The Economic Times, Friday, 22 Sept 2006
Mohit Verma is a worried man. He is all of 32 but has already accumulated huge liabilities in terms of home loan, car loan and other such loans. He also feels an urgent need for taking insurance cover for his life, health, home, et al. However, while everyone advises him to get insured, nobody actually is helping him determine the right quantity of insurance, i.e. how much cover does he actually need.
Mohit’s case is no exception. His predicament, in fact, is commonplace in India where around 97% of people are believed to be either uninsured or under-insured. They have little knowledge of how much cover to go in for, which in case of any eventuality will not only take care of all their future liabilities but also provide enough funds to support their family. And more surprising is the fact that even the experts are not unanimous in their views. Some suggestions, however, merit consideration.
Tata AIG Life Insurance assistant director (agency) Vijay Sinha says: “All individuals who have financial dependants need life insurance. There is, however, no one single formula for deciding the amount of life insurance one needs.”
Aviva Life Insurance director (marketing) Vivek Khanna is also of the opinion that insurance needs are specific to each individual, depending on his financial responsibilities and liabilities, both pre- as well as post-retirement. According to him, one should purchase insurance worth 5 to 10 times the current annual income. “This is an old thumb rule that does not take into consideration current assets and any special needs the customer or their family may have,” he says.
Mr Sinha too talks about some thumb rules one can use to determine the life insurance needs. Under the Underwriters Thumb Rule, for instance, life insurance need is multiple of annual income depending on the age. The Thumb Rule 2 is used when total annual family/dependant expense is known. Here, life insurance need is equal to the product of annual family expenses and a multiple based on rate of return one expects on one’s investment. The Thumb Rule 3 is used when one’s annual income is known. The insurance need is calculated simply as annual income multiplied by the number of years of service left.
“All these thumb rules give different results and hence a more scientific way is required which is possible via financial need analysis done by your insurance/financial planner,” said Mr Sinha.
The optional approach to ascertain life insurance need is, thus, the financial need analysis approach. This is an approach which can take care of specific needs of an individual. Here, the basic objective is that the insurance coverage should be sufficient to provide for the dependants’ needs in case the breadwinner dies early.
“The needs should include the client’s financial liabilities such as home loans, car loans etc and the funds required to support the dependants for the desired period. It may also include money required for specific family needs such as son’s/daughter’s education or marriage,” says Mr Sinha. According to another view, while choosing a cover for a person with dependants, the sequencing should be ‘risk cover’ first and then ‘savings’.
“The amount of cover is a factor of income and consequently the paying capacity, the nature of job, expected earning period, and amount of liabilities (personal loans, housing loans etc.) reduced by any estate already existing (savings & investments),” says a senior executive of Birla Sun Life Insurance.
To begin with, he says, an assessment of one’s own financial needs taking into account the life stage, risk profile, dependants, disposable income and liabilities has to be undertaken. This will help identify the protection and savings needs for the person. The protection should provide for all the liabilities and future earning potential of the person insured. This will be at a minimum ensure that the lifestyle of the dependants is not significantly altered if anything unfortunate were to happen to the person. The savings portion will be determined by the financial goals of the individual.
Thus, the amount required to maintain the standard of living will be based on a comfortable projected monthly expenses indexed for inflation. A person would require at least this amount towards monthly expenses. The actual requirement would be closer to 120% of the amount to account for inflation and increasing it for health related expenses. “Needless to say, the key to any financial planning is to start early as the contributions required are lower and the power of compounding ensures large savings,” advises the Birla Sun Life official.
According to SBI Life Insurance, while planning for retirement, one should also consider the amount of basic expenditure that could be incurred post-retirement like mortgage, medical bills and telephone bills. It’s best advised to take a joint insurance plan for retirement, which not only ensures regular annuities but also protects your spouse. All these calculations, however, will only make financial planning all the more complicated and further confuse people like Mohit. But is there any way out?
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