4 Ways to Calculate Coverage of Your Term Life Insurance

September 25, 2021 Mutual Fund

Life is full of uncertainty, and you never know what tomorrow will bring for you. If you are the sole breadwinner of the family, at the back of your mind, you have thought about your family’s financial security in your absence. Securing your family with Term Life Insurance is an ultimate solution that ensures your family is financially protected in case of an unfortunate demise of the insured.

What is Term Insurance?

Term Insurance is the purest and most affordable form of life insurance that provides coverage for a certain period called ‘term’. In case of the policyholder’s unfortunate demise, it provides financial protection to their family. The policyholder is not a beneficiary in this type of insurance because the sum assured is given to the nominee in case of the death of the policyholder.

A policyholder is required to pay a premium for a chosen term; failing to do so will result in policy lapse. The three significant factors affecting the premium are the policyholder’s age, sum assured, and the policy term. In addition, the policyholder’s health and their medical history are also taken into consideration while calculating the premium.

If the policyholder survives the policy term, they get an option to renew the policy for a new term. However, the premium is calculated considering the age and health conditions at the time of the renewal.

How much life insurance coverage do you need?

We all are aware that buying a life insurance policy is essential to secure our family’s financial needs. But, the question arises, how much life insurance coverage does one need?

There are many methods to calculate the life insurance coverage you require. Hence, there is no ideal figure to be specific. However, we will focus on the four most effective strategies that are widely used to calculate the life insurance coverage:

1. Human Life Value:

This method focuses on a person’s economic value or Human Life Value to their family. The monetary value of a person’s life is nothing but a present value of the future income that they could expect to earn for their family. Since it is a prospective amount, the inflation rate is also considered while calculating a Human Life Value. So, according to this method, the life insurance coverage of a person should be in proportion to their Human Life Value.

Most insurance companies use this method to calculate the life insurance coverage a person needs. You will find a Human Life Value Calculator on most insurance companies’ websites, which will automatically give you a figure of your life’s economic value to your family after you provide the required details. Since each insurance company considers different factors for calculation, the amount of Human Life Value may vary from insurer to insurer. However, most insurance companies typically consider these factors:

• Age

• Gender

• Annual income

• Retirement age

• Outstanding loans

• Current savings

• Current life insurance coverage

Let’s take the example of Radhika. 30 years old Radhika’s current financial details are as below:

(Disclaimer: This calculation is shown for your reference. The amount may vary as each insurer considers different factors for calculating the Human Life Value)

2. Income Replacement Value:

With the demise of the sole breadwinner, a family may have to go through unexpected financial problems. The Income Replacement Value method focuses on replacing the policyholder’s lost income so that their family can continue with the same lifestyle even in the absence of the policyholder.

While there are multiple ways to calculate the Income Replacement Value, the most straightforward and widely used method is:

Current annual income X No. of years left for retirement

So, if we continue with Radhika’s example, assuming her annual income as Rs 7 Lakhs, and she would like to get retired at the age of 60, as per the Income Replacement Value method, her life insurance coverage should be:

7,00,000 X 30 = 2.10 Cr.

3. Expense Replacement:

As the name suggests, the Expense Replacement approach considers a person’s day-to-day expenses, outstanding loans, family members’ important life milestones like child’s education, wedding, the retirement of spouse, etc.

So, the total of all these possible expenses is the amount your family is going to need in the future. And, if you deduct your existing assets and investments from it, you will get the amount of life insurance coverage you need. However, one should not count the assets that the family would not sell, like the house you live in.

Apart from calculating the life insurance coverage requirement, this method is also helpful to calculate your post retirement requirements.

4. Underwriter’s Thumb Rule:

As per Underwriter’s Thumb Rule method, a person should have life insurance coverage in multiple of their annual income depending on their age. So, for instance, if you are in the age group of 21-30 years, your life insurance coverage should be 25 times your annual income. Whereas, if your age is between 31- 40 years, your life insurance coverage should be 20 times your annual income, and so on post

Some insurance advisors suggest opting for a life insurance coverage of 10 times your annual income, irrespective of the age, since it is easy for a layman to calculate and understand. However, one needs to consider other important factors, such as future expenses, current investments, etc., which are completely ignored in this approach.

Factors affecting your life insurance premium:

Once you have calculated the life insurance coverage you need, it is necessary to check how much premium it costs. Although you need to have sufficient coverage, your premium should also be affordable. If you fail to pay the premium even after the grace period, your life insurance policy lapses. Therefore, it is not advisable to opt for excess coverage as it might create a burden of premiums.

• Your Age:

  The age of a policyholder plays a vital role in calculating required life insurance coverage and the premium. Younger people need more life insurance coverage as they have higher responsibilities towards their families. In addition, since the risk of paying a death benefit is lower for younger people, the premium is also lower.

• Gender:

  As most of us are aware that the life expectancy of females is more than the life expectancy of males, most insurance companies charge a slightly lower premium to female policyholders than their male counterparts.

• Medical History:

  An insurance company may ask for a medical check-up before you purchase a life insurance policy. This is because some health conditions like obesity, high blood pressure, high cholesterol, etc., can increase health related complications. Hence, the insurance company charges a higher premium in such cases. If a health risk is very high, the insurer may also reject the policy application.

To Conclude:

All of these methods have different approaches, and hence the required amount of life insurance coverage differs with each method. Therefore, one must select the most appropriate method while calculating the term insurance requirements. Moreover, the required life insurance coverage changes with the change in person’s age and lifestyle. Consequently, it is advisable to review your policy and coverage from time to time.

This article first appeared on PersonalFN here