Recently, my colleague asked me how much insurance cover was good enough for him and his family. His agent was recommending exorbitant insurance cover to him and he was worried that whether that recommendation was correct or not. That’s when I thought that there should be a kind of scientific method to arrive at the required insurance cover for an individual. And this is what I found.
How much Insurance you need?
Quite often Insurance is mis-selled by agent and broker due to higher commissions given by insurance company. At times, even buyer is also not aware about different available insurance products and hence he ends up buying wrong insurance product.
To ensure that you are not either under-insured or over-insured, you need to do this self-analysis to see you are buying accurate product offering you a proper insurance policy.
Analysis of Stages of life
People have different needs at the different stages of life. So, one needs to evaluate the insurance need at the major stages of life, which include bachelorhood, married life, planning a family, reaching retirement or post-retirement.
Once you identify the stage of your life, you need to analyze protection need of that stage. For e.g., bachelor has low insurance needs since he does not have any family obligation or responsibilities. For a married person, the insurance needs will be initially higher when he has small kids. It will decrease when his children become independent or when his home loans, study loans etc are fully repaid. Life is unpredictable. Insufficient life insurance can jeopardize the future of your loved ones. A calamity can turn their lives upside down in a blink of an eye.
Prioritization of Goals
Next, you need to assess your goals and objectives for buying insurance. Do you want a plan for your kid’s education needs or for your foreign holidays? Or do you want to create a corpus for your retirement years? One needs to carefully select product based on goals he wants to achieve. In early years, one needs to save for buying a house while towards retirement one has to think about the necessity of increased health cover to meet his medical expenses.
Calculating Insurance cover
One generic rule is that one needs insurance cover of around 6 to 7 times his annual salary or income. But of course, this is a general estimation and your insurance requirement may vary.
At a broad level, if you want to calculate insurance requirement, it can be calculated as per below.
Consider,
A = (12 x Monthly household expenses) x (No of years the family will need this income)
B = Sum of All outstanding debts including Home Loan, automobile loan & personal loan
C = One time future expense like your kid’s education & their marriage expenses
D = Sum of all existing assets like EPF & PPF, Equity, mutual funds & deposits & other assets like property, gold etc.
So, now your net Insurance requirement is equal to = A + B + C – D
To further explain above with example, consider that
– Your monthly expense of 30,000
– No of years your family needs income is 40 years
– Outstanding home loan is 30,00,000
– Expense of your kid’s education is 20,00,000 & Marriage is 30,00,000
– Value of all existing assets is 50,00,000
Therefore, value of
A = (12 x 30,000) x 40 = 1,44,00,000
B = 30, 00,000
C = 50, 00,000
D = 50, 00,000
Then as your net insurance requirement will be equal to
1,44,00,000 + 30,00,000 + 50,00,000 – 50,00,000 = 1,74,00,000
Again, as mentioned earlier, prioritization of goals should be considered while doing these calculations.
Product recommendation
Once insurance cover is decided, one needs to select from available insurance product depending on priorities. One should decide this product depending on short term goals like purchasing a SUV or going for exotic holiday or long term goals like planning for his retirement.
One should check if the maturity proceeds of savings or investment plan sold to him is adequate to meet his goals as per inflation & future expenses. However the premium for the same should be affordable as per his salary or business income.
So, while buying insurance, don’t just buy blind-folded whatever is being recommended. Evaluate your insurance requirement as per examples given above & consider the different parameters like your age, risks, life stage, type of goals (Short term/long term) & premium paying capacity.