Don't be miserly with your life cover

Last Updated: Mon, Sep 30, 2013 04:10 hrs

How much life insurance do you need? How can you predict future expenses and provide accordingly? While the thumb rule is your life insurance cover should be 10 times your annual income, it is not that simple. There are several factors you must keep in mind while calculating how much life cover you should take.

It is known that Indians are under-insured. According to a report by Life Insurance Council, the insurance penetration in India - the percentage of premium to GDP - was 3.2 per cent in FY13, while life insurance density, the ratio of premium to population or premium per capita, was Rs 2,687 ($43). This is an indication of the average size of the premiums paid.

"The problem is that we insure our cars but don't insure our lives. Only a handful of persons are optimally insured. Life insurance is something you should include in your financial planning," says Sanjay Tiwari, vice-president (strategy and products), HDFC Life Insurance.

You can calculate how much life cover you need using the human life value (HLV) method. Here, you look at the present value of your future income or the discounted value of future income.

Let us look at how you can calculate the life cover needed for a family. You need to consider the expenses of dependents and calculate the corpus required for the balance living years of the spouse (based on inflation-adjusted return).

Children's education is a big expense. Assuming you have two children, you can roughly project Rs 70 lakh for the educational expense for both. This will include primary and higher education.

The next big expense is marriage. You might need about Rs 20 lakh for marriage-related expenses on both. Loans are also a major expense. Suppose you have a loan of Rs 50 lakh. You have to provide for that, too, in your life cover. All this adds to Rs 1.4 crore.

Then, you have to provide for future expenses of the surviving spouse. Remember to factor in inflation while calculating future expenses.

After adding all these, you need to deduct the value of any financial assets such as fixed deposits, Employees' Provident Fund, Public Provident Fund, mutual funds and so on. Other assets such as a second property can be deducted. However, assets such as jewellery and vehicles should not be included, as these are consumption assets.

Similarly, if the spouse is working and contributing to the family expenses, then the cover can be reduced to that extent.

Since insurance is a risk cover, it should be balanced with adequate savings through other investment avenues, points out Kiran Kumar Kavikondala, director, WealthRays Group. "Too much of insurance cover without adequate savings will be of no help either. A corpus needs to be developed when an individual is alive, as one should live rich rather than die rich," he says.

The amount of cover will also depend on the number of dependents. If, for instance, you have children and ageing parents who are dependent on you, then you require more cover than someone whose parents have their own source of income.

Also, if you have taken your policy at an early age, you must upgrade it depending on events in your life such as marriage, children, when you buy a home, and so on.

"Life insurance needs, rather than risk-related needs, should be reviewed periodically (just the way we review investments). One should review one's HLV every few years to ensure one is not over- or under-insured. The logic is simple: increase your cover when your responsibilities or liabilities go up and reduce your cover as and when your asset base goes up or goals or loans get fulfilled or closed," says Sumeet Vaid of Freedom Financial Planners.

This can be done by upgrading your existing policy or taking an additional policy.

"It is always better to avail permissible features in your existing product and customise it to suit your needs but there is a limitation to this exercise. So, to suit life-stage needs, one will definitely have to look at new plans while taking benefits from existing plans in one's portfolio," says Rituraj Bhattacharya, head of market management and product development at Bajaj Allianz Life Insurance.

"Do not make the mistake of discontinuing or surrendering your existing cover before you get the new one, as there could be health issues due to which the underwriter might not be willing to provide the cover or could mark up the premium to substantiate the risk. There are certain products where one can opt for a 'step up' or a 'step down' option. That is, the sum assured will increase or decrease as per the option opted," says Vaid.

The earlier one takes the policy, the lower the premium. As you age, the premium increases for the same cover. "Age is directly proportional to insurance premium. Premium increases with age, so the earlier the better to take an insurance cover to save on premium," says Kavikondala.

Apart from pure-term policies, there are products that offer decreasing cover. These are also term plans but specifically linked to goals. Many banks and housing finance companies insist the borrower must take such a policy as a pre-condition to approving the loan.

In the event of the policyholder's death, the money from such policies can be used only for repaying the loan. As the loan outstanding decreases (as and when the borrower repays it), the sum assured decreases.

"It is advisable to take such policies if you have a home loan, which is a long-term loan. But remember that if you plan to pre-pay your home loan early, then don't take the policy for a very long time," says Prakash Praharaj, a Sebi-registered investment advisor and chief financial planner at Max Secure Financial Planners.

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