HOW MUCH INSURANCE IS GOOD ENOUGH FOR YOU?

Sanjeev Sinha
The Economic Times

While everyone may advise you today to ‘get insured’, few will actually tell you how to get adequately covered. Have you, however, ever wondered how much cover is actually good enough for you? For instance, you might have several insurance policies, but are you also adequately insured? You need to know this, not only as an individual but as a consumer too – particularly in view of the fact that the majority of Indians are still either uninsured or underinsured.

For, “while too little life cover could result in the family not being financially self-sufficient in the event of the unfortunate death of the policyholder and chief wage earner, too much insurance would mean higher outgo of premiums at the cost of other necessary life-stage and lifestyle spends,” says Shyamal Saxena, chief distribution and marketing officer, Bharti AXA Life Insurance Company.

But getting adequately covered is also not easy as “there is no one single formula for deciding the amount of life insurance one needs,” says a senior executive of Tata AIG Life Insurance.

There are, however, certain thumb rules, which could be used to determine the life insurance needs. A very rudimentary method is 10-12 times your annual earnings.

“This is a thumb rule used to calculate the amount of insurance required by an individual. The sum insured basically should be equal to an amount, which, if invested, should fetch a regular income for the dependants of the insured so that they are able to maintain a lifestyle, which they are used to. In case there are any liabilities, such amounts should be added to the amount of insurance required,” informs Rajesh Relan, MD, MetLife India Insurance. The optional approach to ascertain life insurance need is the financial need analysis approach. This is an approach, which can take care of specific needs of an individual. Here the basic objective is that the insurance coverage should be sufficient to provide for the dependents’ needs in case the breadwinner should die early.

“The needs should include the client’s financial liabilities such as home loans, car loans etc and the funds required to support the dependants for the desired period. It may also include money required for specific family needs such as son’s/daughter’s education or marriage,” says the Tata AIG Life executive.

For example, if A has a housing loan of Rs 5 lakh, a car loan of Rs 4 lakh and his family requires Rs 15,000 per month if he is no more, the life insurance cover should be equal to the amount which will earn Rs 15,000 per month for the family and liquidate his outstanding home loan and car loan.

According to another view, while choosing a cover for a person with dependants, the sequencing should be ‘risk cover’ first and then ‘savings’. “The amount of cover is a factor of income and consequently the paying capacity, the nature of job, expected earning period, and amount of liabilities (personal loans, housing loans etc) reduced by any estate already existing (savings & investments),” says a top executive of Birla Sun Life Insurance.

To begin with, he says, an assessment of one’s own financial needs taking into account the life stage, risk profile, dependants, disposable income and liabilities has to be undertaken. This will help identify the protection and savings needs for the person. The protection should provide for all the liabilities and future earning potential of the person insured. This will at a minimum ensure that the lifestyle of the dependants is not significantly altered if anything unfortunate were to happen to the person. The savings portion will be determined by the financial goals of the individual.

“Needless to say, the key to any financial planning is to start early as the contributions required are lower and the power of compounding ensures large savings,” advises the Birla Sun Life executive. Another method used is the Human Life Value (HLV) method. According to this method, the amount of insurance one should buy is directly dependent on his/her economic value, otherwise known as the 'Human Life Value'. This varies from person to person. Human Life Value’ is the capitalized value of the net earning of an individual for the rest of his working span.

Under yet another approach, usually called ‘Underwriters Thumb Rule,’ life insurance need is a multiple of annual income depending on the age (see below). As an indicative rule, for instance, individuals between 20 and 30 years of age should have life insurance worth 15 times their annual income, while those above 56 years of age can have 6 times their annual income.

Once you know how much life insurance coverage you need and for how long, it’s important to analyse your needs. Need analysis is fundamental to choosing the right insurance product. “Typically you would have any/all of the following needs – protection, wealth accumulation, wealth maintenance, and retirement,” says Rajesh Relan, MD, MetLife India Insurance.

Protection needs include protection against death, disability and dreaded diseases. Products, which are suitable for this need, are term or whole life insurance with riders like critical illness, waiver of premium (WOP) or accidental death benefit (ADB).

Once you have understood your need and the suitable products for that need, you have to choose whether to buy a unit-linked or a traditional policy. Unit linked or traditional are two mechanisms to achieve your protection or wealth management goals. Traditional plans generally would have guarantees over the long term and hence are unique in the entire spectrum of financial products. Unit linked plans are also an effective mechanism to plan for your financial freedom as they give you the option to decide where you want to invest your money – equity or debt. However, they generally do not have any significant guarantees.

One significant point to note is that while choosing a cover for a person with dependants, the sequencing should be ‘risk cover’ first and then ‘savings’. However, if possible, the investment part should also be factored in.

“Insurance as an asset class is emerging not only as a means of protection for dying too young but against the risk of living too long. In that sense, the right insurance must have not just protection element but an investment portion too. This is possible if people look at life insurance as a long-term financial plan and allocate at least 20 percent of their monthly savings to this important asset class,” says P Nandagopal, CEO, Reliance Life Insurance.