Covid-19 pandemic has taught us many lessons and showed how unpredictable and uncertain our life is. The 2nd wave was so devastating on many families. Not just covid, but in general, life is very uncertain. A serious accident or critical illness could affect the financial stability of the entire family. All your goals and plans you made for your loved ones go for a toss if you do not have proper risk management. If you are the sole breadwinner of the family, it is even more critical that you protect the financial security of your family and not let them experience misery.As a responsible,loving and caring family member, you must think about safeguarding the financial future of your family in your absence. Term insurance is one of the cheapest and most affordable insurance products whose sole purpose is to provide life cover for the insured. They are the pure form of insurance and very simple to understand. If something happens to the life of insured during the policy term, the nominee receives the sum insured. Thatâ€™s it.There is no maturity value. This is where most people back off from buying a term insurance policy. But, it's a costly mistake. Let me explain why.

One of the biggest mistakes many people make is taking insufficient life cover by buying an endowment policy because their relative or friend forced them to buy it or because they got attracted to the guaranteed returns promised by it. After buying this insufficient cover, many people live under the fallacy that they have life insurance and it is enough. Some people even say that the main reason for them to buy the hefty premium paying endowment policy is to get tax benefit under 80C section.**Remember that the primary motive to buy a life insurance is to provide sufficient financial security for your loved ones in case of unforeseen event**. Somehow, this aspect is missed when people buy life insurance.They focus more on the return aspect and fall prey for the rosy promises made by insurance agents. You need to realise that the guaranteed returns promised by these endowment policies don't even cover the inflation.

For example, The premium charged for a 25 lakh sum insured in one of the top selling endowment policies for a 30 years healthy male for 25 years term by a top insurance company is approximately 1,10,000 per year. Expected maturity value after 25 years is 66 lakhs. For the same individual, the cost of a term insurance for the same sum insured of 25 lakhs is 6500 per year ðŸ™‚.People will argue that the term plan doesn't have maturity value. wait, but you are only paying 6500 per year compared to 1,10,000 per year in an endowment policy. If you invest the difference in an index fund or flexi cap fund with a conservative return of 12% for a period of 25 years, the maturity value would be 1.38 crore.People will argue that the Insurance maturity amount is tax free. wait, even after 10% capital gain tax, the maturity value is 1.26 Cr which is twice that of endowment policy. That means, for the same annual payment of 1.1 lakh per year,you get the same life cover(25 lakh) if an incident happens and you get double the maturity value compared to endowment policies.

**How much term life insurance do you need?**

Once you understand how important a term life cover is, another question many people have in their mind is how much coverage I should take?

There are 3 approaches to determine how much cover you need. We discuss them in detail below. We use the following example for illustration purposes.

*Mr Naveen is a 30 year old male, IT professional, the only breadwinner in the family, with 2 kids of 4 and 2 years. His annual post tax salary is 20 lakhs in FY 2022-2023. He is planning to retire at the age of 60 years. He wants to take term insurance till his retirement which is 30 years from now.*

**Rule of Thumb approach to calculate the life cover needed**

This is one of the basic approaches to determine the amount of life cover needed. In this approach, it is advised that one should take a cover of at least 10 times their annual post tax income. Based on the above data, Naveen should take at least 2 crore life cover. The idea here is that, in case of an incident, the family can reinvest this amount and maintain the same standard of living. However, this approach doesn't consider the inflation, liabilities or potential salary increases in future. For this reason, we need to calculate the human life value of an individual to accurately determine how much coverage is needed.

** Income Replacement method by calculating Human Life Value**

Nobody can determine the value of a human life. But we can determine the economic value of an individual by his future earning potential.The idea in this approach is that we want to find how much a person could earn from the current year until his retirement.

If the person passes away tomorrow, all the income he could earn should be replaced by the life cover so that there is no change in the financial position of the family.

There are few steps in this approach.

First we need to determine the net income Naveen brings to the family by reducing his self expenses. self expenses could be anything that he spends on himself, like travel, fuel, shopping, entertainment, mobile bill, self insurance premiums etc. Let's say Mr Naveen spends 5000 per month on self expenses for living and 5000 per month on insurance premiums(health and life). His annual total self expenses are 1.2 lakhs. This makes the net annual income to the family is 18.8 lakhs in the current year.

But, we also know that Naveenâ€™s salary also increases over the years until he retires. We need to factor in that too. What salary rate should we assume?We can assume a reasonable rate of 6% salary increase per annum for the next 30 years. With this assumption,now let's see how the net income will grow over the next 30 years.

As you can see, Naveen could earn over 1 crore income to the family in a single year in 2050 and 2051.If something happens to Naveen tomorrow, his family will lose all this income which is **14.86** crore if you sum them all. But, we should also remember that this income is future income and its value is far less in the present time due to inflation.

We should apply a proper discounting to get the present value of this future loss. Assume that, if the family gets the insurance proceeds as a lump sum, they can invest this amount in an instrument which can generate 8% interest on an average.With this assumption, each year income should be discounted by this factor to get the present value of the income earned in that year. for e.g 2024 income should be discounted 2 times with 8%. 2051 income should be discounted 29 years.applying this 8% discount to the above future incomes , we get the present value for each year as below.

By summing up all the discounted values, we get the present value of loss to the family which is 2.28 crores.

In this approach, we should also add any existing liability to the above sum insured directly. For example, if there is an outstanding home loan of 20 lakhs, we should add it to 2.28 crore which takes the required life cover to roughly 2.5 crore.

**Need Based Human Life Value method**

There is also a 3rd approach which is called need based approach which goes into even more granular levels like individuals short term goals,long term goals,liabilities and living expenses for the family.Short term goals can be like funding children's primary education. Long term goals can be funding children, higher education or marriage.This approach calculates the present value of money needed for each goal and adds them all to arrive at the total amount needed for all unfulfilled goals.Once the required amount is determined, this approach also looks at what are the current available resources. For example, the amount already available in a savings account or in fixed deposits or in stocks etc which can be used for the above goals.Finally we determine the required life cover as

** Life cover needed = [Present value of Amount needed for all goals - current resources available**]

For example, if Naveen needs 3 crore to fulfil all his future financial goals and he already has 50 lakh in various investments then he needs additional life cover of 2.5crore to bridge the gap so that all his planned goals will be fulfilled even if something happens to him and he is not around.

**Summary**

Term Insurance is one of cheapest and most affordable products to cover your life. But this is most often overlooked or under rated due to misunderstanding that it doesn't give maturity value.On a like to like premium comparison,Term insurance+MF investment will give double the maturity value given by traditional endowment policies and provide the same life cover.

It is also important that one must know how much life cover is needed. We discussed 3 approaches on how to calculate the amount of life coverage needed in detail with an example. I hope this article is helpful. For any clarification, leave a comment or reach out to us. you can also contact us for any guidance on financial planning like investment planning, retirement planning and insurance planning.

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