Is your Life Insurance Coverage justified?

Problems never come knocking the doors. To cover these unfortunate events and provide a financial security there are various Insurance products available in the market. However to what extent is a person insured becomes a major question. Despite of being insured with multiple policies your family should not fall short of meeting their requirements in case of any eventuality. Hence it becomes very critical to calculate the Insurance coverage before opting for Insurance Plans…….

Insurance still remains a push product in the Indian market. Although it is a very common saying that Insurance need not be coupled with Investments still many buyers look at it from an investment point of view. The other aspect of buying Insurance remains affordability of premium. Very few buyers look at the finer aspects of the plan and the total coverage.

Going by the concept of Insurance, the fundamental aspect to look for while planning the Insurance needs remains the risk coverage.  Human Life Value or HLV helps plan the Insurance coverage of an individual. In terms of Insurance HLV is the value of the cover a person should have to cover his family from the financial risks in case of his unfortunate death. Although Human life value is precious and can never be estimated accurately however from an Insurance perspective HLV can be calculated using two popular methods: The Income replacement method and Expense calculation method:

Income Replacement Method. This method takes into account the total income a person is expected to earn during his lifetime. From this total Income the expenses made on self are deducted and the remaining income used for expenses on family is taken into account for calculation. The total income which is expected to be used on the family’s expenses till the end his working tenure shall be discounted by the risk free rate of return.

Lets take the example of Mr X:


Current Monthly Income of Mr X (a): Rs. 50,000
Expenditure on Self (b): Rs. 10,000
Expenses on Family (a - b): Rs. 40,000
Yearly Expenses: Rs. 480,000
Current Age of Mr X: 40
Retirement Age of Mr X: 60
Inflation: 5%
Total requirement for family till retirement* Rs. 15,871,658
Present value of earned money** Rs. 3,405,236
*Rate of increase in Expenses and Salary is assumed to be equal to inflation
**Discounting done assuming 8% risk free rate


Hence we see that going by income replacement method Mr X needs an Insurance coverage of approx Rs. 3,400,000 to fulfill the requirements of his family in case of his unfortunate death. The idea is that in case of sudden death of the bread earner the family shall get the requisite sum insured and invest the same in an instrument earning returns equal to risk free rate and sustain with the same living standards.

Expense Calculation Method or Needs approach: In this method the present value of all the expenses that a persons family will incur on account of his unfortunate death needs to be added up to arrive at the sum insured. Expenses shall be taken into account based on the goals e.g. living expenses, uninsured debt and mortgages, children’s education and marriage whose provision is not in place, any other emergency expenses etc.

Lets demonstrate this with a simple example:


Monthly Expenses of Mr X's family: 40,000
Yearly Expenses: 480,000
Current Age of Mr X: 40
Retirement Age of Mr X: 60
Inflation 5%
Total requirement for family till retirement* Rs. 15,871,658
Present value of family's total requirement (1)** Rs. 3,405,236
Childrens higher education 5 yrs from now Rs. 1,500,000
Value of Childrens education as on today (2)** Rs. 1,020,875
Childrens marriage expenses 10 yrs from now Rs. 1,000,000
Value of Childrens marriage expenses as on today (3)** Rs.463,193
Total Insurance requirement (1 + 2 + 3) Rs. 4,889,304
*Rate of increase in Expenses and Salary is assumed to be equal to inflation
**Discounting done assuming 8% risk free rate


Hence going by the needs approach method Mr X needs an approximate Insurance coverage of Rs. 4,900,000 which the family can invest in an instrument earning risk free rate of return and fulfill the goals accordingly. In case the insured already possess certain assets the total value of these assets shall be deducted from the total Insurance requirement to arrive at the final coverage amount. This method is more complex and takes into account every minute detail which forms a part of the financial goals of the life thus giving a better picture in planning the Insurance requirements.

Having discussed both these methods it becomes important to consider which one shall be used while advising a client on his Insurance requirements. As mentioned above Insurance is still a push product and very rarely do we find an advisor asking for these minute details from clients. To a major extent even clients are also skeptical revealing these details to an advisor. From an advisors perspective commission and premium becomes important and from a client’s perspective premium, sum insured and returns assume prime importance. Hence planning rarely comes into picture while planning or selling Insurance.

Statistics also reveal that the Indian Life Insurance market stands skewed towards ULIPS. Out of the Rs 261,025 crore*** Indian life Insurance market ULIP’s constitute 50%**** of the total premium. ULIP’s by nature are market linked products with a low Insurance coverage. Also Insurance cos offer higher commissions to advisors on sale of ULIP products. I personally believe that if Insurance had been sold and purchased with some planning the market wouldn’t be so much skewed towards ULIP’s.

It becomes significant for investors to do a judicious planning of their Insurance requirements to financially secure their families from unfortunate events and opt for the plans accordingly. Buying Insurance without planning the coverage is just like living in a utopian world with a false sense of security.

I personally believe Income replacement method can find higher acceptability among investors as it doesn’t ask for minute details like the latter. Spreading awareness on this hold the key. To spread the awareness insurers also have launched Human life value calculators on their sites to facilitate the clients in planning their Insurance requirements. Investors might not reveal actual financial numbers to their advisors but certain averages can always be shared with him to get the right kind of plans. The same awareness needs to be percolated by the insurers among the advisors and channel partners who in turn can educate their clients for a better Insurance planning. Before concluding I would like to mention that HLV is not constant and keeps on changing as with time hence it needs to be reviewed and the Insurance coverage also needs to be taken accordingly.


***http://www.dnaindia.com/money/report_life-Insurance-industry-grew-by-18pct-in-financial-year-2010_1397271
****http://economictimes.indiatimes.com/Features/Financial-Times/Ulips-drive-life-Insurance-cos-growth-engine/articleshow/6042525.cms?curpg=1