The pandemic of COVID-19 has given a heads-up to humans, reminding us all about the importance of buying a life insurance plan. Pertaining to which the demand for life insurance has spiked considerably in the past seven to eight months. Talking of life insurance, term insurance is the most popular option as it provides maximum cover at the lowest rate. Not to forget, term insurance is the purest form of life insurance that is easy to understand. All it does is, it pays out the sum assured amount to the family of the insured person if the policyholder dies during the policy term. If the policyholder survives during the entire policy term, then there is no payout.
Merely buying life insurance is not going to ensure the safe future of the policyholder’s family. The reason why people buy term insurance is that they want to ensure that if they face untimely death, their family’s goals, dreams, and quality of living doesn’t suffer. One must get an adequate sum assured to ensure that the family stays financially secured even in his/her absence. For that, the person must select the cover based on the future goals of his/her family members and take into account the inflation rate as well instead of deciding based on current needs and expenses.
Here are four methods to calculate the term insurance cover that will be enough to fulfil the needs of your family.
1. Human life value – The human life value or HLV takes into account the economic value of the person to the family. This method primarily considers the value of future income, expenditure, investments, and liabilities. Thus, the person needs to consider his/her income, expenses at the moment and future goals and responsibilities to determine the coverage needed. This method is trustworthy also because it takes into account the inflation rate. The first step to calculate human life value is to determine the cost of the current lifestyle and future goals in rupee at the moment. Based on it, the person can estimate the coverage he/she might need in future. Many insurers recommend to calculate term insurance coverage with HLV method. Hence, they have an HLV calculator on their website.
2. Income replacement value – In this method, the purpose of term insurance is taken to replace the lost earning with the demise of the breadwinner of the family. There is a simple formula to calculate the income replacement value of a person, which is: Insurance cover = Current annual income x years left before retirement.
For instance, if you are 40 years old, your yearly salary is ₹5 lakh, and you plan to retire at the age of 60 years, then the cover you will need is ₹5 lakh x 20 which is ₹1 crore. There is one drawback to this method. It may estimate a higher coverage amount.
3. Expense replacement method– This method is recommended by many financial planners as it takes into consideration everyday household expenses, loans, goals of policyholder’s kids, and future expenses of financially dependent parents. The figure you get combining all these factors is the term insurance coverage that your family might need.
4. Underwriter’s thumb rule – The underwriter’s thumb rule to calculate the minimum term insurance cover needed is ten times your annual income. Which means if your annual income is ₹20 lakh, the amount of coverage you will need is at least ₹2 crore. However, this method is not trusted by many investment advisors.
