How to calculate if you have adequate insurance
What sum assured do you think is enough when buying a life insurance policy? Rs. 50 lakhs? Rs. 1 crore? Rs. 2 crores? Actually, this depends on your income, expenses, dependents and a number of other factors. Most people choose the sum assured based on the premium rather than their requirements. So, they settle for low coverage because of the cheap premium.
The lack of knowledge about an optimal sum assured results in people choose a sum assured that is lower than their needs. So, how do you determine what is an optimal life insurance coverage amount? There are a few methods and techniques that can help you find out how much you and your family will require from a policy. Here are the techniques.
Income Multiplier Technique
If you don’t like maths or calculations, then this technique will help you find your insurance requirement easily. You just need to multiply your income by a factor based on the age group you belong to. You can arrive at a minimum and maximum insurance cover that would be enough for your age and income. For instance, the technique states that you should have a coverage that is 10 to 20 times your annual income if you are 30 years old. So, if your annual income is Rs. 10 lakhs now, your coverage should be Rs. 1 crore to Rs. 2 crores.
Underwriters’ Thumb Rule Technique
This is a similar to the Income Multiplier technique. You need to take a multiple of your annual income to be the optimal cover. The difference is that the Income Multiplier technique talks about a range of sum assured that an individual will need while the Underwriter’s Thumb Rule technique gives a specific sum assured for an age group.
At lower ages, the multiplier is high, spelling the need for higher coverage. At higher ages, the factor reduces as the requirement of coverage will reduce once you repay all your liabilities and achieve goals such as your children’s higher education.
Here are the different multiplier factors under the Underwriter’s Thumb Rule.
| Age group | Multiplier |
| 20-30 years | 15 |
| 31-40 years | 14 |
| 41-45 years | 12 |
| 46-50 years | 10 |
| 51-56 years | 8 |
| 56 years and above | 6 |
Income Replacement Method
Under this technique, the insurance amount will be based on the value of the income the insured can expect to earn during his or her lifetime. This method seeks to replace your expected income with the policy proceeds in case of your premature death. The method takes into account your present age, your expected working tenure and your annual income. It excludes inflation, any increase in income that you might have in future, and voluntary retirement that you might take before the expected retirement age.
Here’s how this technique works:
| Present age of the insured | 30 years |
| Expected retirement age of the insured | 60 years |
| Active working years left | 30 |
| Present annual income | Rs. 7 lakhs |
| Expected income over the remaining active working life | Rs. 7 lakh x 30 = Rs. 2.1 crores |
The technique assumes that your family expects you to contribute about Rs. 2.1 crores in the years that you will remain employed. In case of your premature death, your family will lose out on this income. Thus, the technique states that you should buy a cover of at least Rs. 2.1 crore which will replace your expected income.
Human Life Value Method
This is the most popular method for calculating life insurance needs. The Human Life Value (HLV) method follows the Income Replacement method with a difference. Instead of replacing the expected income, it seeks to create a corpus which, when invested, will yield the present level of income every year for your family.
For instance, if your annual income is Rs. 7 lakhs, you should create a corpus which, when invested yields a return of Rs. 7 lakhs annually to enable your family to replicate your contribution to your family. Let’s say the rate of return is 8%, the corpus should be (7 lakh/0.08) = Rs. 87.5 lakhs. You should add your existing liabilities and deduct any existing assets to the insurance amount to arrive at the ideal sum assured.
Need Analysis Technique
This technique considers the life stage you are in, your financial goals, your annual expenses your savings, your existing liabilities, your assets, etc to calculate your life insurance amount.
What should you do?
Many online insurance aggregators provide life insurance calculators. When you input the required information, the calculator can compute your ideal sum assured. Even though you can use this information, it is good if you can bring the wisdom of all the above mentioned techniques together to compute the sum assured that is best suited to your family’s needs. You should remember to factor in the inflation rate, your liabilities, financial goals and any contingencies (such as health emergencies). Only after you make a detailed analysis, you should consider a sum assured for your life insurance policy.
Remember that a life insurance policy gives you and your family financial security and this security is possible only if you choose the correct sum assured. So, consider every possible factor before you zero in on a sum assured.
