What is your life insurance need?

Insurance | admin | September 28, 2011 at 5:11 am

A good life insurance policy can protect you from financial difficulties and provide assurances that your loved ones will be taken care of in the event of any mishap. Many a time people find it difficult to estimate the appropriate value of insurance they need.

Your life insurance needs change as your life changes. When you are young, you may not have much need for life insurance. However, as you take on more responsibility and your family grows, your life insurance needs increase. You should periodically review your needs in order to ensure that your life insurance coverage is adequate.

There are several simple methods that can be used to estimate the life insurance need of any person. These are rules of thumb and give you a broad idea of the amount of life insurance you should buy.

Income rule: The most basic rule of thumb is the income rule, which states that your insurance need should be around six to eight times of your gross annual income. For example, a person earning a gross annual income of Rs 100,000 should have between Rs 600,000 (6 x Rs 100,000) and Rs 800,000 (8 x Rs 100,000) in life insurance coverage.

Income plus expenses: This rule considers your insurance need to be equal to five times your gross annual income plus the total of any housing or car loans, personal debt, mandatory recurring expenses such as house rent etc, and special funding needs such as child's education etc.

For example, assume that you earn a gross annual income of Rs 100,000 and have expenses that total Rs 250,000. Your insurance need would be equal to Rs750,000 (Rs 100,000 x 5 + Rs 250,000).

Premiums as percentage of income: Payment of insurance premium results in outflow of disposable income. You may, therefore, not like to buy too much insurance.

One should decide the quantum of insurance keeping in mind the cash-flow problems that will be created as a result of the obligation of regular outgo from salary.

In income and income plus expenses rule you ascertain the minimum insurance you should have. Under premiums as percentage of income rule you can plan your cash flow by committing an appropriate percentage of your income for paying life insurance premium. Conventionally, a minimum of six percent of your gross income (as the primary income earner) should be spent on life insurance premiums. Add an additional one percent for each dependent. Once you determine the percentage of your income which should be spent on life insurance premiums, you should purchase as much life insurance as you can get for that premium amount.

There are several more comprehensive methods used to calculate life insurance need. Overall, these methods are more detailed than the rules of thumb and provide a more complete view of your insurance needs.

Family needs approach : The family needs approach requires you to purchase enough life insurance to allow your family to meet its various expenses in the event of your death. Under the family-needs approach, you divide your family's needs into two main categories:

1) immediate needs at death (cash needs), and

2) ongoing need (net income needs).

Once you determine the total amount of your family's needs, you purchase enough life insurance to cover that amount.

Income replacement : The income replacement calculation is based on the theory that the purpose of life insurance is to replace the loss of your income in case of your premature death.

Under this approach, the amount of life insurance you should purchase is based on the value of the income that you can expect to earn during your lifetime, taking into account such factors as inflation and anticipated salary increases.

Estate preservation and liquidity needs : It is a sensible choice to reassess your insurance cover if you avail a big-ticket-loan against your assets such as a housing loan or business loans.

It provides the much needed economic hedge against risk and protects your family and/or your business.

The estate preservation and liquidity needs approach attempts to calculate the amount of life insurance needed upon your death for items such as debt, expenses and taxes, while preserving the value of your estate. This method takes into consideration the amount of life insurance needed to maintain the current value of your estate for your family.

You may also like to keep in mind that if your family members have independent earning capacity, you may reduce your insurance. Insurance is a protection and not really an investment.

So, you may not get a decent rate of real return at the time of maturity of your insurance policies. It is very important to calculate the amount of insurance one needs.

This is not a one off calculation, it should be reviewed periodically and amount of insurance should be increased or decreased accordingly. The point is that you should be adequately insured at all times.

Source: Economic Times

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