How much life insurance should I have?

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.

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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. The fact that there is more than one methodology to calculate the HLV makes the subject even more challenging to understand.

The most common definition of HLV is the expected life time earnings of an individual, i.e. what is the total income that the individual is expected to earn over the remainder of his working life, expressed in present Rupee terms.

For the uninitiated, inflation eats away the value of money; a Rupee today is worth more than a Rupee tomorrow and therefore one needs to suitably 'discount' future earnings to express the value in present Rupee terms. Our view on how HLV should be calculated is quite different from this. HLV in our view is the monetary value of all the yet-to-be fulfilled needs of the dependents plus all the outstanding liabilities. Why do we define HLV in this manner (notice that we do not factor in earnings at all)? Simply because even though expected incomes may not be sufficient to meet the needs, the needs are still there. And an individual strives to meet the needs of his/her dependents. So, the HLV thrown up by our definition is really a 'target' that you should have in mind; you can and possibly may have to plan for a lower HLV, but don't despair over that.

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