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Insurance & Life: How much life insurance coverage should one have?

, March 11, 2021, 0 Comments

Recently, one of my young friends died due to cancer. Arun was just 35 and was working for a software company in Bangalore. He is survived by his homemaker wife Aarthy aged 30 and 2 kids aged 7 and 5. He used to contribute 1 Lakh per month for the family. His monthly cash flow was as follows.

  • EMI for the Home Loan – 45,000
  • Household expenses – 28,000
  • Parents’ Support – 10,000
  • Life Insurance premium – 5000
  • Mutual Funds Investments – 12,000

life-insurance-marketexpress-inHe was staying in own house purchased on loan and was leading a quality life. Kids are studying in good school. Since there was an insurance cover for the home loan, the home is now debt free and family is staying in the same house.

He was paying an insurance premium of 5000 per month for a life insurance policy of 12 Lakhs. The insurance company settled the claim of 12 Lakhs.

His employer paid another 10 Lakhs from a group insurance policy covering all employees of that company. Aarthy deposited this amount of 22 Lakhs in a bank. She is getting around 13,000 per month as interest on it. Now the family is living on this. But she finds it difficult to manage the schooling of both kids with this income. She is planning to shift both kids to another school from next academic year.

If they want to maintain the same standard of living, there should be an inflow of 28,000 per month. Instead of 22 Lakhs, if there were 48 Lakhs in the bank, she will be getting 28,000 as monthly interest.

In simple words, Arun should have insured his life for 48 Lakhs.

Is it sufficient? In the above calculation, I have not considered the effect of inflation, possibility of reduction in interest rates etc. Accounting for these 2 factors, the amount required to ensure an inflation adjusted withdrawal of 28,000 per month for the next 50 years (till she is 80) is around 1.3 Crore. Here I have assumed that the amount of 1.3 Crore will generate a return of 1% above the inflation. So, this is the amount Arun should have looked at instead of 48 Lakhs.

Arun also had plans to accumulate money for higher education of his kids. He was keeping 10 Lakhs per kid in mind in today’s value. For that he was investing in mutual funds. If you consider this goal also Arun would have insured his life for 1.5 Crores.

Had he insured his life for 1.5 Crore, his family would have received 1.5 Crore as death claim. Aarthy can then invest 20 Lakhs for the children higher education needs and use the balance 1.3 Crore to ensure the same standard of living till she is 80.

Now, let us check the premium for a 1.5 Crore policy. Remember, he was paying a premium of 5000 for a 12 Lakhs policy. Going by that rate, the premium for a 1.5 Crore policy would be around 62,500 per month, which is not affordable to him.

What were the options available to Arun in the above scenario? Before moving further to options, let us try to understand different types of life insurance policies available in India.

Next: Understanding Savings linked life insurance policy/ Endowment policy, stay tuned