This seems like a season of disclosures!
After disclosing to you the stocks and mutual funds I own in my portfolio, today I discuss the amount of term insurance I’ve bought and my reasons for the same.
Buying a term insurance is one of the most important steps in your overall financial planning.
You may avoid buying any ULIP, Endowment, Money-Back, or Child Plan…but just don’t avoid term insurance.
This is especially true when you have dependents but don’t have enough assets (investments, trusts, etc.) to provide for them after your death.
However in case you have dependents and also have enough assets to provide for them after your death – a fully-paid-for home, a large and well-performing investment portfolio, frugal lifestyle – then you “do not” need term insurance.
I fall into the first category above – while I live a frugal lifestyle, I still don’t have enough assets as of now to provide for my dependents after my death – and thus I need term insurance.
Term insurance isn’t ‘life’ insurance
The most important aspect about term insurance, that most people fail to consider, is that it’s not really “life” insurance as it is generally claimed to be.
A term insurance, after all, does not insure your “life”. It will not save you from dying.
In reality, a term insurance is a “cash flow” insurance – it insures the cash flows your family would need to survive, whether you are alive or not.
How much term insurance I’ve bought?
This is how I have calculated my needs – as I mentioned above, I see term insurance as something that will replace the cash flows that I would bring to meet my family’s expenses in case I were to not die.
So if I expect my wife to survive 20 years after I’m gone (I’m keeping my children out of this as by the time I die, I’ve assumed that they would be living their lives independently), the amount of term insurance I must have is:
(20 years x 12 months per year x Assumed Monthly Household Expense in the year I die) x 1.5
= 240 months x Rs 50,000 x 1.5
= Rs 1.8 crore
Why did I multiply my insurance requirement by 1.5 in the above formula? Well, that is to have a margin of safety in case I die much earlier than expected (and thus my wife would need much greater cash flows to survive the remainder of her life).
Also, one thing missing from the above formula is any debt/loan I may have as of now (and I have zero debt as of now).
If you have, say, Rs 20 lac of housing or other loan, just add this amount to the above calculation, and you can arrive at the total term insurance you need.
So, as the above calculation shows, I need term insurance worth Rs 1.8 crore. As of now, I am still short by Rs 30 lac, which I will cover up soon.
Insurance in whose name?
I bring in cash flows to run my household, so the term insurance policies must be in my name.
Remember again, I must not get emotional here and try to insure the “life” of my wife and children, in case they are not adding to the household cash flows.
In short, term insurance acts as a replacement for cash flows, so as a rule, you should only insure people whose death would mean a financial loss to you (and it’s most likely ‘you’).
Insurance isn’t investment
You take term insurance because you consider the probability of dying within the insured period high enough, so that your dependents can get the sum assured.
But if you don’t die within the insured period (20 or 30 years as the case may be), you won’t get anything from the insurance company.
In other words, if you survive, there’s “no” return of capital in a term insurance. And thus, it must not be considered as an alternative to investments, or an addition to your investment portfolio.
Term insurance has just one purpose – to replace an economic loss. That’s it!
It’s not for education savings. It’s not for retirement savings, or to provide a tax-free loan later in life.
No matter how much term insurance you buy (or are sold), it will never replace an emotional loss.
So buy sensibly…but just buy it!
Very nice article Vishal, I like the Margin of Safety concept in your term insurance as well.
It’s good to be little over insured but I think you are insured on the higher side, which is not necessarily a bad thing. The reason I am saying this is because when the nominee receives the funds in a mishap, I hope they just don’t keep it in their bank account for a mere 3-6% return. Ideally, the corpus they get should fetch a return of, say, 10%pa. The other way to calculate the same is,
Current Annual Expense, say 6 lacs (50000*12)
Margin of Safety, 50% = 9 lacs (6lacs*1.5)
To generate 9lacs per annum @ 10% return, we need 90 lacs corpus (90lacs*0.1=9 lacs)
So, term insurance of 90 lacs is the basic requirement. But both these methods does not take inflation into consideration. One has to be careful about this as well.
One should also consider the ability to pay the premium, term insurance is not expensive but not everyone is same. Also, one can spread the risk by taking 2 different term insurances from two different insurance companies with decent claim settlement ratio (the data available on the internet is not to be trusted on claim settlement). Please share your thoughts on this kind of calculation and how destructive it could be 🙂
Hi Mansoor, your calculation also provides a good way to arrive at the base figure. But then, as you rightly mentioned, inflation is a big killer. Having a margin of safety of 50%, which takes into account inflation and probability of an earlier death, the appropriate figure for my kind of a person will still come to around Rs 2 crore.
Also, buying plans from 2-3 different companies also makes good sense (I have plans from 3 insurers).
In our insurance policy we always nominate our wife as a nominee.
But the fact is that whenever the long distance travelling need arises we travel together.
We all know there is high risk in long distance travelling which we do together.
There is less risk in travelling short distance from my office to home and home to office, which i do alone.
So, if both wife and husband expires together then what? is the first point.
The second point, getting claim is not easy, what training we should give to our wife to get claim, especially when our spouse is not highly educated or not from financial background.
Will be happy if u share ur views.
Hi RichFellow, for you first point, it is here that the need of having a Will is so important. If both you and your wife die together, who should get the claim to your insurance and other investments needs to be clearly specified in the Will.
As for your second point, you could arrange a meeting between your family (including your wife) and your insurance advisor to understand the claim settlement process. Visiting the insurance company’s office with your wife and discussing the matter with a manager there can also help.
Hi,
How about deducting the amount of investments already made from the insurance requirement and then arriving at a net Term Insurance Figure. Considering above numbers, if one has made investments of lets say 30 Lakhs, then the term insurance number gets reduced to 1.5 Crores. Also there is a new debate going on for online Vs traditional term insurance. Which one should we consider. Does buying traditional term insurance initially and topping it up with online plans make sense. Please share your thoughts.
Nakul, that’s a nice idea but that can be done when one has good enough clarity about the kind (and size) of investments one can accumulate by the end of the insured period. Personally, I plan to gradually reduce my sum insured as I reach closer to the end of the insurance term (about 20-25 years from now). This is assuming that I will create a large enough investment pool that will take care of my family’s cash flows after I’m gone.
As for your question about online vs traditional insurance, I go with the latter because what I know is that when you take up an online pan, while your premium is low, you don’t get any kind of branch support from the insurance company.
Some other reader(s) of this post might shed a better light on this topic though.
taking insurance online is 50% cheaper then traditional one and if you have given right detail then chances of claim rejection will be very low and after 3 years of your policy start it will be really difficult for company to decline your claim without giving solid reasons
Thanks for your suggestion, Ashoka!
Did you take any rider with your term insurance?
No Ram, I have no riders attached with my term plans.
vishal,
Thanks for your excellent Post. i have bought insurance policies a couple of years back … without even planning or thinking, solely because others were buying it and my financial planner asked me to do so.
After reading your post on “7 steps to being a personal financial planner” i realized the poor decisions that i have taken all along with respect to managing my finances…
I have scouted for a good term insurance policy that meets my objective, and have already decided to dump the existing … no use … policies that i have taken.
I have been following your posts for less than a month and have become a huge fan of you 🙂 …. I have recommended all my friends and relatives to subscribe to your posts.
You are an eye opener …. Hats off vishal … Continue the good work that you are doing.
Hi Venkatesan, thanks a lot for your kind words of appreciation! It is thoughts like these that keep me going.
Hai Vishal,
Man, you make sense. Keep the good work going. Thanks
Thanks for your feedback, George!
Fantastic article. Few questions
1) Will monthly expnese not reduce since you are no longer there. For exaple if monthly expnese was 50k pm. In your absence your family can make do with 35K.
2) Can a person have multiple life insurance from multiple providers? Will all claim be settled or like general insurance(medical/car) only 1 claim is entertained and settled.
Thank you in advance
Mark
Dear Vishal,
Good post. I have few points to say:
It is not about that 20years that you expect your wife to survive 20 years after you are gone.
I am 30 and my wife is 25 and if I die today there is most likely chance that my wife may survive another 40 to 50years. Even if you are 40 and your wife is 35, still 30 to 40years left out.
As you rightly pointed out it is a cash flow insurance. I see this as a income replacement, if I am not there today for my family, still I need a income and the income should come from this insurance amount.
I arrive at the insurance amount this way. I am 40 and I have 20years of income ahead of me easily. In this period most of my life time goals including kids education, marriage, regular monthly expense (through a corpus) for my wife till her life time will need to be achieved from this income. That means the minimum insurance you should have is to create a corpus to generate an income equal to your monthly income without excluding any goals. You should safely assume a safe 6-7% return on that corpus and workout the corpus required. You may add a margin of safety to adjust for inflation as you have suggested but in this case 1.5 may be on the higher side.
The idea is that you continue to get an income in your absence, an equal amount to your salary from that corpus and the family continue to spend and invest to meet the needs.
While the target you have calculated could be the same even by above method but if you change the age of the insurer the value may vastly differ.
Regards
Thanks for the feedback and inputs, Ajay!
Dear vishal ,
Just to add to my earlier comments, your insurance amount should towards meeting the goals that you would have set already for yourselves.
Lets say to meet all my goals, I need 4Crores and I have already saved 1Crore, then if you take insurance for 3 crores, it will solve all you problem. But the insurance amount you pay for that will be equally higher. Therefore, that montly investment amount to that target amount of 3 crores + your monthly expenses amount should ideally come out from the insurance corpus you get via a interest of 6-7% on the insurance corpus. In this case, lets say your monthly investment to meet is about 50,000 + Monthly expense is 50,000/- then you need about 1.5Crore of insurance. You may add a 20% margin of safety here.
The above is amount is based on the goals. And the goals take care of your age, inflation etc. The only variable factor here is interest on the corpus. 6-7% is safe to assume, you can cover addittionally by margin of safety to give comfort to your assumption.
Regards
Dear Tribesman,
I wanted to take a term insurance for nearly 2 crore after going through the calculation. But if I have to take policy from reputed insurance company like LIC, the premium is too high. On the other hand if I look at Religare, the premium is less but the settlement ratio is low. Kindly share your suggestions…