How to calculate Insurance Requirement

Today i will discuss about the calculation of Insurance Amount one needs . Though there is nothing great in that , but most of the people miss on this part and according to studies , more than 80% of people in India are under insured , which means the amount there nominees will get will not be able to cover them against the financial crisis.

In case you have not read my previous articles on Life insurance, please read them

How much should be the Insurance cover ?

you will hear that it must be 6-7 times of Gross yearly income which is good enough estimate. but it does not consider other things like Debts or living style . It may be true for you but not for other . Some people may have simple lifestyle , whereas some other can have expensive lifestyle . So lets answer this question in another way .

This is pretty easy to answer , The Insurance amount much be enough to pay off

- All the debts
- Should be able to provide monthly income which is good enough to cover family expenses
- Any future needs for future .

Example :

Ajay is 30 yrs old and earns 40,000 per/month . He is married and has 2 kids . There monthly expenditure is 20,000 per month .

His debts and future expenses .(total : 47 lacs)

- home loan of 24 lacs (remaining)
- Car loan of 3 lacs.
- His children studies expenses. (20 lacs , in future)

His investments are (total 8 Lacs)

- 5,00,000 in Fixed Deposits
- 3,00,000 in Mutual funds

He has 47,00,000 worth of Debts and expenses in future and monthly expenses of 20,000 , considering inflation @5% , which will also increase every year.

His Insurance money should be able to pay for both of these .

We have to Answer that how much money will provide 20,000 per/month (post-tax) or 2,40,000 per year.

Considering 15-20% tax , The family should get 3,00,000, so that after paying tax they are able to get 2,40,000 per year . So how much money will give them 3,00,000 per year .

Fixed Deposits pay around 9-9.5% per year . Which means 3,00,000 X 100 / 9.5 = 32,00,000 (approx) .

So if they have this much amount in Bank which pays interest of 9.5% yearly , they will receive around 3,00,000 per year as interest and after paying taxes , they will be left with 2,40,000 , which can meet there monthly expenses .

Also the insurance amount should have 47 lacs extra , which will be used to pay there debt and future expenses .

So total = 32,00,000 + 47,00,000 = 77,00,000

As he has 8,00,000 worth of investments also , His Insurance needs comes down to 77,00,000 – 8,00,000 = 69,00,000 (let make it 70,00,000)

This is the minimum amount for the insurance needs.

It should also be considered that the expenses will rise and some emergency may also happen . So insurance can be increased by 10-15% . But for the moment we will not do it . Its in fact not necessary in this case because the money for future expenses can be invested and which will grow .

Tracing Back

So we arrive at the figure of 70,00,000 . Now lets go back again and see that in case there is sudden death of the family head (earning member) , how this money helps the Family .

They receive 70,00,000 , Out of which they pay 24,00,000 of home loan

Money left = 70,00,000 – 24,00,000 = 46,00,000

They put 32,00,000 in bank or Monthly income plans , which will provide them with monthly income of 20,000 per month (post-tax) .

Money left = 46,00,000 – 32,00,000 = 14,00,000

Now this 14,00,000 can be invested in Debt or Mutual funds which will grow to become at least 20,00,000 in some years (considering its needs after 10 yrs at least) .

At the end of 10 yrs , when family needs this 20 lacs for there children education , they can use it . And for any emergency needs they have another 8,00,000 in investments .

So in general All the requirements of Family is taken care of . If insurance amount is less than 70,00,000 they will have to compromise at one place or the other.

How much will the Insurance cost him per year ?

As i write this Article , i can see on http://www.click2insure.in/ that for a 30 yrs old non smoking male for 25 yrs of cover , the minimum premium per year for 70,00,000 Term Insurance is Rs 21,000 per year (taxes extra).

The premium is just 4.4% of this yearly income . Just imagine how cheap term insurance for total peace of mind for rest of the life.

So whats the final formula ?

Insurance cover = A + B + C – D

where
A is Money which can give you monthly income = Monthly expenses * 12 * 100/(interest rate which bank gives in a year , example 9.5%)

B = Future Debts or Expenses.

C = Some money for contingency or emergency .

D = Your investments or Assets (excluding HOME)

If you are under insured , please take extra insurance and cover your family , Please read my ear liar articles on Term Insurance to understand more .

I would be happy to read your comments.