When I say “Cover you with Life Insurance”, I do not mean a Herculean task.
Not even a fraction of that.
Unlike a financial plan, insurance planning—being a part of it—is a very simple and less demanding task, so that you can focus on your investments and capital growth.
Yet, life insurance is as significant. It is your replacement to provide financial security for your family, in your absence.
You may have heard, “Time is Money”.
But both—time and money—literally are the two things one needs to consider while getting insured.
Time and money in the right proportion will make your insurance to be the most effective.
“I need a ‘sum’ of life cover for a ‘number’ of years”, Simple as that.
Today, we’ll learn how to find the optimal Sum Assured and Term so that your insurance plan will complement your financial plan.
Life insurances are meant to act only as a backup plan.
If you survive the insurance term, the policy will be terminated with no benefits.
And your primary focus is your financial plan, not a worst-case scenario that may never happen.
That being said, let’s start with…
To put it straight, the optimal term for your insurance is the number of years between today and the year you are planning to retire.
In this case, it is 25 years.
As seen above, life insurance is your replacement to provide financial security to your family.
By the time you retire, you would have attained or have enough savings to attain all your financial goals.
And hopefully, your children will have become financially independent, too.
This means you will be paying your policy premium from your retirement corpus.
It is an unnecessary expense from your limited resource of savings.
On a side note: be sure to choose the right retirement age in your financial plan.
For example: you may have planned to retire a few years early, say at 55 years of age, in your financial plan.
Just in case, if you have to extend it later due to uncertainty, your life insurance policy will expire at the predetermined date.
Then, you will have to get a new life insurance policy for higher premium or spend those years with no life cover.
Think long-term, account for uncertainty; choose—not ideal—but practical retirement age.
So, have you calculated your optimal insurance policy term?
Keep it ready, because you’ll need it to calculate the optimal life cover that fits your financial plan.
The optimal life cover for you is what we call, your Human Life Value.
Human Life Value (HLV) is one of the most important concepts in life insurance planning because it helps determine the right amount of coverage required to protect your family’s future financial needs.
Of course, it does not mean an actual value for one’s life, which isn’t quantifiable.
Here, the Human Life Value signifies today’s value of all the money you will be earning.
That is the sum of your next pay check to your last pay check at retirement.
For example: Imagine a person, Kishore. He is 30 years old and his annual income is ₹12 Lakhs.
Understanding how to calculate Human Life Value in insurance helps avoid both under-insurance and excessive insurance costs.
In that case, considering an ideal scenario, Kishore’s total earnings will be ₹3.6 crores in 30 years.
But that is not all. Nothing is ever ideal, is it?
There are factors like potential increase in your income, change in lifestyle due to change income, inflation, return on investing the insurance benefit,
We have to consider these for the Human Life Value to be as precise as possible.
Since a change in lifestyle or added financial commitments cannot be predicted, we should count them in only when necessary and during financial plan reviews.
On the other hand, return on investing the insurance benefit, by the nominee, to offset the inflation can be predicted.
Years of track records show low-risk debt fund investments give an average return of 8% per annum in the long term.
With all the data in place, we can calculate the Human Life Value of Kishore as,
The Human Life Value formula in insurance generally considers current income, expected income growth, working years remaining until retirement, inflation, and expected investment returns available to the nominee.
In the event of the insured’s death, his nominee will receive this optimal life cover.
Investing this Human Life Value in a low risk 8% return instrument will fetch his nominee ₹12 Lakhs per annum for 30 years.
This example clearly shows how Human Life Value in life insurance acts as an income replacement mechanism for dependents in the event of an unfortunate loss of the earning member.
It will be a virtual financial replacement for Kishore.
To calculate your optimal Life Cover and Policy Term that fits your Financial Plan, use this “Life Insurance Calculator”.
A proper HLV calculation can help you choose the right term insurance cover and avoid purchasing inadequate or excessive life insurance.
The building phase of your Life Insurance Profile will be complete with the completion of this step.
But you might still face a practical challenge in finishing up.
“How do I choose the right insurance policy from the list of term plans available in the market?”
“What would define the quality of a good insurance policy?”
If you cannot seem to find answers to these questions, don’t worry. We’ve got your questions answered in this article:
Here’s “A Cheat Sheet to Select the Best Term Insurance Plan for you”.
Selecting the best term insurance plan also means, keeping it in the best shape.
Like your investment portfolio and your financial plan, your insurance plan needs periodic review, too.
It will help to keep your insurance plan in good shape, and in turn, your financial plan.
Human Life Value Formula: Key Factors That Influence Your Life Cover
The Human Life Value method takes into account factors such as current annual income, expected salary growth, remaining working years, inflation, outstanding liabilities, and expected investment returns.
While different insurers may use different versions of the HLV formula, the final objective is to arrive at an appropriate life insurance cover that can replace future income for dependents.
Understanding how HLV is calculated can significantly improve your life insurance planning decisions and help align insurance coverage with long-term financial goals.
Just as the insurance cover building phase, reviewing it is also quite simple and quick.
Since it does not take much effort or time, you may review your insurance plans, too.
It is much like checking if you have fastened your seatbelt before driving your car.
However, your insurance cover review is a must if there is a substantial increase in your monthly income, say 25% or more.
A breakthrough in career or promotion could bring such a dramatic increase in income.
And often, it also inevitably increases expenses. It has happened to many people, and it may happen to you too.
In such cases, you will need to increase your life cover.
On the other hand, you might choose to change your retirement age in the future.
Even though it is very rare, it is a possibility.
In such scenarios, you might want to extend your life cover.
Reviewing your insurance plan will show, if it will still be effective for your financial plan.
Building a sound insurance cover is the simplest there is in financial planning.
Yet, many of us mix up insurance and investment—unaware of its harmful effects.
If you or someone you know is still unaware—or want to get rid of those financial drains—read “Is Your Insurance Policy Hurting Your Portfolio?”
Regardless, I appreciate you for choosing to build your insurance profile by yourself.
If you find this article helpful, share it on your social media.
You might help someone choose the right insurance plan.
If you feel your financial plan deserves a professional touch, feel free to reach out to us by registering below.
Quick Summary What Works What Doesn't Strong alpha over 1-year, 2-year, 3-year, and since-inception periods…
Listen to this article A self-employed chartered accountant with a ₹70 lakh home loan parks…
Listen to this article Quick Summary What Works What Doesn't Positive alpha over the S&P…
Listen to this article Every day, millions of Indians check the Sensex and Nifty before…
Listen to this article Few segments of the stock market generate as much excitement—and anxiety—as…
Listen to this article Income tax filing in India has undergone significant changes over the…
View Comments
This blog offers a simplified and practical guide on prudently covering yourself with life insurance, making it an essential read for anyone looking to ensure their financial security and peace of mind.