How to have an optimal life insurance cover?
A second name for life is "uncertainty" which surrounds the life of every human being. Uncertainty refers to the unpredictability and doubts which exist in all our lives. More often than not, contingencies in life occur when we least expect them and it is important for us to remember that we are not immortal. You see, due to our fast paced lives we often forget to safeguard ourselves from the risks and perils that we are exposed to. In other words, we fail to insure ourselves appropriately. You must be wondering what exactly is Insurance? Insurance in its purest sense refers to indemnifying risk. So, by buying an insurance policy you are buying a protection shield (for the risks faced by you) which will enable you to live life peacefully.
But will merely buying any insurance policy indemnify you against risks? The answer is no. You need to have the right amount of insurance cover and the right policy so as to protect yourself from any financial losses or uncertainties such as risk of illness, disability, damage to property, and the most important of all - one's demise. You see, having an adequate insurance cover enables you and / or your family to maintain the standard of living despite of any mishaps or unforeseen tragic events that could have broken you financially. These days, with greater awareness due to more advertising, more and more people are wondering whether they are adequately insured or not. Today we are going to address and resolve this query.
There are many ways to calculate the insurance requirement but according to PersonalFN the best and the most effective way of calculating insurance requirement is through the Human Life Value (HLV) - Expense method. HLV evaluates the need for insurance cover in terms of money required to sustain the same standard of living by the family in case something happens to the bread earner of the family.
If you are the bread earner of the family, then you should determine the amount of insurance cover that is required for the well-being of your family. In order to calculate your Human Life Value on the basis of the expense method, there are various factors which you need to take into account such as life expectancy of your spouse, number of children and their dependency period on you, monthly household expense of the family excluding your personal expense, cost of inflation, outstanding loans etc.
Let us understand this with the help of an example
Mr A is a 40 year old married individual who has 2 dependent children. His wife earns just enough to take care of her own livelihood. He already has a life insurance cover of Rs 30 lakhs and Rs 35 lakhs worth assets which can be used by the family in case of his demise. But he also has outstanding loans worth Rs 30 lakhs which are yet to be repaid. Mr A is not sure whether this insurance cover is adequate enough to achieve all the financial goals of his family in case he meets with an untimely death. His family details are as under:
(Note: Inflation on Household expenses is assumed to grow at 7% p.a.;
|Monthly Family Household Expenditure
|Annual Lifestyle Expenditure
|Number of Dependents
|Age of Dependents:
Return on Risk free Securities is expected to be 7.5% p.a.)
25% of household expenditure and 30% of annual lifestyle expenditure is spent on Mr A himself, which will not be required to be taken care of by the life insurance policy. On the other hand 25% of the monthly household expenditure and 20% of the annual lifestyle expenditure is spent on the daughter and son each, who are going to remain financially dependent on Mr A till they both attain the age of 23 years (i.e. for more 8 and 13 years respectively).
The financial goals of Mr A are as follows:
||Graduation (in Rs)
||Post-Graduation (in Rs)
||Marriage (in Rs)
By means of the HLV (expense) method, one can calculate the insurance requirement for Mr A to be Rs 49,56,572.67 (using the HLV calculator). Hence Mr A would require an additional cover of Rs 50 lakhs (approx.) to be able to meet his financial goals and maintain the existing lifestyle of his family.
You see, Mr A had no idea about the exact insurance cover that would suffice his family requirements in case something untoward was to happen to him. But with the help of a proper approach he was able to determine his insurance needs appropriately.
Instead of blindly following any insurance agent's advice who would earn handsome commissions if you opt for any policy recommended by him, it would be prudent for you to undertake a rational approach of your own. This would give you a more realistic picture of your insurance needs rather than asking your friends or relatives for guidance who are probably as ignorant as you are.
It is important for you to understand that knowing the exact amount of life insurance cover that you require is only the first step towards insurance planning. After this, you must find out what kind of insurance policies would suffice your requirements. Broadly speaking, four popular variants of life insurance policies are available i.e. term plans, endowment plans, money back plans and ULIPs. At PersonalFN, we advise our clients to keep their insurance and investments separate, and when seeking life insurance to opt for a straightforward term plan. Once you know which type of policy to buy, you need to check a few important things (such as Promoter's background, Number of years of experience, Financial Background, Terms and Conditions and most importantly the claim settlement ratio of the insurer, among a host of other factors) before you blindly hawk into buying a policy from any insurer. You see, insurance planning is an integral aspect in the exercise of financial planning and must be undertaken with utmost care.
Finally, buying insurance is a continuous activity. Every individual's needs change over a period of time. This in turn necessitates a review of your insurance requirement. Over a period of time, many people do need to buy additional insurance to ensure that they remain adequately covered at all times.
PersonalFN believes that without an optimal life insurance cover you are most probably bidding a goodbye to the dreams and financial objectives of your loved ones. To ensure that your family lives a stress free financial life even after you are gone, it would be prudent to find out whether you are adequately insured or not. Lastly, no matter how young you are, never procrastinate taking an optimal life insurance cover as no one can foretell when life will change its course.
PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.
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