Post the COVID-19 outbreak, there has been a rising awareness about the benefits of life insurance products as people have realised that life insurance policies are one of the most critical financial decisions they could make. These financial investments may not appear to be that valuable to us, yet they can make a huge impact on the people we care about.
Why life insurance policies?
A life insurance cover helps to address the psychological and financial requirements of your family after an unforeseen tragedy. Life insurance covers help your family to be independent enough to take care of themselves when you are no longer there to support them.
These policies can be used to pay off mortgages, cover everyday living expenses, and fulfill other needs of your family members. However, purchasing life insurance coverage alone is insufficient. The goal is to make sure you have enough life insurance coverage to meet all the requirements of your family. But how much life insurance do you require?
Ways to determine policy cover
When it comes to insurance, factors such as outstanding obligations and the lifestyle of your family must be considered. A life insurance calculator is used to determine the monthly or annual premium for an insurance policy. This calculator helps you to figure out how much of a premium you will need to pay to receive the desired payout. There are five different ways in which life insurance coverage is calculated:
- Human life value methodology – The quantity of life insurance coverage one should acquire is directly proportional to their human life value (HLV). This is the capitalised value for the estimated remaining years of one’s life. It is calculated using current inflation rates. Age, employment benefits, target retirement age, expenses, and earnings of the family are elements that determine the HLV.
- Income replacement value – This is an annual income-based technique of assessing your life insurance coverage needs. Here, we consider the income of the earning member of the family in the event he or she passes away unexpectedly.
Insurance coverage required = Annual income * Years remaining in retirement
For example, suppose you earn Rs 5 lakh per year, are 35 years old and aim to retire at the age of 60. So, right now you have another 25 years before retirement. Therefore, your required life insurance coverage in this scenario would be: Rs 5,00,000 * 25 = Rs 1.25 crores
- Needs analysis – This method might look a little complicated as it takes into account all the daily expenses of the family. It even considers the life expectancy of the family’s youngest member. Some of the key points to consider when using this method are:
- Number of dependents in the family and their basic requirements
- Marriage and education plans of children
- The type of lifestyle you wish to provide for your family
- Other unique requirements
When these expenses are added, you get an approximate figure that represents what amount your family would require in case you were to pass away today. But this is not the final amount. The final amount is achieved by subtracting the existing life insurance policies, if any, and all of the family’s assets.
- Underwriter’s thumb rule – According to this formula, the minimal amount covered must be a multiple of annual revenue multiplied by age. For example, if we consider 60 years to be the general retirement age, then people who are 25 would need life insurance coverage that is 35 times their annual earnings. People in their 40s can get life insurance for 20 times their annual income.
- Premium as a percentage – According to this method, life insurance premiums must equal 6% of the policyholder’s (earning member’s) annual earnings, plus an additional 1% for each dependent. This is after assuming the client’s gross annual income is Rs. 10 lakh, and they have a spouse and two infants to care for. As per this method, the proposed premium is:
6% * 1000000 + 1% * 1000000 * 3 = Rs. 90,000
The bottom line
It is important to understand that these methods indicate estimated values only, and also that life insurance coverage changes with time. So, we recommend that you contact financial experts before investing in these policies.