Steps for Choosing the Suitable Sum Assured For Your Term Plan
To find out the right coverage amount for term insurance, here are a few steps that you can take –
Step 1 - Income replacement for your future working years:
Your family might be dependent on you. So, in case of your death, they might suffer a loss of income. For such an unforeseen event, you may consider providing for the loss of income that your family might suffer in your absence.
To account for the loss of income, estimate the future working years. The longer the number of years you expect to work for the higher the coverage requirement would be and vice versa.
For instance, if you are 30 and expect to work till 65, you need a sum assured that would replace 35 years’ worth of lost income if you pass away tomorrow. On the other hand, if you are 40, the coverage requirement would be lower since you would have to plan for the next 25 years.
Step 2 - Consider your life goals:
There are major life goals one may have in their lives, such as higher education, trips abroad, marriage, children's education planning, retirement, etc. These events in life require a considerable corpus for which you need to plan. The sum assured while investing in life insurance plans may be chosen after factoring in these milestones or goals.
The higher your financial goals, the more the sum assured you would need. For instance, if you have to plan for buying a home, a car, a child’s higher education and retirement, you may need a sum assured that would provide funds for all these goals. On the other hand, if your goals are limited, the requirement of the sum assured may also be limited.
Step 3 - Calculate the annual expenses:
Your current annual expenses determine the coverage requirement. You may consider taking into account your family’s lifestyle expenses. Consider all the recurring and ongoing expenses such as healthcare bills, education fees, utility and grocery bills and other miscellaneous expenses along with the cost of inflation while estimating the required coverage.
Step 4 - Take your investments and debts into consideration:
Now consider your liabilities, debts and investments. If you have made adequate investments and savings in other forms, then you might go with a comparatively lower sum assured. Similarly, if you have high debts and liabilities, you might be required to avail a higher sum assured to meet them. Hence, you should consider both your assets and liabilities to determine the suitable sum assured for your term plan.
Step 5 – Factor in inflation
Inflation increases the cost of goods and services over time, thereby requiring a higher corpus to fulfil your financial goals in the future. So, when calculating the sum assured, it is important to factor in inflation to ensure your coverage meets your needs. Then, choose the right sum assured which would be able to sufficiently meet the inflation-adjusted expenses.
Methods to calculate the suitable sum assured
While the aforementioned steps help in fact-finding analysis to assess the term life insurance coverage required, there are a few methods that may help you calculate the right amount of sum assured. These methods of basic sum assured calculation are as follows –
The basic thumb rule
For calculating the minimum cover you need, the basic rule of thumb states that the sum assured of your term plan should preferably be 10 times your annualised income¹. So, if your annual income is Rs. 10 lakhs, you might need coverage of Rs. 1 crore to Rs. 1.2 crores.
The Human Life Value method
The Human Life Value (HLV) is a method wherein your future income, expenses, liabilities and investments are considered. are considered. Thereafter, a corpus is determined, which, when invested in a fixed-income avenue, would generate an annual return equal to your present annual income.
Take the following example to understand the method
Monthly income
| ₹25,000
|
Annual income
| Rs.25000 * 12 = Rs.3 lakhs
|
Risk-free rate of return (assumed)
| 6%
|
Corpus needed
| (Rs . 300,000 / 6%) * 100 = Rs 50 lakhs
|
So, Rs 50 lakhs invested at 6% annual return would yield the annual income of Rs 3 lakhs, which would give your family the income that they lose in your absence.
Income replacement method 1
This is also a straightforward method of calculating your sum assured. Under this method, your annual income is multiplied by the number of active working years to get the sum assured.
For instance, say you earn Rs.10 lakhs every year and you are 35 years old. Now, if you expect to retire at 65, your family expects to earn Rs.10 lakhs every year for the next 30 years. So, the sum assured should be Rs.3 crore so that if anything happens, the lost income is replaced.
Underwriter’s thumb rule2
This rule is similar to the basic thumb rule where the sum assured is determined as a multiple of your annual income. However, under this rule, the multiple depends on your age. Lower the age higher the multiple and vice-versa.
Expense replacement method
Financial advisors commonly recommend this method for determining adequate life insurance coverage. Begin by assessing the total financial requirements of your family, which should include regular household expenses, outstanding loan obligations, future goals such as children’s education, and lifelong support for financially dependent parents. The sum of these elements represents the overall amount your family will require.
From this figure, deduct the present value of your existing life insurance cover and financial investments. While calculating the value of your investments, exclude assets such as your primary residence and personal vehicles, as these are intended for continued use by your family. The resulting balance will provide a clear estimate of the additional life insurance coverage needed to secure your family’s financial future.
What factors should you consider while buying term insurance?
When buying a term insurance plan, the following factors may be considered –
Claim Settlement Ratio of the Insurance Provider
The Claim Settlement Ratio (CSR) is the percentage of claims that an Insurer settles in a year out of the total claims received. You may consider assessing the claim settlement ratio of an insurance company before buying a product. Higher claim settlement ratio indicates a better probability of the insurer honouring the claims.
Inclusions and exclusions of your term insurance
Check the coverage inclusions and exclusions. While term plans offer similar coverage, there might be some inbuilt riders, flexible death benefits and other optional coverage features that set the plan apart from the rest. So, check for these inclusions. Choose a plan that allows you to opt for a comprehensive scope of coverage that suits your needs.
Also, have a look at the policy exclusions to know the exact scope of coverage.
Medical process and filling the proposal form
Fill up the proposal form in detail, providing all the information about yourself and your medical history. Based on the details provided and/or your age and coverage level, the insurer might ask you to undergo a pre-entrance health check-up. Take the medical tests prescribed by the insurer so that coverage can be issued.
Premium amount
Check the premium amount being charged. Ensure that the premium is affordable so that you can pay future premiums consistently. Also, check the premium across different insurers. Consider Buying a plan that charges the affordable premium without compromising on the coverage.
Additional Rider Benefits offered by the Insurance Provider
Check the additional riders that are being offered, both inbuilt and optional. Look for suitable riders like accident benefit rider, critical illness insurance rider, etc., and add them to the policy for a wider scope of coverage.
Key takeaways
- When buying term insurance plans, choosing the right sum assured is essential for optimal financial protection.
- When choosing the coverage, factor in your goals, annual expenses, liabilities, etc.
- There are various methods of sum assured calculation, like the human life value method, the income replacement method, the underwriter’s thumb rule, etc.
- When buying term insurance, consider the insurer’s CSR, coverage benefits, premium, medical requirements, etc.
Conclusion
When buying the term insurance plan, do your research. Assess your financial needs and opt for a sum assured that would suitably compensate your family. The amount should help your family meet their daily expenses as well as their financial goals. Use the aforementioned methods and factors to determine the suitable coverage amount and then consider investing in a comprehensive term insurance plan.
Frequently Asked Questions
What should be the sum assured in my term plan?
You should choose a sum assured based on your income, expenses, number of dependents, age, investments, existing assets and liabilities, among other factors. There are various methods using which you can calculate the sum assured that you should buy.
Alternatively, you can use a term insurance calculator and choose the suitable sum assured.
Ensure that the sum assured is adequate so that your family is duly compensated in your absence.
Are riders important?
Yes, riders are important aspect of coverage since they help you get coverage against a host of other contingencies that cause financial loss. So, you should opt for suitable riders for an comprehensive scope of coverage.
What is the meaning of the Claim Settlement Ratio?
The Claim Settlement Ratio is the measure of the number of claims that the insurance company has settled vis-à-vis the total number of claims made on it in a financial year. The higher the ratio, the more the number of claims that the insurer has settled. A high ratio is beneficial since it increases the probability of settlement of your claims.
Is it better to buy term insurance online?
Both online and offline mode has its own benefits and it is not fair to compare the two. You need to understand your requirements and then choose the plan which suits your needs.
What is the maximum time to submit the claim form?
You should fill out and submit the claim form as soon as possible to get an early claim settlement. If you delay, the claim settlement will also be delayed.
Who gets the term insurance claim amount?
In the case of a death claim, the nominee makes a claim and gets the claim amount. However, if the nominee has not been appointed, the legal heirs of the insured can make a claim. They would have to submit a succession certificate when making a claim.
How long does the insurer take to settle the claims?
An insurer shall settle or dispute a claim under a life policy providing all the relevant reasons, if any, within 30 days from the date of receipt of all relevant papers and clarifications required.
What is the ideal term for term insurance?
The ideal term depends on your financial goals and needs. It is recommended to buy a long-term policy for coverage up to the maximum possible age.
