How To Calculate Life Insurance Coverage

We often hear it is a rule of thumb that life insurance cover must be 6 to 7 times as much as the yearly income. Suppose a person earning 4 lakhs per annum goes must decide on an insurance of 30 lakhs (more than 7 times the amount). If he has a family of four and an expense of 3 lakhs per annum excluding himself, that amount is supposed to provide coverage for around 10 years. But factoring inflation, it will actually be sufficient for 5 years only, after which his family will face severe financial crisis.

When it comes to insurance you must take into account factors like standing debts or standard of living. While calculating your insurance cover, you must follow some basic steps before proceeding any further:

Step 1. Calculate your total unavoidable expenses (TUE)

This is a major part of your insurance coverage. The main reason for getting insurance is to provide your dependents with at least the basic needs after your demise. So make sure to include the following costs, among others :

• Your child’s education costs
• Household bills
• Other insurance premium for your dependents, like medical, automobile and housing
• Medical needs, entertainment and other recurring expenditures

This gives the total unavoidable expenses (TUE) for one year. But the actual cost must also take inflation into account; for this purpose use an inflation calculator. Factor in an approximate number of years for which the money will be needed.

Step 2. Add Your Debts (D) and Subtract Your Assets (A)

Any outstanding loans, mortgages, credit card bills, or other types of debt must be added to the TUE. However, any disposable property, such as land, an extra house, gold, stocks and fixed deposits must be subtracted as they can be liquidated to meet immediate expenses. Make sure that you do not subtract the value of your current residence.

Step 3. Add Arbitrary Responsibility Expenses (ARE)

This step factors in large predictable expenses which are taken on by the policy holder as secondary responsibility, after meeting the family’s unavoidable expenses. This may include higher education and weddings for children, as well as your funeral which can also pose a considerable expense. This varies according to personal requirements, but remember to factor in inflation,over and above current prices.

After completing these 3 steps, make the final calculation:

TUE+ARE+D-A=Sum Assured

This will give you an accurate idea of the minimum insurance cover you should opt for, given your current standard of living and long term goals.

Now that you have calculated the amount of life insurance coverage that you need, ask yourself some important questions before purchasing a policy…