A reader asks me “How much Insurance is Enough ? Is 1 crore Enough ? ” . Now this is an extremely important and very easy to answer . How do you think about it is very very easy .
There are two models of answering this , One is to sum up everything as per your situation and then come up with a Figure and the other one which I recently thought about is a reverse answering yourself (yes !! , yourself) on how it will take care of your dependents after you are gone .
Are you Wondering How much Insurance you should take ?
Many people I interact with come up with Weird Figures for their Insurance Cover , Without any calculations they will cough up numbers like 5 lacs , 20 lacs , 50 lacs , 80 lacs or 1 crore (Come on .. this is not a game called “Even Figure , Even Figure” , Its not a Game !! ).
I ask them a very Simple thing, I ask them to explain me, literally explain me in writing, How the money your Dependents are going to receive will be utilized and How it will take care of things once they are not there.
Not even one of them succeeds in allocating that money for different goals which are pending after they are gone and be satisfied with it.
There are numerous things to be taken care of after the earning person is gone, like –
- Providing Regular Income to your Family (like you would have done if you were Alive)
- Making sure all the Debt is Paid off (Which you were going to clear off If you were there, Things like Home Loan, Car Loan, Any other loan)
- Making Sure that your Children Future Expenses like Education and Marriage are taken care of (Some money might be required to be Invested for these goals which will haunt you later in life)
- Enough Money for Emergencies which could Arise and Literally Destroy your Family Happiness like Unexpected Accidents, Some Critical Illness etc
Seriously !! .. This is Common Sense .
Insurance Cover as 10 times of Yearly Income is not a good Idea
Now most of the Insurance agents definition of Insurance cover is “10-15 times of your yearly Income”. I ask Why?
Ajay Earns 8 lacs, Just one dependent, Has some good asset corpus, Should he just buy 10-15 times of Insurance cover … No !!
Robert Earns 4 Lacs , Has a home loan (Read how to find the cheapest Home Loan), 4 Children and a personal Wife along with Old Parents, High Expenses, No other Earning or “Capable of Earning” Member in Family. Should he buy 10-15 times of Insurance only? NO !! .
The Model just gives a rough Idea on what can be your Requirement but most of the times it does not work, have the guts and logical mindset to Deny what People in personal Finance space tell you , they are not GOD, they lack common sense sometimes (Read “most of the times”)
Calculating Insurance is not a very tough process, Its just Logical and step by step process.
An Example
Robert tells me that he earns 4 lacs a year and he thinks that 50 lacs is enough for Insurance cover. Some one told him that 10-15 times of his yearly Income is what he should be Covered for.
Conversation goes like this
Me : So you believe that 50 lacs is a good amount for you to be Covered. Fine !!, You are dead and tell me what happens Next !! .
Robert : hmm .. ok , See , my Family expenses is around 20k per month If I am not there , So that is one thing which should continue , so I will put 30 Lacs in some Instrument Like some Best Fixed Deposit (FD) or MIP and it will pay 20k per month to my family , I think 30 Lacs would go for that . 30 lacs getting 8% interest will be 2.4 lacs and that means 20k per month .
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Me : OK , Not the best way of doing it , but looks workable and safe .. Go ahead
Robert : Another 20 Lacs will be enough for other Important things 🙂
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Me : No .. Get Deeper !! , Dig out things and tell me exactly How !!
Robert : OK , I have 3 children .. I think a Good Education today can be taken care by 20 lacs for all of them .
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Me : Talk About Future , Its 12 yrs away , They are kids now .. Today 20 lacs is good , but what about 12 yrs from now ? Do you know that Education costs are increasing by 10% per year now a days . You require 60 lacs after 12 yrs For Higher Education of your Children . Understand Inflation .
Robert (quiet) : Hmm.. That’s something I didn’t think about . So I will need 60 lacs , I need 40 lacs more of cover .
___ Read Top 10 Financial Planning Doubts
Me : Actually No !! , All you need is to get 20 lacs only , because you will actually Invest it , You need 60 lacs at the time of their Education , not now . So you Invest that money in such a way that you get around 10% return and you will have enough savings for your Child Education , Make sure you dont take more than required risk for this .
Robert : ok , Got it . So the 50 lacs exhausted . I am not sure what are the other things which needs to be taken care of ?
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Me : DO you have some liabilities, Like Loans?
Robert : I had a Car loan, but only 6 lacs is remaining. Should I take care of that also?
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Me : I don’t mind if you don’t think about it , just tell me how is that going to taken care of if you I kill you just now !! If Its paid from 20 lacs , then somewhere your Child Education is compromised . (This Idiot Doesn’t have a Home yet and He is riding a Honda , and smartie earns 4 lacs a year)
Robert (Dying to kick me) : OK OK . Add another 6 lacs , now its 56 lacs .
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Me : Good 🙂 . Was there anything you wanted to provide your Family if you were there with them.
Robert : (after a lot of thinking and trying to hide his guilt now) Well Actually We dont have a Home yet. I am planning to buy a Home soon, may be around 30 lacs. [doesn’t fits his Budget, but smartie recently bought A Home Theatre (Doesn’t Have a home yet), This is what I call “Not understanding Difference Between Needs and Wants” ]
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Me : So definitely you want to make sure that they have a Home once you are not there , the same way you were going to buy one , or you want to live on rent on life because you are not there to enjoy the “Sweet Home”.
Robert : So that adds up 30 lacs more and the requirement is around 56 + 30 = 86 Lacs .
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Me : I am happy to say “YES” 🙂 . you made my day …
Robert : So that’s it .. I need 36 lacs More .
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Me : So your Parents are Old , correct ? And you people have spacial blessings from god that your Family can never have accidents or your family will never get into Emergencies ? Right !!
Robert : Well .. That can Happen , But lets skip it . It has never happened and I don’t think it would happen with my Family .
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Me : No !! I refuse to accept it .. You have taken care of other things, All your 86 lacs is going to help them in some or the other way. Now tell me how will your Family will Handle with emergency situations which might demand 10 lacs of Expenses. I know you cant calculate exactly how much they might require. It can be 5, 10 or 20 lacs, but lets take a good figure of 10 lacs and better prepare for something if not anything .
Robert : OK, Lets add 10 lacs more for anything unexpected or Emergency expenses which we have not taken care of .. Its 96 lacs now ..
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Me : OK, this is a better situation !! I would not say that this is the best Insurance Planning, but you have done a good planning and this is a much better situation than earlier. This is what a common person can do for himself and this should work.
Robert : Yup .. I accept .. I understood it now ..
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Me : So Robert , Make sure you understand that Insurance is something which you need to take for your Family and it should be enough to make their life comfortable once you are gone, this extra 46 lacs of cover will cost you not more than 20k per year (10k for people around 28-29 yrs). If you are planning why not plan systematically and 100% , why mess it up.
Robert : Yup, Actually my Uncle told me that I should take around 10-12 times of my Yearly Income as my Insurance Cover, so I came with figure of 50 lacs
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Me : F^&%#!^#(@^……….F#*(^$(*@^*$^@*(…….F*&#^&^$*#^$
Robert : Yes, you are right !! I understand it now.
Note : the assumption is that there are no assets, If there are Assets, then you need to deduct it from your Insurance cover.
Learning from This
So if you think you should have Rs X amount of Cover, Just ask yourself how is that amount going to take care of everything after you are gone and you will be surprised to know how wrong you were . This is specially for people who have those Endowment Policies stinking in their portfolio.
I ask them openly if they want to share with us How is that helping their Families if they are not there. Some Important learning are.
- Covering your Dependents is P1 (software guys will understand this), P1 means some thing with Highest Priority, something for which you should stop all other tasks and make sure you fix that.
- It does not cost a bomb if you fix this, Term Insurance is Cheap
That’s all ..
@Ganesh has a very good comment which completes the post with his awesome thoughts . please go through it ..
I don’t think any part of the example is incorrect or unnecessary. In fact, a thought process like this can open up someone’s mind completely, and arrive at a well adjudged decision on his/ her insurance needs. Kudos to you.
But having said that, drawing a line between one’s insurance needs and his means to cover premium expenses is critical as well.
Let us take Robert’s example. He has a salary of 4 lacks per Annam (33.5K per month). Expenses include 20K per month living expenses (excluding his own) and roughly 13.5K per month EMI (for 6 lakhs, at 12%, for 10 years) among many other.
So he is living way beyond his means already. How will he ever pay premiums for insurance? Beats me 🙂
But it is just an example, right? Characters like Robert, though rare, do exist. Before he starts with high insurance cover, he should start building assets or save/ invest for building assets.
So in my opinion, Robert should cover living expenses, loan liabilities and sufficient contingency to begin with and slowly increase his cover based on how his earning/ saving potential progress. It is unfortunate that he is in this position already, but that’s the truth.
So providing exclusive cover for children’s education and future home, though very important, is beyond what he can afford at present. (By the way, LIC’s Anmol Jeevan – a term plan – for a cover of 96 lakhs and 25 year term would cost 36.5K per Annam or around 3K per month)
Here is another view point (bit radical) on being heavily insured. The amount at stake is 96 lakhs in case of Robert’s death. It’s a scary thought, but in today’s world it might just be enough for greedy, evil minds to devise devilish ways to stake claim for the bumper jackpot (given his current earning potential).
To put it simple, the insurance amount should be sufficient enough for Robert to say “I care about you” to his dependents and not so much to hear “Hell with you” from them!
Comments are Welcome, If you read this and feel like you learnt some thing useful, you are obligated to put your Comments here ..
