How much Life Insurance Cover should i avail? This is one of the most common questions creeping on personal finance forums/newspapers. Certified Financial Planners suggest that a cover of 10 times your annual income is sufficient. I find same suggestion for all such queries. Now, this advice is deep rooted in psychic of an individual who does proper research before buying a Life Insurance Cover.
Recently i wrote a post, Life Insurance Plan – 5 Possible reasons why you should not buy. In that post, i highlighted 5 general cases under which an individual doesn’t need Life Insurance Cover. There might be cases wherein the need of Life Insurance Cover is more than 10 times the annual income. On the contrary, there can be cases with the lesser requirement. The point i am trying to make is that Life Insurance Cover is need based. We cannot generalize it as a thumb/universal rule.
You must be wondering why i am stressing so much on the quantum of Life Insurance Cover. There are 2 key reasons for the same. The first reason is that it financially impacts you. Today i am paying approx 1L premium annually. It works out to be approx Rs 8,333 per month. It also includes a premium of traditional plans like money back and endowment plans. These plans are more of investment plans. In my opinion, it is a huge sum. If i calculate right life insurance cover based on my needs then i could have saved the premium by not opting for couple of policies.
On the contrary, the second reason is now i am worried whether the cover availed by me will be sufficient for my family in case of any unforeseen event. On a lighter note, the worst part about the insurance is that i cannot practically find out its utility/sufficiency till the unforeseen event actually occurs :). It is all based on assumptions and likely scenarios. I will not mind paying an extra premium in case my existing Life Insurance Cover i.e. 10 times annual income is not sufficient. In such scenarios, to justify lower or NO cover, people make all kind of excuses to escape. I shared it in my post, Insurance – Top 7 excuses.
The basic objective of insurance is to provide protection against the financial loss. In this case, the financial loss is subjective and vary from case to case. It will be right to say that it is perceived financial loss. The reason being, the quantum of financial loss will depend on multiple factors. Let’s check some of the critical factors to be considered before deciding on the life insurance cover. In my opinion, these factors are critical though i never found any reference to most of these factors in the literature on insurance. One of the reason might be that the insurance companies would like to keep things simple because insurance itself is a complex subject.
Is Life Insurance Cover 10 times Your Income Sufficient for Your Family?
1. No of Children:
In my opinion, this is a very important factor that is completely ignored by the financial planners. At the macro level, a person with two children will need higher life insurance cover compared to a person with 1 child. Assuming the inflation-adjusted cost of raising a child is 50L and i have a life insurance cover of 1.5 Cr. I decided to extend my family and now i have 2 children. In this case, i need to top up my existing life insurance cover with 50L. As i mentioned that life insurance cover is need based.
The age of a child can be another criterion but then calculations will be too complex. Therefore, to keep it simple you can consider no of children as a critical factor to decide the cover.
2. No of Dependents:
Here i am referring to dependent parents or siblings. No prizes for guessing that more no of dependents means the need of a higher life insurance cover. In such scenarios, any cover bought specifically for dependent parents or siblings, the nomination and WILL should mention them as the beneficiary of life insurance cover. This is must, to avoid any future dispute within the family else the purpose of availing life insurance cover will be defeated.
3. Source of Income:
In you have multiple sources of income, your financial dependency on life insurance cover is less. For example, in the case of working spouse, you may opt for lower cover. If your spouse is not working then the insurance need is high. You should also evaluate your insurance needs from time to time or at every imp event in life.
To share an example, a few years back my wife was working and accordingly i availed a cover of 1 Cr. Today due to some unforeseen circumstances or family compulsions she decided to leave her job and become a housewife. In this case, i need to reevaluate my insurance needs. To fine tune my life cover in view of recent development of my wife leaving a job, i may opt for the additional cover of 75L.
Here i will refer to Home loan for reference purpose. The reason being, a home loan is a single biggest liability during a lifetime. Other types of debts or loans like personal loan, auto loan, consumer durable loan etc are of low value.
Normally the banks and HFC’s push Home Loan Protection Plan to hedge the risk of home loan foreclosure in case of any unfortunate event. Home loan protection plan has its own limitations and disadvantages as i shared in my post on the same topic. In my personal opinion, availing term insurance policy equivalent to home loan amount is cost effective and better option. The only catch is that the beneficiary of life insurance cover availed against loans and debts should be same as the beneficiary of mortgaged assets.
Secondly, you should always keep your insurance needs separate from cover required to hedge debts and loans. Even if we go by the suggestion of financial planners to avail cover equivalent to 10 times annual income then it should be exclusive of any liabilities like loans and debts. For example, i have life insurance cover of 3 Cr and avail a home loan of 75L. In this case, i should buy a separate cover of 75L to hedge the home loan risk.
Words of Wisdom:
We can independently assess the risk and can arrive at the quantum of life insurance cover. The million dollar question is whether insurance companies will agree to provide the life insurance cover based on my need or not. The insurance companies have their internal risk assessment or underwriting process. If any individual applies for high-value life insurance cover then insurance companies become skeptical on the reason for the same.
To explain the risk of insurance companies, let’s understand with an example. I am not sure how many of you watched a movie “Gambler” of Govinda. In that movie, the actor knew that he is going to die and buy a life insurance cover. Thankfully he survived because the death alarm was fake. Imagine if the actor would have died then the insurance company would have been at a big loss :). The fake and fraudulent claims are another major concern for insurance companies.
Moreover, after recent changes in Insurance laws, no claim can be rejected after 3 years for any reason even if it is a fraudulent claim. Therefore, the underwriting process is now more stringent. On the contrary, if your insurance need is low then you can save insurance premium as i explained earlier. At the same time, you should also keep a tab on Free or Cheap insurance covers inbuilt with some financial products. These free covers may come handy during distress.
Please note that all the examples and figs mentioned in this post are only for reference purpose.
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