Don’t rely on rules of thumb when determining term insurance coverage
NEW DELHI: Term insurance is the simplest form of life insurance that pays out the sum insured if the insured dies during the term of the contract. The rules for term insurance can be straightforward, but calculating the insurance coverage you may need can be tricky, as inadequate coverage could be devastating for your dependent family members.
You might come across various simple rules of thumb for calculating a sufficient sum, however, financial planners and industry experts do not suggest such rules.
Some of the main methods of calculating required insurance coverage include the value of human life, the income replacement method, the expense replacement method, and the insurer’s rule of thumb. We take a look at each of these methods in detail.
Value of human life
Insurance coverage should be commensurate with the economic value of the individual, or also referred to as the value of human life to the family. The concept primarily considers the value of future income, expenses, liabilities and investments.
Under the HLV method, you must consider your income, expenses, expected future responsibilities, and goals to determine the need for insurance.
Income replacement value
It is assumed that the purpose of life insurance is to replace the loss of income of the breadwinner in the event of death. One of the easiest ways to calculate the replacement value of your income is: insurance coverage = current annual income multiplied by the years remaining for retirement.
Expense Replacement Method
In this method, individuals must first calculate their household’s daily expenses and goals, such as loans, child rearing and marriage, as well as providing for financially dependent parents. The figure above is the total amount your family needs today.
The next step is to deduct your current invested assets and any life insurance coverage you may already have. However, remember to exclude assets such as home and car in this calculation, as your family members are most likely to continue using them and may not liquidate those assets upon death.
The resulting figure you will get by deducting invested assets and insurance coverage from expenses and goals will give you an idea of how much coverage you need.
Rule of thumb of the insurer
To calculate the minimum sum insured in term life insurance, the easiest way is 10 times the annual income, i.e. if your current annual income is ₹10 lakh, you should have life insurance coverage worth at least ₹1 crore.
However, according to investment advisers, this method is the wrong way to calculate policy coverage.
The premium is one of the most important factors when choosing a life insurance plan. According to experts, individuals should not follow any rule of thumb when it comes to premiums, as they depend on the sum insured. However, a customer can get the best prices online and compare premiums and plans based on their needs.