How much insurance cover we need?

After we saw how to set and track our financial goals, it is important to know whether we are sufficiently covered for life.

There are many methods available to calculate the insurance cover like as simple as multiply the yearly expense by 10 to more complicated one  like real life value. I have learned a more practical approach where the insurance value (I.V) is calculated  based on three factors

1. Real Expense
2. Goals and
3. Liability

Let us take an example:

Personal Profile:

	Name	Age	Income
Self	Arun	30	10,00,000
Spouse	Lavanya	27	-
Kid	Ajay	1	-

Financial Profile:

Annual Expense		7,50,000
Savings		5,00,000
Liablity	Home Loan	25,00,000
Goals	Ajay Education	10,00,000
	Ajay Marriage	6,00,000

Real Expense Calculation:
For every insurance calculation we need to calculate the actual annual expense. Arun has mentioned that he is spending R.s. 7,50,000 annually. In that he is investing around Rs.1,00,000 and paying EMI of Rs.3,00,000 so we need to subtract these values from his annual expense

7,50,000 - 4,00,000 = 3,50,000

assuming that his expense alone out of this total expense is 10%

350000 - 35000 = 3,15,000

Rs.3,15,000 is required by the family every year to meet the personal expense should something happen to Arun.

Expense Corpus calculation to generate Rs.3,15,000 annually  :
Expected Inflation: 6%
Expected Returns: 9% (Should be safe enough in absence of bread winner)

Effective Returns: 9-6 =  4%

Tax Slab : 20%
Pre Tax Annual Requirement : Rs. 3,93,750

Expense Corpus Required = 393750 * 100/4(Effective Return) = Rs. 98,43,750


Life Insurance Calculation:
I.V = Expense Corpus + Goal Value (Today's Value) + Liablity - Net Worth
I.V = 98,43,750 + 16,00,000 +25,00,000 - 5,00,000 = Rs. 1,34,43,750


Which Insurance to Choose?
There are many types of insurance policy available in the market like plain vanilla Term plan, Monthly income plan, Endowment plan and ULIP. As you might know that for the coverage of around 1.3 crores Arun cant afford premium in any of the plan except the term insurance.

The important thing to note is insurance is not investment, it helps your family in case of any eventuality so you should not fall into prey of getting returns from the insurance premium you pay.

I have taken an example to show you how much premium Arun will need to pay in case if he choose a term insurance.

Plan : Aviva i-Life
S.A : 1.3 Crores
Age : 30
Policy Term: 35
Non Smoker

Premium : R.s 10,612 Annually

Some thoughts:

I feel that this method gives me more accurate value of my insurance requirement. However there are some variable components involved in this calculation like

• Expense which may go up or down ( Not based on inflation which we already factored in, but based on the need like kids expense may go up considerably once he joins the school etc). 
• Goal: It may go up once you have another kid or when you have more goals

so it is very much important to do the calculation once in 2 years at-least and  add/reduce your insurance coverage accordingly. To start with I suggest taking 3 term insurance plan for Expense,Goal and Liability respectively and once the goal is achieved are you have no liability stop the insurance of those two. 

Summary:

• Always take term insurance (Online preferable).
• Review the requirements once in 2 years and add/remove covers.
• Never lie while filling the insurance application. In case if you missed or lied anything call them and correct the mistake now itself. Even if they cancel the policy, it is ok rather than living in false belief that your dependents will get the S.A in future. 
• Fill the application by yourself.
• Never let the insurance agent talk.

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