You know by now that insurance is an absolute necessity. But how to calculate sum assured or life insurance coverage needed? Inadequate insurance is as good as no insurance. Recently I attended a death ceremony of a relative. There was a lot of commotion with loan sharks asking for settlement at a death house. As inhuman as it may sound but it’s a reality we face in India.
The father who just passed away was paying Rs 16,000/- yearly premium. But yet his sum assured was less than 7 lakh. I don’t know what policy he was using. I’m sure it was not a term policy. But he owed Rs.3,00,000 principal with interest which the loaners were demanding. This is a pathetic situation. If he had bought a term policy with same premium amount, he could have easily got Sum Assured above Rs.60 lakhs.
We do not want you to repeat the same mistake. Using the below methodology, compute the sum assured you would need based on your financial situation. Note: It is almost 90% accurate.
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Advantages of Term Insurance policy
Even at the sake of repetition, we stress the importance of term insurance for an individual. It has variety of pros like
- It is the purest form of insurance. You should not even consider other insurance types if you do not have a term insurance policy.
- It is adjustable and cancel-able at any time. For eg., after 10 years you feel, there are no dependents on you. You can cancel the policy without any monetary loss. If you feel it’s inadequate you can top up or add a new policy. You never know what future holds for you. So it is best to have a flexible policy.
- It is cheaper than any other form of insurance . For Rs.4000 premium you can buy Rs.20,00,000 sum assured(assuming you’re around 30 years)
Related Wikipedia article: Brief history of Insurance in India
How to Calculate Sum Assured/Life Insurance Coverage
Step 1: Calculate your current expenses / monetary liabilities
The reason you take insurance is to make sure your loved ones have enough money to maintain their current standard of living in your absence. So you need to calculate this pretty accurately. Estimate the exact amount you spend each year currently like
- Your children’s fees and education expenses
- Expenses each month (like electricity,phone,gas,grocery,milk etc.). Multiply by 12
- Collective Insurance premium paid each year for each member of the family
- Medical insurance premium (if it’s a family floater)
- Include any other expenses (like gifts to friends, eating out , entertainment, recurring minor medical expenses)
This gives your annual total expenses which is unavoidable each year. Now comes the important part. These expenses will increase each year due to inflation and your family will need expenses until someone starts to earn (may be your son 20 years from now). If you’re 30 years old now then the time span is 20 years approx.
Related Read: What is Inflation and how it affects you
For eg., if the total expenses you arrive at is Rs.3,00,000 per annum. Do you think 20 years from now you family can maintain the same standard of living with this Rs.3lakh. Absolutely NO. Yet almost every sum assured calculation you find on the internet/books never seem to consider this inflation factor. And it’s a big mistake.
The current Rs.3,00,000 expense after 20 years considering 7% inflation will be Rs.11,00,000 per year. So to maintain the same standard of living 20 years from now your family needs Rs.11,00,000 lakh per year. Use INFLATION Calculator.This grows gradually at 7% from Rs.3 lakh to Rs.11 lakh. In this case, a simple average expense (rule of thumb) is around Rs. 6 lakh annual expense. So for daily expenses your family will need
For total 20 years, Rs.6lakh X 20 = Rs 1.2 crores = (A)
Note: The assumption here is that received insurance claim amount will not be re-invested. If invested, then the total 20 year expense will reduce as claim amount will earn interest each year. This interest can be used to cover part of expenses.
Step 2: Add your total liabilities and subtract your disposable assets
Suppose you owe a mortgage on your home and the total EMI is Rs 20,000 for 10 years. You have a personal loan or borrowed from your friend. Add all these into a lump sum amount. Assuming you just have mortgage, then
Total EMI outstanding= Rs. 20,000 * 12 *10 years = Rs. 24,00,000
If you have money in stocks, fixed deposits, PPF or jewels which you can dispose then subtract them. Assume worth of Disposable assets = Rs. 9,00,000
So, Rs.24,00,000 – Rs.9,00,000 = Rs. 15,00,000 (B)
Note: Each person’s outstandings and assets is different. So do your own calculation.
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Step 3: Add expenses of any important responsibility or events
This step includes to plan for your must have responsibilities/liking. For eg., you may want to provide for your daughter’s marriage, your son’s foreign education. These are entirely your desires. If you feel it’s important you need to include the cost they will involve. If you want a fat Punjabi wedding for your daughter, then you need to provide more
In this case let us assume we don’t have such expenses.
Arbitrary responsibility Expenses = Nil (C)
Now that we have calculated the daily expenses requirement, responsibility expenses, external liabilities we can arrive at the Sum Assured needed.
Sum Assured(in Rs.) = A+B+C = 1,20,00,000+15,00,000+0 = Rs 1.35 crores
Tip: Revise this Sum Assured every 5 years you survive. Based on that, either top up or reduce the Sum Assured. Also note that if your family will invest the insurance claim amount then this Sum Assured will reduce. To calculate LIC premium for arrived Sum Assured use this LIC Premium Calculator
So for this person, the sum assured or life insurance coverage needed is Rs 1.35 crores. You can use the similar approach to arrive at Sum Assured you need. Remember, inadequate insurance is similar to no insurance. And over insurance is wasting premiums which can be deployed usefully somewhere else. To compare policy rates you can use PolicyBazaar.com or MyInsuranceClub.com . Caution: These sites collect your contact details before giving comparison quote and will contact you.
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