after which he may need to review it.

    Cover accidents and illnesses
    Death is not the only tragedy that can strike a family. The incapacitation of the breadwinner due to an accident or illness can also plunge the family into a financial crisis. Your life insurance cover, no matter how large, cannot come to your aid during such emergencies. “With
    increasingly hectic lifestyles making people more vulnerable to diseases, it is important that you protect yourself not just against death, but also outcomes where you lose your capacity to earn,” says Arora of Aegon Life.

    To guard against such situations, it makes sense to buy accidental death and disability as well as critical illness covers. All life insurers offer such plans in the form of rider benefits, or add-ons that can be purchased with life policies upon payment of additional premium. While life insurers offer a host of riders such as income benefit and waiver of premium covers, critical illness and accidental death and disability riders are the two riders that can ensure comprehensive protection for you and your family. They are linked to the base life cover throughout the tenure. A critical illness rider hands out a lump-sum amount upon the diagnosis of serious diseases like cancer, stroke, kidney failure, cardiac arrest and so on. The sum can be used for treatment as also to finance expenses not covered by your regular health insurance policy. It can also come in handy to fund your recuperation expenses and replace loss of income during the period. An accidental death and disability rider provides compensation, over and above the base sum assured, to the nominees in case of the policyholder’s death in an accident. The rider also gets triggered if the accident leads to loss of limbs or other disabilities.

    Riders vs standalone covers

    You also have the option of availing of independent covers not linked to your life cover. They function much like riders, but with more flexibilities. To start with, you are not tied to your life insurer and can compare and choose from policies offered by several life and non-life insurers. Mathur recommends standalone covers over riders. “With riders, there may be limitations on the coverage level and premium paid vis-a-vis the base plan. In such situations, working out a bespoke critical illness and disability cover is very important,” he says. Arora recommends disease-specific products covering cancer or heart in case your family has a history of such illnesses. Raman, on the other hand, casts his vote in favour of riders, which tend to be cheaper than standalone covers. “Riders ease the procedure of buying and managing a policy. Even from a cost perspective, in most cases, adding a rider is less expensive than buying a standalone policy,” he says. Buying riders cuts down on documentation and renewal hassles as they can be purchased with the base life cover.
    ( Originally published on Jul 23, 2018 )

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