Include expenses on current and future needs, interest to be paid on loans and inflation while calculating the life cover amount
Life is indeed filled with various twists and turns. There could be various dangers and misfortune lurking in some unseen corners of life. In order to shield yourself from these unseen dangers, one must have a life insurance. But there is always a burning question that arises, "What is the right amount of coverage for me?" or "Will the life cover I have be sufficient enough for my loved ones?"
Calculating the correct coverage amount
The answer to this question varies from person to person. Every person has different needs, dependents and family members. Are you the sole breadwinner or do other family members also actively contribute to the family income? Let's have a look at a few such factors that need to be considered:
Family's complete needs: The first thing that you need to determine is what are your family's existing needs. In the case of an unfortunate incident like your untimely death, your loved ones should be able to carry on with their lives. The amount provided in the life insurance should be enough to meet the family's expenses till such a time the next family member becomes capable of earning. The amount that you arrive at becomes your income substitution cost.
Family's future needs: Providing for only the living and day-to-day expenses of the family is not enough. While the sole breadwinner is gone, needs of the family should not be compromised in any way. Especially, children's future education or wedding or your spouse's retirement expenses. One must also consider rising inflation while arriving at a decision. The price of goods and services may rise in the future and the value of money may not be the same in the future. Once you have determined this amount it should be added to your income substitution cost.
Current debts: There may be instances where one may have to borrow money to meet some expenses or goals. These could be home loans, car loans, personal loans, etc. These debts can weigh down the family in the absence of the breadwinner. To arrive at the correct life insurance coverage amount, one must first calculate all current debts. Also, don't forget to factor in the interest that you have paid on your loans and add this amount to the above amounts.
This step is very crucial because the lender will not forgo his money on your death. After you pass away, the lender will either seize the asset mortgaged or pressurise your family to pay off your loans.
Other ways of calculation
One can also arrive at the correct insurance coverage amount by using one of the following methods:
Multiplication of annual income: You must have heard people saying, "I have a life insurance cover X times my annual income". What does this mean? This is one of the easier ways of arriving at a sufficient amount of life coverage amount. It is a simple method which involves basic multiplication. In this calculation, only two factors are required which are your annual income and the multiple factor.
The most ideal multiple factor that one should choose should be 20 on the higher side and 15 on the lower side. These multiple factors will provide you with an appropriate life cover amount. So, if a person has an annual income of Rs 5 lakh, the ideal life cover amount for him will be 5,00,000 x 20 = 1,00,00,000, that is, Rs 1 crore.
Human life value (HLV) calculator: Nowadays, insurance companies and brokers have developed online variants of HLV calculators for determining the correct life insurance amount. These calculators consider the total income a person would be earning during the remainder of his working life. It also considers the expected inflation rate, while at the same time subtracts his current savings, existing life insurance cover, other investments. The final value shown is the person's monetary value for which he has to buy the life cover.
The best way of achieving complete peace of mind with regards to your family in your absence is having adequate life insurance coverage for yourself. While calculating the same, consider factors like income replacement, your family's life goals, inflation, retirement corpus for your spouse, accidental and critical illness cover.
The author is director – health, life and strategic initiatives, Coverfox.com
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