How To Insure Life Optimally
Oct 31, 2017

Author: PersonalFN Content & Research Team

10-year Benchmark G-Sec Yield

Insurance is a vital component of financial planning. Many do recognise the importance of a life insurance cover. But the fact is, a large number of individuals do not recognise the fundamental purpose of insurance, and are, therefore, sub-optimally insured.  

The core objective of life insurance is indemnifying risk to life.

However, our experience shows that often individuals aim to kill two birds with one stone and buy insurance-cum-investment plans that insurance agents (who work for commissions) push. Also, insurance policies are bought considering:

  • The amount of premium to be paid;
  • The tax saving benefit that comes along; and
  • The insistence or influence of elders (who have invested a predominant portion of their savings in products of LIC of India)

As a result, not only are many individuals sub-optimally insured, but their investments, particularly in endowment plans and some ULIPs, prove unrewarding. Hard-earned money is deployed without a holistic approach that recognises: risk profile, investment objectives, financial circumstance, goals, and investment horizon; and other factors. Thus, costs outweigh the benefits. 

When you’re addressing your insurance needs, the question that you need to be actually asking is: “Will the insurance coverage sustain my family’s needs once I’m gone?”

You will agree that the only thing predictable about Life is that it is full of uncertainties. We don’t know what’s in store. And sometimes, an untoward event takes place, when it is least expected. Hence, you ought to safeguard the interest of your loved ones, dependents by prudently assessing your ‘Human Life Value’. This approach will financially safeguard them if you, the breadwinner, pass away.

What is Human Life Value?

Human Life Value (HLV) could be defined as the amount of money a family requires to sustain their standard of living in the event of demise of the main bread earner. 

HLV is a scientific method of determining insurance needs. There are many ways to determine life insurance requirement. And according to PersonalFN the best and the most effective way of calculating insurance requirement is through the Human Life Value – Expense method. It takes into account factors such as:

✔ Life expectancy of your spouse
✔ Number of children
✔ How old the children are, and how many years they’ll be dependent on you
✔ Total number of dependents
✔ The financial goals you’re addressing for the dependents
✔ Your monthly household expenses (excluding your personal expenses)
✔ Lifestyle expenses
✔ Total expenses of dependents
✔ Contingency reserve (if any)
✔ Assets
✔ Current insurance (if any)
✔ Outstanding loans
✔ Cost of inflation
✔ …and many more!

How to go about calculating Human Life Value using the Expense Method?

The first step under HLV-Expense Method is accounting your net annual income, and then deducting expenses for your personal use. The remainder is the amount that you can afford for your family annually.

Let’s take a case study to understand this better…

Mr Salunke, aged 40 years, earns Rs 15 lakh per annum, and spends Rs 6.36 lakh annually on his family towards household and lifestyle expenses.

He wants to provide for his spouse Radhika’s (age 36) retirement as she is dependent on him. Further, he intends to provide for the education and marriage expenses of his children, Vishal and Vibha. His son, Vishal, is 9 years old and his daughter, Vibha, is 6.  According to Mr Salunke’s calculation, he is keen to provide Rs 41.74 lakh for Vibha’s education and marriage (in present value terms) and for the son’s education and marriage Rs 38.77 lakh.

Currently, Mr Salunke has loans outstanding to the tune of Rs 45 lakh, which has to be taken into account when calculating his insurance cover. He has also accounted for a contingency reserve of Rs 10 lakh and has an existing life insurance coverage of Rs 50 lakh. The assets the family will be able to financially benefit from, in the case of his demise, are worth Rs 12 lakh.

Inflation is assumed @ 8% p.a. for the purpose of time value of money, while the risk-free investment rate is assumed at 7.3% p.a.

Now with the vital inputs and a prudent assessment on the basis of the assumptions, here’s the granular number crunching tabulated below:

Family’s monthly expenditure (per month) (Rs) 35,000
Family’s annual lifestyle expenditure (Rs) 2,16,000
Percentage of monthly household expenses on Mr Salunke (% per month) 15
Percentage of annual lifestyle expenses on Mr Salunke (% per year) 25
Expected inflation on household expenses (%) (assumed) 8
Expected return on risk-free securities (%) (assumed) 7.3
Number of financial dependents 3
Dependent 1: Spouse
Spouse’s (Radhika) current age 36
Number of years Radhika will be dependent on Mr Salunke 44
Percentage of monthly expense spent on Radhika (%) 25
Percentage of annual lifestyle expense spent on Radhika (%) 25
Provision for retirement planning for Radhika (Rs) (rounded off) (present value) 25,56,325
Total monthly expense on Radhika (Rs) 13,250
Financial Value of Mr Salunke’s life to Radhika (Rs) (rounded off)                                (A) 1,06,29,532
Dependent 2: Son
Son’s (Vishal’s) current age 9
Number of years Vishal will be dependent on Mr Salunke 19
Percentage of monthly expense spent on Vishal (%) 25
Percentage of annual lifestyle expense spent on Vishal (%) 25
Provision for graduation for Vishal (Rs) (rounded off) (present value) 10,81,156
Provision for post-graduation for Vishal (Rs) (present value) 16,64,469
Provision for marriage expenditure for Vishal (Rs) (present value) 11,31,505
Total monthly expense on Vishal (Rs) 13,250
Financial Value of Mr Salunke’s life to Vishal (Rs)                                                          (B) 70,82,236
Dependent 3: Daughter
Daughter’s (Vibha’s) current age 6
Number of years Vibha will be dependent on Mr Salunke 22
Percentage of monthly expense spent on Vibha (%) 25
Percentage of annual lifestyle expense spent on Vibha (%) 25
Provision for graduation for Vibha (Rs) (rounded off) (present value) 11,02,454
Post-graduation expenditure for Vibha (Rs) (rounded off) (present value) 16,97,258
Marriage expenditure for Vibha (Rs) (rounded off) (present value) 13,75,580
Total monthly expense on Vibha (Rs) 13,250
Financial Value of Mr Salunke’s life to Vibha (Rs) (rounded off)                                    (C) 79,23,655
Other Areas
Outstanding loans (Rs)                                                                                                        (D) 45,00,000
Other liabilities (Rs)                                                                                                              (E) 0
Contingency fund that will be required by the family (Rs)                                             (F) 10,00,000
Current life insurance that the client already has (Rs)                                                  (G) 50,00,000
Assets that the family will be able to financially use in case of Mr Salunke’s demise (Rs) (H) 12,00,000
Total life insurance requirement (Rs) [(A+B+C+D+E+F) - (G+H)] 2,49,35,423

The sole objective of this extensive exercise is to determine the total financial value of the breadwinner towards each dependent and obligations/loans. After this summation, subtract the current life insurance cover along with existing assets, if any, to determine one’s ‘Human Life Value’.  In the aforesaid case, Mr Salunke’s Human Life Value, as per the expense method, works out to a little over Rs 2.49 lakh.

Yes, estimating HLV is a bit complex; but you can always use PersonalFN’s advanced Human Life Value Calculator. It is a quick tool to determine the optimal insurance coverage required to protect the financial interest of your loved ones.

What next?

Once you’ve determined the optimal insurance coverage, go ahead and choose an appropriate life insurance product. You see, there are a number of insurance products available in the market today, from term plans to ULIPs to endowment plans, money back policies, and so on. It can be rather perplexing if the fundamental approach is flawed. Here’s what you must keep in mind…

Four common mistakes to avoid when buying life insurance:

  1. Buying insurance as a tax saving option – Simply opting for a policy because it offers a tax deduction under Section 80C of the Income Tax Act, 1961 is an imprudent approach. Ending up with a bunch of insurance of policies in this endeavour will neither help you address your insurance needs, nor effectively address your vital financial goals.
  2. Focus on the premium rather than coverage – Going by the premiums alone can be a rather cockeyed approach.  You ought to meticulously assess if the coverage is at least somewhere close to your Human Life Value. The benefits should outscore the cost, or you could be seriously underinsured.
  3. Non-disclosure of the mandatory information – If you disclose only partial personal information to an insurer, your family / dependents would be in a hot soup during the claim settlement process. Their financial security could be jeopardised. So be honest and disclose all the material information to the insurer. Ensure that the insurance agent has forwarded all the documentation, information you have shared at the meetings with the insurance company to avoid any disappointments later.    
  4. Mixing ‘insurance’ and ‘investment’ needs – Don’t make an attempt to get two birds with one stone by buying insurance-cum-investment products. It could end up doing injustice to your insurance as well as investment needs.

Ideally, life insurance and investment needs should be dealt separately. To address the former, a simple pure life-term insurance plan is by far the best. A pure term insurance addresses only your insurance needs. It does not commingle insurance and investments. It provides financial security to your family/dependents vide the sum assured on your demise.

Term Plans have the lowest premium structure. They are cheaper compared to insurance-cum-investment policies and provide a better cost-to-benefit advantage. Meaning, against the premium you pay, the sum assured is much greater as against endowment, ULIP, money-back policies, and likes.

Term plan come with a policy term: 15, 20, 25, 30 years and so on with an aim to provide longer life coverage. If you as a policy holder survives the policy term (i.e. the period for which the policy offers you insurance cover), you get nothing – there is no maturity benefit. This is one of the reasons why many individuals don’t opt for a term insurance policy, as there is only a death benefit. Also, it is believed that since the insurance is available only for a particular term after which there is no cover, it is not a comprehensive policy. But what they fail to recognise is the financial security of their family members.

Today, there are term life insurance policies with a Total Return Of Premium (TROP) option. However, they come with an additional premium outlay, i.e. the premium is much higher. In PersonalFN’s view, it does not make sense to pay that additional premium. Instead your hard-earned money saved therefrom could potentially be invested in wealth-generating investment avenues to counter the inflation bug better and accomplish the envisioned financial goals.

Before blindly buying a policy from any life insurance company, here are a few things you must check:

  • Promoters background of the insurer
  • Number years of existence
  • Financial background of the insurer, where you need to gauge these factors:
    • Claims Settlement Ratio (CSR) – This will help you assess the percentage of claims settled, against the total claims lodged with the insurer (i.e. insurance company). 
    • Solvency Ratio – This ratio reveals the strength of the balance sheet of the insurance company and its capability to settle insurance claims. It takes into account the net worth and the reserves and surplus held by the insurer. 
    • Profitability Ratio – This ratio reveals whether the insurance company generates enough income for its stakeholders after meeting all the expenses (both operating as well as non-operating expenses). It helps you gauge the efficiency and effectiveness with which the insurance company is run.
  • Watch out for the devil in the fine print

(Do read: What should be your check points before buying insurance?) 

It would be prudent to go with season players (insurers) rather than companies that are relatively new entrants in the insurance business.  After all, when you are buying an insurance cover, you want peace of mind that the insurance company will settle the claims. However at the time of underwriting, honestly disclose all the necessary details, so that your family will not face a rude shock later.

You see, insurance is an integral aspect in the exercise of financial planning and must be undertaken with utmost care. We believe, without an optimal life insurance cover you are bidding goodbye to the dreams and financial security of your loved ones.

Finally, buying insurance is a continuous activity. Every individual's needs change over a period of time. This in turn necessitates a review of your insurance requirement. So, over a period of time, ensure you review your insurance needs to buy an additional insurance, if needed, and remain optimally insured. If you need superlative assistance to ascertain your insurance requirements, do reach out to our team of Certified Financial Guardians on +91 (022) 61361221 or write to us: We will be happy to help you!

No matter how young you are, don’t procrastinate taking an optimal life insurance cover, as no one can foretell when life will change its course.

“Perhaps the best cure for the fear of death is to reflect that life has a beginning as well as an end.”  – William Hazlitt.

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