Capitalmind
Capitalmind
Actionable insights on equities, fixed-income, macros and personal finance Start 14-Days Free Trial
Actionable investing insights Get Free Trial
General

How Much Insurance Do You Need?

This is perhaps the most often asked, and misunderstood question. Insurance advisors will tell you that you need to be covered for a sum that looks big (like Rs. 30 lakhs or so) but that much money is not at all enough! In fact they sell you those amounts so that you can buy endowment plans and ULIPs which are not at all beneficial to you.

What you should do FIRST, is buy term plans to cover your insurance requirement. Buy only term plans where you don’t get your money back, since these are the cheapest. And buy them early in life – the later you wait, the higher the premiums are (but it’s never too late, unless you are 55+).

Let me take an example. If you earn Rs. 4 lakh a year, and you want your better half to live the same lifestyle for the next 30 years, you must also consider inflation and tax. 8% FD is subject to approx 25% tax overall, and inflation is around 6%.

If you were to die today, your wife will need Rs. 1.09 crores to survive 30 years from now without having to work. This is the amount you need to be insured for. (For an age of about 30, term insurance for
this amount costs about Rs. 35,000 per year)

If your wife is 30, you should assume life expectancy is 75 years. Add Rs.
50,000 per year as your investment towards FUTURE medical costs, and
then you need an insurance for: Rs. 1.91 crores. (For an age of about 30,
term insurance for this amount costs about Rs. 62,000 per year)

Note: This is a simplistic model, not considering things like one time payments needed for education, marriage and such. You will have to add those and recalculate manually.

Some of you have mentioned that for an income of Rs. 4 lakh a year, this is a HIGH amount. Rs. 35,000 a year is Rs. 3,000 per month, and you save tax too on this amount. But Rs. 62,000 is way too high, one can imagine. So Let’s consider this: For a 30 year old what can be the real cause of death? Disease is usually far away, and stress isn’t usually that developed for heart and brain ailments.

Accidents, however, are unpredictable and can happen in a vehicle, or even when walking! Such incidents are what you should insure against. Most insurers provide “double accident benefit”, meaning that if you should die in an accident, your next of kin will get DOUBLE the sum assured. So if you need an insurance of 1.1 crores, you can buy a 55 Lakh policy, with double accident coverage, which would cost around Rs. 21,000 per year. Much more affordable!

But also consider this: You will also be saving and investing money (that’s why you’re reading this blog). Therefore as your wealth grows, you don’t need SO much insurance, because your investments will cover a part of the money required. If you run the calculation every year, you may find that your investments cover a significant part of the money required, so why pay for extra insurance?

The way to do this is to buy multiple term plans. Instead of buying one term plan for Rs. 1.91 crores, buy TEN term plans for Rs. 19 lakhs each. Then, everytime you see that your insurance requirement has come down by Rs. 19 lakhs (because your investments are that much now), Throw out one policy.

Term policies are very easy to throw away; simply stop paying the premium! There is no legal requirement for you to to pay the premium every year, and companies give you upto two years of “grace” period, meaning if you don’t pay the premium for upto two years and then want to reinstate the policy (say you invested in a property that went bust) you can do it. (They may change the premium though, to your disadvantage)

Eventually, you may become so rich you don’t need (life) insurance at all. That’s fine; if you already own 1.91 crores and spend 4 lakhs a year, do you care about insurance? Probably not life insurance. Yes, you still have to insure your property, car, gold etc. against fire/theft/damage etc. but those are, by definition, term insurances and should be bought to cover those risks. The risk of losing your life should only be covered as much as your dependants need in order to live the rest of their lives in comfort.

If you have understood this, tell me how much insurance a 60 year old widower needs, if his children are all earning for themselves and he has no dependants?

Answer: ZERO.

How much insurance does a 1 year old child need? ZERO.

But if you have dependants, provide them a secure and comfortable life by insuring your life, for the amount that they need.

Like our content? Join Capitalmind Premium.

  • Equity, fixed income, macro and personal finance research
  • Model equity and fixed-income portfolios
  • Exclusive apps, tutorials, and member community
Subscribe Now Or start with a free-trial