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Rediff.com  » Business » How much life insurance to buy?

How much life insurance to buy?

By Chandnee Sinha
August 20, 2007 11:45 IST
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Indians do not buy insurance for the sake of insurance. They primarily buy insurance to save tax or as an investment. Given this most Indians do not have an adequate insurance cover.

These days a lot of thumb rules for the amount of insurance an individual needs get bandied around. "The insurance cover of an individual should be at least 5-7 times his annual income" is a rule that gets bandied around the most.

While this rule ensures that an individual has some cover, it may not ensure that the individual has the right amount of cover. The "human life approach" is the right way of calculating the exact amount of life insurance that is needed.

Let us take the case of a 30-year old individual who is married and lives with his parents. His wife is a homemaker and his parents are totally dependant on him. He earns Rs 60,000 per month, after tax or Rs 720,000 per annum. His own monthly expenses are around Rs 10,000 per month. The remaining Rs 50,000 is what is available to his family.

Let us say that if the individual expires suddenly his family will require Rs 50,000 per month to continue living at the same standard that they were used to. To earn Rs 50,000 per month a capital of Rs 75 lakh (Rs 7.5 million) would be required assuming a rate of return of 8 per cent per annum.

At 8 per cent per annum, Rs 600,000 can be earned per year from an investment of Rs 75 lakh.  Rupees six lakhs in a year, means Rs 50,000 per month, the amount the family will need.

The individual should essentially be taking a term insurance policy of Rs 75 lakh. Term insurance policies are pure insurance policies. If the individual dies during the term of the policy his nominee will receive Rs 75 lakh.

If he survives the period of the policy, he does not get anything. The yearly premium on a cover of Rs 75 lakh, for a period of 25 years, on Anmol Jeevan-I, the term insurance policy from Life Insurance Corporation of India comes to Rs 28,660 per annum.

If we had used thumb rule of 5-7 times the annual income, even at 7 times annual income, the right amount of cover would have come around Rs 50 lakh (Rs 720,000 x 7). This amount would not have been enough to help his family continue maintaining the same standard of living.
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Chandnee Sinha
 

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