You never know what is enough, until you know what is more than enough. ~William Blake
There are so many people, who ask me the big question: how much life insurance do I need? I have heard it from 21 yr old working in BPO’s, 35 yr old married person with wife and children,from super rich HNI’s and so on.
Many life insurance sales agents who are out selling life insurance start out by asking the following question : ‘How much insurance premium do you want to pay in a year”. Unfortunately many people take up wrong life insurance product on the basis of thier premium paying capacity.
My advise to you is that if you come across such life insurance agent, simply get up and walk away. Insurance is a need and should not be reverse engineered. The sum assured has to be decided first. And then the appropriate life insurance product has to be chosen. So, this leads us to the question – How much life insurance do I need?
If at all you are looking for insurance coverage, and truly there is a need, then the term life insurance is the way to go. All Other types of policies have some kind investment built into the insurance policy and may turn out to be inadequate. Term policies are simple to understand. They offer a certain amount of coverage over a certain period of time. If you die within that time period, your beneficiary will receive the value of the insurance. Period. As simple as that. Pure insurance.
Point number 1 – Not everyone needs life insurance. The Super Rich HNI’s or People who have accumulated enough wealth throughout their lives often might have no need for life insurance as they’ve accumulated enough wealth on their own to sustain their family. Also, people with no dependents often have little need for life insurance.
The important question – how much insurance do I need? The following pointers should help in answering this all important question:
(A) Income shortfall for the dependents – How much money each year would your survivors need to maintain their current standard of living? Take into consideration the annual expenses like home loans , auto loans, Rent, Debt repayment, education expenses, household running expenses, entertainment expenses, home maintainance, general insurance, and various other expenses (which are recurring in nature) and add them up.
(B) Time for which they need this income – If children are young, it will be quite a while (say 20 yrs or so). If you just have a spouse, the need might not need it for as long. For parents, get a term which is long enough so that the children become independent before the term expires. Shorter terms tend to have cheaper monthly premiums, but you may find yourself buying a new, more expensive policy in 10 or 20 years time frame. Remember the younger you are the cheaper are the insurance premiums. Of course, one can plan to increase the policy in a staggered manner in 5-10 years depending on the major changes in life)
(C) Future Lump Sum requirements: Things which should be considered : child education cost in future (Graduation/ Post Graduation), child marriage cost in future, any special care needs (for example, taking care of elderly parents after you’re gone?).
(D) Current Assets – how much do you have now? What’s in your savings? Your investments (FD’s, Provident Fund, Mutual Funds, Stocks, Real Estate)? What other insurance policies do you have? Will the dependents be willing to sell off the house and downgrade or would you like them to maintain the current lifestyle?
The above pointers are essentially doing a Gap Analysis and Identifying the Gap. A*B + C – D That’s how much life insurance you should have, Roughly speaking, which will be required to plug the Gap. Please read the time value of money in my previous post (What is Time Value of Money) , to better understand future value requirements and converting them to present value. This will help you to arrive at proper numbers.
In case of unsure of certain numbers, you can make a rough estimate. It is always better to make the estimates on the upper side rather than letting your loved one’s down in case if ever the unfortunate event were to happen.
Finally , be aware that life insurance is bought for the benefit of loved ones. Having sufficient cover provides you with a peace of mind.
Do the calculations, ask pertinent questions to the people selling insurance. Asking the right questions will help in procuring optimal policies. And of course the knowledge will give a good night sleep.
Pls note that the above method is to quickly and roughly estimate the insurance need. Inflation etc, needs to be considered in doing a detailed analysis. In future post, I will cover some quantitative methods (Human Life Value, Need Based Analysis, Income replacement method etc.) and probably present a spreadsheet with case study which will help you in actually understanding the doing the calculation.