In the past couple of years, there’s been a lot of noise about the need for life insurance – everyone’s telling you to get it – from your friendly agent to your neighbourhood bank to all those screaming television commercials. They all remind you of good and bad events in life, make you dream about your children’s educational needs, their marriages, your old age or illnesses. They warn you of impending doom, of the need to buy life insurance Right Now!
It is true that an unforeseen accident can leave a family not only emotionally bereaved but also financially devastated. As an earning member with dependents, it is your responsibility to protect your family in the event something happens to you and you are not able to provide for them anymore. But, do you know all the facts about Life Insurance? Do you know how much cover you need and how to calculate it? Do you know the term you need it for? If you can’t figure out the answers to these questions yourself, you’ll be putty in the hands of some unscrupulous agent.
”You would do well to keep your insurance separate from your investments” warns Financial Planner, Chitra Iyer.
In this article contributed by Chitra Iyer, she attempts to answer some frequently asked questions about life insurance and how to calculate how much cover one should get.
Chitra has a diverse range of experience in the field of finance, with close-to a decade in Financial Planning as the Chief Operations Officer and Financial Coach of My Financial Advisor. She has previously worked as a consultant for Development Credit Bank, and has also worked in investment and merchant banking. Chitra is the Financial Planning expert on MoneyChat.in’s Panel of Experts. You can read more about her here.
What is the difference between General Insurance and Life Insurance?
There are broadly 2 forms of insurance life and non-life, or general insurance. General insurance includes cover on loss due to fire, flood, theft, accident, professional practice, etc. In the event of any of these situations, the value of the loss can be precisely calculated. But in case of life insurance the exact value of loss of a human life is very difficult to calculate. Life insurance insures against loss of financial income caused due to death of an earning family member. An insurance company will offer you life cover only of you’re deemed insurable. Similarly, for the insurance policy to hold good, you must truthfully disclose all material facts about yourself at the time of the insurance proposal.
Do I need Life Insurance at all?
It depends on your personal situation. If you answer YES to BOTH questions below, then you should consider getting Life Insurance:
a) Are you an earning member of your family, contributing a significant amount to your household income?
b) Do you have dependents?
Let’s also consider some specific scenarios:
Scenario 1: You are a single woman with no dependents – You do NOT need life insurance.
Scenario 2: You are a single woman with children – You should seriously consider Life Insurance.
Scenario 3: You are a single woman with dependent parents – You should seriously consider Life Insurance (calculation of cover requirement will differ).
Scenario 4: You are a married woman with a family. You are not working. – You do NOT need life insurance.
Scenario 5: You are a married woman with a family. You are working. – You should seriously consider Life Insurance if you are making a significant contribution towards your household finances.
Scenario 6: You are a married woman with a dependent husband – You should seriously consider Life Insurance.
How much cover should I get?
The amount of cover suitable for you depends entirely upon your personal financial and family situation. We’ll give you an example of how to calculate an adequate amount of cover. You should use your own numbers to replace the ones used here:
1. HOW MUCH LIFE INSURANCE DO I NEED?
After determining whether you need Life Insurance, the next step is to work out how much cover you should get. We will use the example ahead to show you how to easily calculate how much insurance cover you need. Replace the figures in the example with your own numbers.
Step 1: Your Income and your Dependents
Step 2: The financial needs of your dependents
Step 3: Adjust for Current Assets & Income
Step 4: Adjust for inflation
2. YOUR INCOME & YOUR DEPENDENTS:
Let’s assume you are a 35 year old woman with:
– 2 young children
– a 40 year old husband
– aged parents
– a job that brings you Rs. 25,000 per month
3. THE FINANCIAL NEEDS OF YOUR DEPENDENTS
Now assess the future financial requirements of your family:
– Children’s education (up to graduation) – approximately Rs. 10 lakhs
– Cost of getting the children married – approximately Rs. 25 lakhs
– Medical needs of aged parents – approximately Rs. 5 lakhs
Total of the above = Rs. 40 lakhs
ADD
Monthly expenses Rs. 60,000 pm Rs. 7.2 lakhs per year for say next 40 years of your life ** (till you turn 75 and your husband 80) which is Rs. 2.88 crores.
So the gross total is Rs. 3.28 crores.
** The term of calculation depends upon how many years you think your dependents will continue to financially depend on you. Example: If your parents are your only dependents then rework the example only keeping their health, life expectancy, and monthly expenses in mind.
4. ADJUST FOR CURRENT ASSETS & INCOME
From the total of Rs. 3.28 crores:
DEDUCT : Current Assets
– Investments already made by you and your spouse in Savings and Fixed Deposits – approximately Rs. 10 lakhs
– Stocks and mutual funds – approximately Rs. 15 lakhs
– Second house – valued today at approximately Rs. 40 lakhs
Total Current Assets – Rs. 65 lakhs
Also DEDUCT Other Income – income from spouse or other family members is Rs. 1 lakh p.m., i.e. Rs. 12 lakhs per year. Over 20 years (till your husband retires at 60), this will amount to Rs. 2.4 crores.
So, from a total of Rs. 3.28 crores, deduct Rs. 65 lakhs of Current Assets and Rs. 2.4 crores of Other Income. This leaves you with Rs. 23 lakhs. This is the amount of Insurance Cover you need to take out today.
5. ADJUST FOR INFLATION
An important thing to remember is that all the calculations above do not consider inflation. Since inflation can have a significant effect on your cost of living, your insurance cover requirements MUST be reviewed every year.
What kind of Life Insurance should I buy?
Ask your agent or check online for TERM INSURANCE PLANS only. These are pure life insurance policies where you can get a substantial cover for a very low premium. In the example shown in the slide deck above, as a 35 year old seeking a cover of Rs. 23 lakhs, you could get a pure term plan for just under Rs. 4000 premium payable annually. This policy will not give you any lump sum money at the end of the term, say 15 years, if we were to consider you would work till the age of 50.
All the other traditional insurance policies that you hear about all the time from your agents, your bankers, or on TV, are investment oriented policies. These are a strict ‘No No’. These policies take your money in the form of higher premiums and invest it in the stock markets. They charge you huge administration and other fees to do the same. The returns on such traditional policies are usually only around 5 to 6 percent. Instead, the better thing to do would be to buy a Term plan policy and invest the money you have directly in a combination of stocks, mutual funds, fixed deposits etc.
What are other important points to remember when getting Life Insurance?
– Remember to figure out how long your dependents are expected to be financially reliant on you when working out your insurance cover requirements. Most agents will assess your requirements over the rest of your expected working life (for a 35 year old woman, this could be 25 years). However, if your only dependent is a 12 year old child, she will be financially reliant on you only for the next 10-11 years. Your insurance cover requirement should only be based on a calculation over 11 years instead of 25; this will bring down your premium significantly.
– Do not assess your child’s post-graduate education costs when calculating your insurance cover requirements. You will pay an unnecessarily high premium. Save for your child’s post graduation through other investment/savings schemes such as stocks, bonds, FDs etc.
– Remember that in the event of your death, your dependent will get the lumpsum amount which can also be reinvested to earn interest income.
– If you have any loans that need to be repaid, you need to include the repayment for these loans when you calculate the financial requirement for your dependents.
MoneyChat.in thanks Chitra for contributing this important and useful article.