Ok. So you are finally convinced of the desirability of term insurance and have decided to go for it. However, the question now is how much insurance cover you should opt for. Will 20 lakh be enough, or should it be 30 lakh, 50 lakh, 1 crore…?
The question would not arise if the premiums rose significantly with insurance cover. In that case, the higher cover policies would be significantly more expensive and your choice would be limited by how much premium payment you can afford. As things stand however, premiums do not rise too much with the rise in cover and even higher cover policies would be well within your reach. Therefore, it really becomes difficult to decide how much cover you should seek. Let’s see how people generally decide that.
Problems in Deciding the Traditional Way
Many people, whom I ask the question, answer it in a weird way. Without any thought or calculation, they come up with numbers like 5 lakh, or 10 lakh, or more, saying that would be enough for them. But when I ask them how the amount will meet the needs of their family members when they are no more; how much will go under what head; no one is able to give a satisfactory answer. So, is this a game of making guesses? No. It is a serious business and is going to affect your family in a really serious way if, God forbid, something unexpected happens to you.
Some other, more enterprising people have devised novel methods to calculate their insurance cover needs. They say a cover of 10 times one’s annual income is enough. But is it? If someone earns Rs. 8 lakh a year with the spouse also working and no dependent parents, has only one or two children, and possesses a good corpus of investment, does he still need an insurance cover of 80 lakh? And on the other hand, if someone earns only Rs. 4 lakh a year with the spouse not working, has 4 children along with dependent parents, and has a home loan to pay off, will an insurance cover of Rs. 40 lakh be enough for him? I am sure your answer in both the cases is no. After all, there are varied requirements of everyone’s family which they should be able to meet with the amount they receive. For example:
- A regular income to meet their daily needs, which are being met at present with your salary.
- Clearing off the debts if you have any, like home loan, or car loan, or other small time debts.
- Meeting future expenses of your children, like education and marriage.
- Meeting any unforeseen circumstances or emergencies, like accidents or illnesses.
So now you see, deciding insurance cover is a serious business and depends on the particular situation of every individual. So, while deciding the insurance cover for you, ask yourself some fundamental questions: What are the current and future requirements of your family members, how much money they will need to meet each of those different needs, what liabilities you have at present that will have to be taken care of, what assets you possess that can supplement the insurance money, and so on. Let’s understand it with an example:
The Right Way of Deciding the Cover
Paul earns Rs. 4 lakh a year and is told by his insurance agent that a cover of 10-15 times his annual income is enough for him. So, he wants to buy a policy with a cover of Rs. 50 lakh. But before that he decides to talk to me. Following is an account of our conversation:
I: So you believe Rs. 50 lakh would be a good insurance cover for you. Fine. Now suppose you are no more and your family gets Rs. 50 lakh. How are they going to meet their needs now?
Paul: Well, our monthly expenditure at present is about Rs. 20,000. So, they can invest Rs. 30 lakh from that amount in a fixed deposit. At 8%, it will give an interest of Rs. 2.4 lakh a year which is Rs. 20,000 per month.
I: Not really a best method of investment, but yes, workable and safe. Next?
Paul: The remaining 20 lakh will be enough of their other needs.
I: Which needs? Be exact.
Paul: Education of my children. I have 3 children and they can get good education with Rs. 20 lakh.
I: Think in terms of future. Your children still have at least 12 years before they go to college. Rs. 20 lakh can get them good education today, but will that be enough 12 years hence? You know education costs are rising by about 10% every year. So, Rs. 60 lakh will be required for the higher education of your children 12 years from now.
Paul (thinking): Yes. You’re right. So, Rs. 60 lakh are needed for that. That means I need to increase my cover by Rs. 40 lakh.
I: No. Again wrong. Rs. 20 lakh is enough for your children’s education because they will need it 12 years from now. The amount can be invested in a way that it gives a return of 10% and that will give Rs. 60 lakh after 12 years.
Paul: So you were fooling around with me?
I: No, I was just testing your presence of mind. But, your 50 lakh will be exhausted this way. What about other needs of your family?
Paul: What other needs? I don’t think there will be other needs.
I: Really? Don’t you have any liabilities? Loans perhaps?
Paul: I had taken a car loan but I have paid off most of it. Only Rs. 6 lakh remain. Should I take into account even that?
I: Don’t, if you don’t think it necessary. But suppose I kill you just now. Your family will have to pay 6 lakh from that 20 lakh. Won’t your children’s education be compromised then?
Paul (desperate to kick me): Ok,ok. Add another 6 lakh. So, I need Rs. 56 lakh cover.
I: Don’t be in such a hurry. Isn’t there anything else you would like to provide for your family (he lives in a rented house; I am trying to hint at that).
Paul (thinking hard, and possibly feeling guilty now): Oh yes, I don’t own a home yet. I am planning to buy one now. Will cost about Rs. 30 lakh. No? (Smartie, earns Rs. 4 lakh a year and thinking of Rs. 30 lakh; doesn’t have a home, but bought a Home Theater last month).
I: So, will you like your family to continue living in a rented house since you wouldn’t be there to enjoy the comforts of home?
Paul (looking concerned now): No, no. So, I will have to add Rs. 30 lakh more. That means Rs. 86 lakh. Enough now?
I: And does your family have some special blessings from God? Do you think your old parents will never need any medical care, or your family members will never have an accident? No such emergencies will occur in your family?
Paul (irritated beyond measure now): Oh, leave all that. Nothing has happened so far. Why should I think it can happen in the future?
I: Why then do you think you can die suddenly? Why are you taking term insurance in the first place?
Paul: Ok. Go ahead. How much for that then?
I: You have no means to know exactly how much but you can certainly make a provision for an additional Rs. 10 lakh for emergencies. Something will certainly be better than nothing, no?
Paul: Ok. Rs. 10 lakh more then. Rs. 96 lakh, alright?
I: Better now. I still won’t say this is the best plan but it is certainly much better than your earlier estimate of 10-15 times your annual income. Isn’t it?
Paul: Yes it is. But how am I going to pay for this extra cover of Rs. 46 lakh?
I: How much more will it cost you? Hardly Rs. 10,000 more in a year. Is that too much? Can’t you control your expenditure on things like latest mobiles and Home Theater for that?
Pau: Yes, you are right. I got it now. Thanks a lot.
What We Learn from It
So, now you see how you should go about deciding your insurance cover? By the way, Paul is only 30 years of age. But even if you are older, an additional cover of 46 lakh will not cost you more than Rs. 20,000 annually. And in Paul’s case, we did not consider any assets. If you have some assets, then your insurance cover will go down by that much. So, we learn two things for all this:
- Providing for enough cover to meet all the present and future needs of your loved ones should be your first priority. All other things of desire should come only after that.
- It will not cost you a fortune to do that. Term insurance is really cheap. You just need to go about it intelligently, asking yourself what the requirements of your loved ones are going to be.