NEW DELHI: When Prasad Patil bought a term insurance cover of Rs 1 crore, he was single and had no dependents. Now married, he feels the Rs 1 crore insurance cover won’t be enough to sustain his family’s needs and cover his goals 10 years down the line. “It may be adequate now, but I have to plan for a situation where we will have kids,” says the Mumbai-based self-employed professional.
Policyholders like Patil are a rare breed. To most others, a Rs 1 crore insurance cover seems sufficiently large to sustain their family’s expenses in case something untoward happens to them. “Many people buy a cover they are mentally comfortable with, and Rs 1 crore is a popular number. They buy without doing the basic math,” says Mahavir Chopra, Director, Health, Life and Strategic Initiatives, Coverfox.
To be fair, the eight figure sum certainly seems large. If a family puts Rs 1 crore in a bank deposit that earns 7 per cent interest, it will get a monthly income of Rs 58,333. That can sustain an average middle class Indian household.
Or can it? The amount won’t be as big when you take into account the outstanding loans taken by the policyholder, inflation and the impact of income tax. Also, one needs to put aside a corpus for one-time expenses such as children’s education and marriage and the retirement needs of the spouse. Our calculations show that if the individual has a home loan and two children, the Rs 1 crore received as insurance money will not sustain the family for more than 12-13 years.
Not surprisingly, many Indians are underinsured. A Swiss Re study conducted in 2014 found the shortfall in mortality protection in India to be as high as 92 per cent. In other words, the average Indian was insured for Rs 8 lakh though he required an insurance cover of Rs 1 crore. This can be attributed to poor awareness about insurance as well as the general fixation with insurance-cum-investment products.
CALCULATING INSURANCE NEEDS
One thumb rule says the insurance cover should be at least 8-10 times your annual income. But this is a rudimentary calculation that does not take into account the liabilities of the individual, his existing investments and the needs of the family. In reality, the financial situation of every individual is unique and a one-size-fits-all approach may not yield an accurate result.
The calculation should take into account the number of years your dependents will need a monthly income, your outstanding loans and the one-time expenses you have planned in the coming years. “If you have a home loan of Rs 50 lakh, that amount will straightaway get deducted. The balance amount, even if invested prudently, will not be able to take care of your family over a long period of time,” says Pankaj Mathpal, CEO, Optima Money Managers. This should be an eye opener for those with large home loans. The lender will not give your family a grace period to start repaying the EMIs after you are gone.
RETIREMENT KITTY FOR SPOUSE
The insurance cover should also cover your spouse’s future requirement, particularly if she is not earning. “Your cover must be capable of protecting your spouse’s old age requirements to enable a life of dignity and comfort. Consider the potential medical, living and help-related expenses,” says Rishi Mathur, Head, Products and Strategy, Canara HSBC Oriental Bank of Commerce Life Insurance. However, it is important to note that every individual and family’s needs are unique.
HUMAN LIFE VALUE
The concept of human life value (HLV) calculates the total income that the individual is expected to earn over the rest of his working life and discounts that future income by the expected inflation rate. In other words, the future income of that person is given at today’s prices.
The expenses incurred on the individual are subtracted from this value to show how much is the monetary value of the individual for the household. For instance, a 35-yearold woman, who has a 30 per cent share in household expenses and 50 per cent in home loan EMI, will have to factor in the annual cost of replacing these contributions. In addition, her life insurance policy should cover the present value of her contribution towards the child’s education corpus. This will give the inflation-adjusted total cost that needs to be replaced in the period of financial dependence of her child.
ACCOUNTING FOR INFLATION
Don’t forget inflation when calculating future costs. Your family’s needs will grow as prices keep rising. If your family needs Rs 50,000 a month in 2018, even a nominal 7 per cent inflation will push up that figure to Rs 70,000 a month in five years. By 2028, the monthly household expenses would be Rs 1 lakh. The insurance cover must factor this.
Experts say one must review one’s insurance cover every five years, particularly during critical milestones such as marriage and birth of children. Some policies have in-built features like increasing sum assured or life-stage linked enhancement. This does away with the need to buy additional cover periodically.
The increasing sum assured feature eliminates the procedural hassles, including medical check-ups, that fresh covers entail. It helps your family avoid a situation where the sum assured loses value over time.
Of course, not everybody needs a big term insurance cover. “It is meant purely to protect the financial needs of one’s dependents. If one has no dependents and doesn’t plan to have any, then a term plan can be avoided,” says Prerana Salaskar-Apte, financial planner and Partner, The Tipping Point.