Do you have adequate life insurance cover? This is how you can estimate life insurance cover!
Insurance planning is the most important section of financial planning. Insurance protects financially in case of occurrence of any unfortunate event. Life insurance is designed primarily to protect the dependents or beneficiaries in case of the insured’s unexpected death. Through life insurance, the beneficiaries will have the financial resources to protect their future income and pay for immediate & future financial obligations. Purchasing adequate insurance cover is very important; underinsurance, as well as over-insurance both, can be risky. Underinsurance can lead to great financial stress in case of unfortunate events. On the contrary, over-insurance can lead to higher monthly premiums, which may hamper your current finances. With this, we come to know the importance of purchasing adequate insurance cover, which won’t cause financial stress and support in hard times.
There are two popular ways of estimating insurance cover:
For instance,
Mr and Mrs Jha aged 36 & 32 years have a life expectancy of another 40 years. Their data depicts the following information:
• Mr Jha is the sole breadwinner of the family and has no children.
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• Current investments have a market value of Rs 15 lakh.
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• Annual expenses of Rs 3 lakh (including Rs 50,000 of Mr Jha's personal expenses)
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• Mr Jha’s income post-tax is Rs 5 lakh. He will retire at the age of 60.
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• The inflation rate of 6 per cent per annum, salary growth is 5 per cent and returns on investment are 7.5 per cent p.a.
Let’s see what insurance cover Mr Jha will require using both the abovementioned methods
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Needs Approach:
Annual expenses = Rs 3 lakh
Less: Mr Jha’s expenses (as after the death of Mr Jha, these expenses won’t be required and so, it will get deducted)
Net annual expenses = Rs 1.5 lakh (Rs 3 lakh - Rs 50 thousand) Mrs Jha will require in case Mr Jha dies.
Inflation rate = 6 per cent p.a.
Investment rate = 7.5 per cent p.a.
Real rate of return = 1.415 per cent
Life expectancy of Mrs Jha = 40 years (Mrs Jha will require annual expenses for 40 years in case Mr Jha dies).
The current investment that they already possess = Rs 20 lakh (will deduct this amount as insurance is needed are in excess of investment).
Therefore, life cover required = Rs 57,03,794.88.
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Human Life Value Approach
The post-tax annual income of Mr Jha = Rs 5 lakh (Mrs Jha will require income replacement of Rs 5 lakh, which will be growing by the salary growth rate in case Mr Jha dies).
Salary growth rate = 5 per cent p.a.
Investment rate = 7.5 per cent p.a.
Real rate of return = 2.381 per cent p.a.
The current investment that they already possess = Rs 20 lakh (will deduct this amount as insurance is needed in excess of investment).
Therefore, life cover required = Rs 83,74,895.71.
