What role does insurance play in financial planning? And how much insurance do you need?
Insurance, especially life insurance, is generally neglected by most people, even though it is of great importance to their financial well-being. The reason is that people treat it as an unproductive expense. But such thinking is not correct. Not only should you be insured, you should also make sure you are not under- or over-insured. If you are under-insured, you have not secured your family sufficiently against the risk of an eventuality. On the other hand, if you are over-insured, you are spending more money than is necessary on buying insurance. Those surplus funds, if invested properly, would enhance your wealth over the long term.
Technically, insurance means transferring risk and protecting the economic value of your assets. Life insurance protects your family against the risk of sudden loss of income due to the untimely death of the insured. To secure the family against this risk, it is important to buy sufficient life insurance cover on the life of the earning member.
Financial reasoning discourages buying insurance for non-earning family members, especially children, as the risk of loss of income stream is not involved in their case. But several insurance advisors, after selling policies in the name of earning members, i.e. the parents, suggest buying insurance in children’s name. Instead of buying insurance in children’s name, earning parents should buy the cover in their own names. Along with the main policy you should also buy a waiver of premium rider. This ensures that future premiums are waived in case of an eventuality. Only if a substantial liability is incurred in the name of children, such as an educational loan, should a term cover be purchased to cover such liability.
How much insurance
Several methods exist for calculating insurance needs.
Income-based calculation. The sum assured is calculated as three to five times annual income.
Premium-based calculation. The premium payable is calculated as a percentage of annual income, say five percent. On this basis the sum assured is decided.
Need-based calculation. The expenses (needs) are