35-year-old Nilay has 3 insurance policies for a total sum assured of Rs 10 lakh. But the insurance cover he needs is at least Rs 1 crore.

I am 35 years old, working in a company with annual salary of Rs 26.5 lakh. I have the following policies.

15-year Money Back (Life Insurance Corporation - LIC) with sum assured of Rs 5 lakh with annual premium of approximately Rs 30,000
20-year Endownment policy (LIC) with sum assured of Rs 5 lakh with annual premium of approximately Rs 25,000
HDFC Pension plan (unit linked insurance plan - ULIP) for 25 years with annual premium Rs 10,000 (2 years completed)

Investment and liability
I have NSC (National Saving Certificate) for Rs 60,000 and invested Rs 50,000 towards Equity Linked Savings Schemes (ELSS). I have a housing loan liability of Rs 40 lakh for 15 years with Rs 41,000 as equated monthly installment. My life is covered towards housing loan liability.

My questions
1. Is my insurance cover sufficient? If not, what type of policy should I opt for?
2. Should I invest in insurance policies or mutual funds for future savings and my son's (6-year old now) education?

-Nilay

Kartik's Reply:
The extent of life insurance required depends on:
1. The loss of income
2. The savings that your family needs
3. The existing assets you have
4. How much you need to cover the liabilities you may have in respect of any loans

Given that your loan liability is covered, your need for insurance depends on the extent of loss of income to your family and the savings that you propose to do in years to come.

How much is enough?
The quantum of money required for savings depends on:
-- Your financial goals
-- The time available to meet those goals
-- Your preferred risk quotient

All these factors need to be considered in order to determine the exact amount of insurance you need as on today. A financial plan with detailed analysis would be able to indicate the level of cover you need. However that said, your level of insurance cover looks grossly inadequate.

Note: The level of cover will change in line with your changing financial circumstances in years to come.

Also read: An interview with Life Insurance

How to calculate insurance amount
There are popular ways of doing this like multiplying the annual income by 8 or 10 times. That would give you a ridiculously high figure.

In my view, the best way to estimate life insurance is to consider the replacement cost of all the future expenses that your family will incur during their lifetime.

Your insurance requirement = Annual household expense
-----------------------------------
Existing bank deposit rate

For instance: If your annual expenses are Rs 3 lakh, dividing that by a conservative estimate of bank deposit rate of 6 per cent (post-tax basis) you need an insurance cover of Rs 50 lakh. Double that amount to budget for inflation. You would need a cover of Rs 1 crore.

Taking a more realistic view and expecting say 10 per cent as investment returns to your family on your life insurance proceeds, I think a cover of Rs 65 lakh should be adequate.

Also please note that each year as you make more investments, this life insurance need of Rs 65 lakh will keep falling. At a period of say, 10 years from now or lesser, you will not need any life insurance.

How to choose the right policy
I think, the policies you have got with you are completely redundant. You can continue if you like. For additional insurance please consider term life policies.

Term life policies (without return of premiums) are the best option – it is like paying a small price to cover of life. Your family get the benefit only if you die, else nothing will be paid. That is the best way to cover life risk in my opinion.

Caution: Please do not take any pensions policies. You may generate good investment returns for now but when you have to take the annuity at retirement, almost 2/3rd of your money will be blocked to provide annuity. You are likely to get a tiny return of 3 to 4 per cent as annuity plus you will have to pay tax on that amount. There are better strategies for retirement planning.

How to plan long term savings?
For the future of your son’s education I would suggest you look at investing into equity mutual funds as that is the most prudent way to provide for this life goal.

Also read: Invest Rs 125,000 and reap Rs 1 crore

Illustration: Vaibhav Shirke

Disclaimer: The contents of the above article are the intellectual property and copyright of the author, Kartik Jhaveri. No part may be used or reproduced in any form or manner. If you choose to act upon the information contained in the above article it is at your own risk. This article is purely educative and you are strongly advised to consult an expert prior to taking any significant decision.

e-mail: Kartik Jhaveri

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