It is best to revise one’s term insurance requirements at least once in every 5 years because of changing lifestyle and dreams and earning potential.
Today, as the world economy is growing so the standard of living of every individual and family is raising day by day. Having said that maintaining the standard of living is becoming a costly affair due to host of factors one of which is ‘inflation’. Prices of all products have increased but more importantly, the price of the basic necessities have increased. Thus, for a common man, it is becoming very difficult to sustain a good lifestyle with every passing day. Now to safeguard against any unforeseen adversity and to secure the family’s future an individual buys a term plan and normally it’s a 1Cr coverage plan. But considering this rise in prices and inflation does the one crore term insurance plan satisfy all the future financial needs of your family in your absence? Probably not. So let us understand how much cover one needs to cover all the contingencies.
To start with the biggest difficulty is calculating how much insurance is required i.e. knowing the value of life in terms of money. A net worth of an individual’s life is different at different stages of life. People usually think that it is beneficial to have a one crore term insurance plan as these plans offer financial stability and comfort to the family of the life insured in case of his death. But how can one be sure that one crore term plan is enough for his or her family? They could need more or even less than one crore for satisfying their financial needs so let us first understand how to calculate actually required insurance coverage for any individual.
It is a general rule of thumb that ideal insurance coverage for an individual should be 15-20 times of his or her annual income but this proposition does not take into consideration following factors like:
- Inflation
- Number of dependants in the family
- Loans that need to be finished
- Monthly expenses
- Contingency funds
Consider a scenario that one is not around to take care of his or her family and to satisfy their needs. Let’s assume that individual has taken a 1 crore term plan. Now with the help of following factors, we will now see whether this amount is sufficient for his or her family:
- Calculation of Current Expenses: The basic reason to buy term insurance policy is to safeguard the future financial needs of loved ones. Term insurance policy is purchased with a view that the loved ones have enough money in your absence to maintain their current standard of living. So one must calculate the current expenses accurately. The current expenses would include.
- School or college fees for children
- Unavoidable monthly expenses like electricity bill, Phone Bill, Gas Bill, Grocery etc.(multiply all these expenses by 12 to get accurate amount)
- Health Insurance Premiums
- Contingency fund and financial assets like FDs, Mutual Funds etc.
Adding all these expenses would give the annual total expense. Let’s assume all the unavoidable expenses cost Rs 3 lacs annually. But these expenses would increase every year so it would be difficult for an individual’s family to maintain the same standard of living with these 3 lacs. One must consider inflation factor while buying the term plan. So to maintain a similar standard of living the family would require Rs 11 lacs annually considering inflation rate to be 7%. Out of these 11 lacs, expenses amount to Rs 6 Lacs.So here goes the calculation; for the sake of family’s future in an individual’s absence for next 20 years this amount would be 20 years X 6 lacs = Rs 1.2 Crore (A)
- Calculate existing loans and disposable income: Next stage is to add disposable incomes like FD’s, Mutual Funds, Stocks etc. and subtract it from all existing loans like home loans, personal loans etc.
For E.g.: Suppose one has a housing loan EMI of Rs 20000 and 10 years are remaining for the same to be repaid in totality. So your liability comes out to be 20000 X 12 X 10 = Rs 24 Lacs.
Now assume the total amount of disposable income to be Rs 9 Lacs. Do a little math and subtract total disposable income from total liability to get your net liability: 24 lacs – 9 lacs = Rs 15 lacs (B).
- Expenses of Important Responsibilities or events: Here one must include expenses required for special events like marriages of children, foreign education of children etc. The amount one considers here are totally as per an individual’s wish. Now for calculation purpose let’s assume that we do not have any such expenses. So Expenses for Important events = NIL (C)
Now that we have calculated our daily requirement expenses, existing external liabilities and expenses required for important events, we can add all of them to arrive at the Actual Sum Assured needed.
So Actual Sum Assured = 1.2 Crore +15 Lacs +NIL = Rs 1.35 Crores.
Thus looking at the figures we can clearly state that an individual may require more than the customary Rs 1 Crore Term Plan Coverage. So it is best to revise one’s term insurance requirements at least once in every 5 years and if an individual thinks that he or she is underinsured then they must go for more insurance coverage.
Inadequate insurance is as good as to No Insurance