The numbers must stack up

Determining the exact insurance cover required by an individual involves an interplay of several factors

How much insurance should I have? This is a billion-dollar question to almost all insurance prospects. In fact, nobody on earth can either mitigate or indemnify the loss and the hardship faced by the deceased’s dependants. But to arrive at an approximately equal and justifiable value of human life, there are certain thumb rules or empirical formulae.

Human Life Value (HLV)

Insurance companies generally go by this rule. Let’s not deeply delve into those actuarial calculations, which have far too many complex details.

Suppose the breadwinner of a family is going on a tour for two to three days. He arranges a few thousands of rupees for his spouse and children to spend until he returns.

If the same person has to go for a two- or three-month period on project work, he provides ₹40,000 or ₹50,000 depending on his earning capacity and the spending habits of the family.

And, if the same person disappears suddenly, the amount he might have provided for his family for maintaining the present standard of living during their lifetime determines the HLV of that person.

To arrive at that value, let’s not go deep into factors such as inflation rate adjustments, yield earned on investments, increase in incomes, decrease in expenses, and the like. Let’s restrict ourselves to some thumb rules to make it simple.

To put it straight, ascertain your income minus loans, expenses, savings and the like. Calculate this up to your retirement. That amount will be the value of insurance you have to take. Let’s take an example: Mr. Raj, aged 35, has the following income and expenses per month: Income (net after tax) — ₹1 lakh; EMIs on loans — ₹50,000; family expenses — ₹30,000; savings — ₹10,000; emergency fund — ₹10,000.

As such, if Mr. Raj can provide ₹30,000 per month to his family, they may survive. But he had taken loans worth ₹60 lakh, both for housing and vehicle put together. Some companies offer insurance against outstanding loan on diminishing balance method — the premium for such a policy will be added to the loan principal and the EMI will be fixed. This is also one of the options.

To get a recurring income of ₹30,000 a month at present rates, one needs a corpus of ₹60 lakh at 6% return; or ₹72 lakh at 5% return or ₹90 lakh at 4% return. Add the ₹60 lakh loan to this. Both these put together, will be the amount of insurance Mr. Raj needs viz. ₹1.20 crore, ₹1.32 crore or ₹1.50 crore, respectively.

Traditional policies for such a huge amount will cost heavily.

Hence, it will always be better to opt for a term insurance cover or join a group insurance (if you are an employee and your employer provides the same). Here also, the most important thing to bear in mind will be to have a provision for coverage of your outstanding loans. Otherwise, the entire claim amount arising out of a policy may or may not be sufficient to clear the debts of the deceased. That defeats the basic purpose of insurance.

Almost all insurance companies offer online sale of term policies. As per the table, Mr. Raj is eligible for ₹3.60 crore term insurance. But, given his commitments and necessities, he may opt for ₹1.20 crore; ₹1.35 crore or ₹1.50 crore term insurance, as the case may be.

Before taking a policy, one has to ascertain the premium rates, riders offered and claim settlement ratios of the insurance company.

Under- or over-insurance

These are two major problems that prospects generally face while taking an insurance policy. Under-insurance means the insurance policy one takes is not sufficient to meet his obligations. In our example, if Mr. Raj takes insurance, say, for ₹50 lakh sum assured, how will it be sufficient to maintain his family and repay the outstanding loans in case of any contingency? This is under-insurance.

Likewise, if one is over insured i.e. insurance not commensurate with one’s income and expenditure, the policy premium becomes a white elephant for him to continue and ultimately results in lapsation, which is a great loss to the policy holder.

Opt for longer tenures

It is always better to choose longer term policies. As the age advances, the premium rates will be very high and one has to undergo many tests to get the same coverage as one gets at a younger age.

The most important thing to remember here is at a younger age, one will not have any medical history which is a favourable sign for companies to offer insurance at lower premiums and for longer terms. Advanced age is the time when there is a real necessity for insurance.

Hence, it will always be better to choose a term up to the maximum age allowable under term insurance.

(The author is an insurance professional)