Managing life risks is one of the first things you should do, even before you begin investing. Therefore, it is crucial that you have adequate life insurance coverage to reduce the financial impact of an untimely death. Insurance, essentially, works as a financial tool to replace the income of the bread earner in the event of his or her death, i.e. it ensures the same standard of living for the dependents.
But, the most crucial aspect is the amount of life insurance coverage that one should have. Interestingly, there’s no single answer to the question — How much life insurance do I really need? A number of variables will need to be addressed in determining the right coverage amount to purchase. Age, financial assets, financial liabilities, goals, annual income, and expenses associated with dependents are just a few of the variables that go into determining the necessary sum assured. Therefore, an appropriate need-based analysis needs to be done before arriving at the amount of life cover.
A scientific approach to zero down to the actual amount of life cover required is to calculate the human life value (HLV) before buying life insurance plans. Four factors—annual income, annual expenses, years until retirement, and inflation-adjusted cost of expenses—are taken into account when determining the insurance requirement using the human life value (HLV) approach.
Here are some basic steps to calculate HLV
First, subtract from your annual income, which includes your pay, bonus, employee provident fund contributions, and income from investments, all of your personal expenses, such as food, clothing, travel, entertainment, and so on. What’s left is your family’s requirements.
Second, determine how many years you have before retirement (your retirement age minus your current age). Estimate household expenses up till retirement, taking into account realistic increments. Subtract whatever retirement benefits you will get on retirement. Include one-time costs such as your children’s wedding or their higher education. You need to buy insurance equal to the difference or the shortfall.
Third, determine the shortfall’s present value while accounting for an acceptable inflation rate. To arrive at a more accurate HLV estimate, you can subtract your current life insurance coverage and net worth while simultaneously accounting for any debt, such as large home loans. Lastly, keep reviewing the goal at least every five years as it will change over time.
If you want the HLV process a tad complex, here’s a thumb rule to give you a headstart. As a general rule, one might consider purchasing a life insurance policy that is at least 15 times your net annual income while also taking into account other liabilities like a mortgage.
Buying a sum assured (life cover) 15 times of annual income may not be as expensive as it looks. This is because there are term insurance plans that fit the bill.
Term insurance plans are high-cover, low-premium plans. The premium of term insurance plans varies across insurance companies, therefore, before deciding on a plan, it is better to compare the term insurance premiums from various insurers.
Once you are aware of the amount of life coverage you need, go ahead and buy the right insurance plan. Having purchased the right amount of life coverage and the right insurance policy will ensure a carefree life – a time well spent with your loved ones and focusing on investments rather than the risk, anymore.
If you are looking to calculate the right HLV and the right insurance plan that can give you