How much life insurance cover does one need? Which type of life insurance should one buy? These are some common questions bothering most people. While these are important questions, one must first understand why life insurance is required in order to answer these questions.
The need for life insurance
In any household, the regular expenses are incurred out of the income earned by the family members. The remainder after the expenses – the savings – get invested for funding various long term goals as well as to create wealth.
When an earning member of the family dies, the family incurs two losses – an emotional loss and a financial loss, i.e., the loss of income. While not much can be done financially about the emotional loss, the latter’s impact could only worsen the emotional loss.
The loss of income on account of death of an earning members can lead to deficit in funding of various critical financial goals or even compromising on the lifestyle of the surviving family members. In such a situation, life insurance works as a protection for the surviving family members from financial hardship. Such an insurance, also called risk cover, can be bought from a life insurance company at a reasonably low cost, known as “insurance premium”.
Which type of life insurance should one buy?
Check with any insurance company or any insurance portal and you would be overwhelmed with the plethora of options available as life insurance products.
If we understand the purpose of life insurance as explained above, it is about buying the maximum possible risk cover at the lowest possible cost (premium). Such a risk cover is available through pure term insurance plan.
Understanding pure term life insurance
Many clients are interested in knowing how much money would they get on maturity of the insurance plan. However, if the purpose of the insurance plan is protection of family members in the event of untimely death of the bread earner, the question should be about knowing how much money would the family get in such an unfortunate event. If the earning member lives long, with prudent investment strategies, one would have accumulated enough to not worry about insurance proceed.
A pure term life insurance product is one in which the policy holder gets nothing back if one survives the whole term. However, on death of the policy holder any time during the policy term, the nominee gets the full sum assured. The benefit of such a policy is that it offers a large risk cover for a reasonably small premium – incidentally, this is the product where the premium payable is the lowest for the sum assured.
Buying protection at the cheapest cost is a smart thing to do.
How much insurance cover does one need?
Insurance cover and risk cover are the terms we have used interchangeably. While the former is a more popular term, the latter is the industry jargon. Having said that, this is the amount of money the nominee would get in case of insurance claim.
There are multiple ways to calculate how much risk cover one needs. While many use thumb rules, the financial advisors often recommend an approach known as “replacement of costs” method. It requires you to estimate your ongoing family costs, liabilities, and financial goals. Consider expenses such as your children’s education, marriage, and caring for financially dependent parents. The total sum you calculate represents the amount your family will need. To arrive at the coverage amount, deduct the current value of your investments and any existing life insurance coverage. Exclude assets like your home and car from this calculation since your family will continue to use them. By deducting investments and insurance coverage from your expenses and objectives, you can determine how much additional insurance you require.
Review
Since many of the things mentioned above change over time, it is essential to review the insurance needs periodically.
Conclusion
Term life insurance is a valuable tool for protecting the family’s financial future in case of untimely death of the main bread earner. By understanding the methods used to determine the right coverage amount and regularly reviewing the insurance needs, once can ensure that the family members are well taken care of in any eventuality.