Life Cover: What's the Minimum?

Here are pointers to help you decide on the minimum life-insurance coverage amount you should have.
By Morningstar Analysts |  09-01-13 | 
 

Most individuals face the question of buying a life-insurance cover at some point or the other (though the sooner it arises, the better it is). The second question that follows is: how much cover do you need?

As a general rule of thumb, many advisors suggest your life cover should be 15 to 20 times your annual income. However, such a one-size-fits-all advice may not be ideal or appropriate. Two individuals of sound health, same age and the same income may need different amounts of life cover.

Here’s a more systematic approach to this:

Since the basic idea of a life insurance is supposed to act as a cover in case of untimely death, there are various aspects one needs to keep in mind when you decide on the amount and duration of your life cover.

Dependents: The number of people financially dependent on you for their sustenance and their future. These would mostly include your family members like spouse, children, parents and siblings.

Debt/Loan: You should total the entire outstanding loan amount (including all types loans: home, car, education, personal etc) that you and your family owes and keep it mind while deciding on your life-cover amount.

You would not want to subject your dependents to bear the burden of loan repayment in your absence or lead to a situation where they may not be able to service such loans or face the prospect of eviction or forfeiture of the asset against which a loan was procured.

Education: The biggest expense that your family could encounter is your kids’ education, especially their higher education. If you have siblings whose education expenses is also your responsibility, take into account that as well.

While there is no exact method to estimate this amount--difficult as it may be--you may need to take a rough guess of how much education costs would be when your kids grow up.

Income replacement: Since the concept of buying life insurance implies that in the case of the death of the insured, the dependents should be able to continue their lifestyle as before. Hence the death benefit amount should be such that the returns received from investment of this amount should be sufficient to maintain the planned lifestyle.

Generally 30%-40% of one’s own income goes towards their own expenditure, but this is not always the case. If you know the exact figure, the remaining amount of your income is what will go towards expenses and savings of your family. Calculate this amount that your loved ones would need in terms of per annum. Given below is a chart which can help you in deciding what amount of life insurance for the purpose of Income replacement should you have for a given desired annual income and average rate of return that you expect your investments will earn.

Medical costs: If your family has a history of recurring medical expense which cannot be medically insured, an estimate of this required amount would also have to be made. Even if everybody in the family is covered by medical insurance, these policies come with a long list of exclusions and the entire medical expense may not always be covered/reimbursed, so depending upon the number of dependents you have having an amount reserved for each individual may prove helpful.

Add all the above mentioned estimated figures and you will get a more appropriate figure of how much minimum life insurance you need to have.

You may then tweak this figure to suit yourself better. You may decrease you coverage if your spouse or anyone else in the family earns a substantial income or you have another source of income or investments in place, you may increase the coverage if you do not have pension or wedding expense of your children or siblings.

Finally, there are some life insurance needs that are permanent while others are temporary or short-term in nature.  You need to categorize your life insurance needs accordingly and buy the right product with right amount of duration.

For most families this amount will be in the region of 7 to 8 figures, possibly Rs. 1 crore or more. Do not be afraid though, with term insurance products available getting this amount of life insurance cover will not cost an exorbitantly high amount of premium.

Do your research and select a product that is not only cost effective but the insurance company offering it should also have a good claims ratio. You would need to strike a balance between the two.

Durgesh Savkur is Data Analyst with Morningstar India.

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