By Sunil Kadyan,
Determining the life cover is the most crucial part in a life insurance policy. It is the amount which will be paid to the nominee in case of the policy holder’s death during the policy term. For this, the human life value (HLV) has to be determined based on the estimated future earnings life of the individual.
This attempts to arrive at a cover amount which is equal to the present value of the insured’s future earnings, and takes into account various aspects such as after-tax earning, expected number of years the income will be earned, annual estimated increase in income, a discount factor for the future earnings (risk-free like PPF rate), etc.
Methods of calculating HLV
Need analysis method: It attempts to arrive at future needs of the beneficiaries and then translates this into death benefit. This method is generally based on assumptions such as (a) it provides benefits in the period immediately following the death of the insured to offset additional expenses; (b) it supports the normal living expenses of the dependents; (c) it provides long-term income for the retired surviving spouse.
Multiple salary method: This method is the simplest of all methods. The maximum amount of insurance cover is determined as a multiple of salary. This multiple will depend on the age of the life to be insured and his salary. It assumes that the life insured is the only breadwinner of the family, and the family can live adequately on some percentage of the insured income.
For example, 40-year-old Raju is earning Rs 12 lakh a year. His family consists of wife (a homemaker), 10-year-old daughter and retired parents. Applying multiple salary methods, he can take a cover which is 10-15 times of his annual income. The cover would be Rs 1.2-1.8 crore.
Income replacement method: Under this method, it is assumed that life insurance should replace the lost earnings of the breadwinner. Here, insurance cover = current annual income x years left to retirement. For example, if you are 40 years old, your yearly salary is Rs 15 lakh and you plan to retire at the age of 60 years, the cover you will need is Rs 3 crore (Rs 15 lakh x 20).
By following these methods and considering various factors, one can arrive at an appropriate sum insured that provides adequate financial protection for their loved ones in the event of untimely demise. One should seek advice from a financial advisor or insurance expert who can provide personalised guidance based on one’s specific financial situation, goals, and risk tolerance.
The writer is associate professor, School of Management & Commerce, Manav Rachna University, Faridabad.
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