The primary reason for purchasing a life insurance is to protect family members from financial burdens in adverse situations. However, lack of clarity on adequate sum insured still remains a major issue for an individual. Most individuals end up choosing a saving oriented unit-linked insurance policy (Ulip) or a traditional plan where the actual life cover is minimal and investment component is high, as a result of which, he remains underinsured and his family unprotected.
As per Insurance Regulatory and Development Authority's financial year 2010-11 (FY11) annual report, the average sum assured per in-force life insurance policy is only Rs 1,17,144. Here are few methods, to calculate adequate life cover: For those who have not taken loans: The basic method to know adequate life cover, you first need to calculate your net annual income by deducting annual personal expenses from the annual income after taxes. Then a multiple of income generating years has to be calculated by subtracting present age from expected retirement age.
For instance, if the individual is 25 year old and is expected to work till 60 years, then the multiple would be 35, while if the individual is 50 year old, then the multiple would be 10.
Supposing your net annual income is Rs 4 lakh and you expect to work for the next 25 years, then the adequate sum insured for you would be Rs 1 crore. You should take out a term policy on this amount for the longest tenure available to you.
For those who have taken loans : “For people who have taken loans, a more robust and analytical method should be used.
The method that we use considers their monthly expenses, loan instalments and expected long-term deposit rate,” said Vijay Sinha, senior vice-president of product development at Tata AIA Life Insurance.
Supposing you have an outstanding loan of Rs 60 lakh, then your sum assured should be at least this much. To this, you add that sum of money which when invested in a safe fixed-income instrument, will give you an annual interest that will match your annual household expenses (total minus loan instalments since the latter is taken care of in the Rs 60 lakh base figure for covering the loan).
Say, the expense figure is Rs 3 lakh and the annual interest rate on a safe bank fixed deposit is six per cent.
At this rate of interest, a Rs 50 lakh amount will give you Rs 3 lakh per year. Your total life cover, therefore, should be Rs 1.1 crore (Rs 60 lakh + Rs 50 lakh). “For financial savvy customers, we recommend human life value method which factors in inflation as well. Under human life value, income, potential growth over policyholder's working life and an estimated value of inflation are considered,“ said Malay Ghosh, president and executive director of Reliance Life Insurance.
Avoid tax trap: Don't try to capture Rs 1 lakh worth of Section 80C tax benefit by investing a large sum in Ulips and get a very low, or inadequate, life cover. Instead, pay just Rs 10,000Rs 25,000 towards a pure term life policy and invest the balance in 80C-eligible avenues, such as public provident fund (PPF), taxsaving bank deposits and mutual fund schemes.