How Much Term Insurance Cover is Required?
It is common knowledge that the living expenses of any household increase over time. For example, in 2017-18, the per capita consumer spending in India was INR 77,085 per annum. That is a 10% increase from the 2013-14 period’s per capita spending of INR 52,086 per annum. The World Economic Forum predicts consumer spending in India to increase 4x by 2030. All this means is that you and your family are going to need much more money in the future, as compared to today, to lead a comfortable life.
Let us understand this better with an example of Raju.
| Members in family | 3 |
|---|---|
| Monthly income | INR 80,000 |
| EMI expenses per month | INR 20,000 |
| Household expenses per month | INR 50,000 |
Now imagine an unfortunate possibility of Raju’s untimely death or him facing a critical illness. This unfortunate event would mean Raju’s income would stop, but his family still has to manage their expenses.
Imagine the state of Raju’s family in two possible scenarios. In scenario one, his family has limited savings and no insurance to fall back on. In scenario two, Raju has a term insurance coverage of say INR 1.5 crores. It is not hard to visualize that Raju’s family will be much more secure in scenario two. They can pay off their remaining home loan, yet have a decent amount left to lead a comfortable life.
Term insurance provides financial protection to families in case of untimely events like death or critical illness of the insured. A life cover of 1 crore for up to 100 years costs anywhere between INR 500 to 1,000 p.m. depending on the plan chosen. Come to think of it, for most people in metros and tier 2 and 3 cities, INR 500 per month is a negligible amount. The average order value (AOV) of leading food delivery apps ranges from INR 250 to 300. It is not unusual for people to pay INR 500 to 1000 on the subscription of various streaming services.
Just like there is joy and happiness associated with these expenses, term insurance offers peace of mind. A common question is how much term insurance cover does one need. Here are the factors involved in calculating the required term insurance cover:
Monthly and Annual Expenses
A key determining factor of term insurance cover is the monthly expenses of your family. In the example above, Raju’s family requires a minimum of INR 50,000 a month, which works out to INR 6 lakhs per year. A good rule of thumb is to get coverage of 10-15 times one’s annual expenses. In Raju’s case, that amount works out to between INR 60 and 90 lakhs.
| Annual expenses | Term insurance coverage multiple | Coverage required for living expenses |
|---|---|---|
| INR 6 lakhs | 10x (minimum) | INR 60 lakhs |
Calculate Liabilities
In Raju’s case, he has an outstanding home loan of INR 50 lakhs. In case of an emergency, he would want his family to have a secure shelter. By adding this amount to the amount above (INR 60 lakhs plus 50 lakhs,) you get a required term insurance cover of INR 1.1 crores.
Factor in Future Events
So far, we have covered the essentials, which is housing and living expenses. However, a family’s needs go much more beyond this. For example, everyone wants their children to get educated from the best university. Let us say Raju wants INR 10 lakhs in the next 10 years for his kid’s education. He is investing INR 5,000 every month in a systematic investment plan (SIP) to meet this goal. This means the family would require INR 60,000 every year for the next 10 years (INR 6 lakhs in total) to contribute towards this goal.
Vacations are another essential requirement for every family. People would want their families to enjoy at least one vacation every year, even in their absence. If we were to assume a conservative INR 50,000 per year for vacations for the next 10 years, that would add INR 5 lakhs to the required term cover.
Children’s marriage is another important life event. Suppose Raju is saving INR 5,000 every month for this goal. That would add another INR 6 lakhs to the insurance coverage.
Apart from this, families have recurring expenses of buying gadgets (replacing mobile phones) or replacing home equipment and furniture. Everyone wants their family to have a comfortable lifestyle, even after they are gone. Even if you assume a conservative INR 60,000 every year for the next 10 years, that adds up another INR 6 lakhs to the required term insurance cover.
Adding these amounts increases the required term insurance amount by INR 23 lakhs.
| Event | Term insurance coverage multiple | Coverage required for future events |
|---|---|---|
| Contribution towards children’s education | 60,000 x 10 years | INR 6 lakhs |
| Family vacation | 50,000 x 10 years | INR 5 lakhs |
| Contribution towards Children’s marriage | 60,000 x 10 years | INR 6 lakhs |
| Gadgets and household maintenance | 60,000 x 10 years | INR 6 lakhs |
| Total | INR 23 lakhs |
Health Emergencies
COVID-19 has shown that no one is immune to health emergencies. Depending on their city of residence, people have shelled out lakhs of rupees for COVID-19 related hospitalization. Even beyond COVID-19, there is always the risk of health emergencies, especially for elderly members of the family. Let us assume Raju has taken a health insurance cover for his family, including parents, which requires paying INR 1,000 per month or INR 12,000 per year. In his absence, his family would continue their health insurance premiums to deal with unforeseen illnesses. Assuming he wants to set aside health insurance funds for the next 10 years, that would add another INR 120,000 to the term cover required.
Spouse’s Retirement Fund
So far, we have set aside amounts for the next 10 years. However, Raju’s spouse will require a retirement fund even beyond that period. Let us say he wants her to have INR 15 lakhs after 10 years, and he is investing INR 10,000 every month in a mutual fund for that corpus. That would increase the required term insurance by another INR 12,00,000 (120,000 per year x 10 years.)
Total Term Insurance Required
If you add up all the expenses, the total term insurance covered required works out to around INR 1.46 crores.
| Expense | Term insurance required (INR) |
|---|---|
| Living expenses for 10 years | 60 lakhs |
| Liabilities like home loans | 20 lakhs |
| Future events | 23 lakhs |
| Spouse’s requirement fund | 12 lakhs |
| Health insurance for family | 1.2 lakhs |
| Term insurance required | 1.16 crores |
As you can see, the amount of term insurance can vary by 1) the expected expenses, and 2) the amount set aside for different expenses. Each person can adapt their own approach to calculate the term insurance cover required for the family.
Given the expected increase in consumer spending, it is advisable to be conservative for living expenses. If a family requires INR 6 lakhs today for living expenses, they will require a much higher amount in the future.
If someone has a lower home loan liability, they can reduce the funds set aside for those expenses.
Future events are another subjective area, and different people have different priorities. Someone with 2 kids may simply want to set aside funds for their education and not necessarily for their marriage. Also, with the advent of newer and newer gadgets, tomorrow’s kids would require a lot more money to buy new gadgets and keep up with their peers.
Similarly, it is not surprising to expect an increase in health expenses, especially for elderly members. Contributing a small amount towards medical insurance can safeguard the family from denting their savings.
Do Not Forget to Factor in Age, Wealth, and Life Stage
In the above example, Raju is somewhere in his mid-40’s and has a lot of liabilities and no assets. Someone who is 30 years of age, has recently got married, and has a financially independent spouse will have a much lower term insurance requirement.
Likewise, someone who is 55 years of age and is free of major commitments will just want funds to meet their spouse’s retirement funds.
In another example, someone who has savings and has inherited some property will require lower term insurance. Continuing with the above example, let us say someone has inherited a family home of INR 1 crore. They can deduct this amount from the term insurance cover required and take an insurance cover of only INR 50 lakhs.
Conclusion
To conclude, using the basic framework above, anyone can calculate the term insurance cover required for their family. Each person’s financial situation is unique, which will result in different term insurance amounts. Irrespective of their financial situation, it is always advisable for everyone to set aside a small amount every month for term insurance premiums. In case of unforeseen events, this small amount can go a long way in safeguarding their families' financial futures.
When buying term insurance, one must review the insurer’s claims settlement ratio and the number of claims filed with them. Every year, the Insurance Regulatory and Development Authority of India (IRDAI) publishes the death claim settlement ratio of different life insurers. Before buying term insurance, you should compare the claim settlement ratios of different insurers over 5 to 10 years to make an informed decision.