Life insurance has always been a rather neglected area for the public.
Historically, consumers have bought life insurance for reasons of tax saving rather than the core need of providing for one's family in case of death of breadwinner.
Secondly, Indian consumers have been unaware that insurance too needs change with every change in one's life stage (e.g., if one gets married or has children, one's need for insurance goes up).
As a result only 8 per cent of India's population is insured and the average insurance size is around Rs 80,000.
This implies that people who think they are insured are also heavily under-insured.
One of the most significant reasons for this is the inability of the advisor / agent to educate the customer about the true nature of life insurance.
They have tried to highlight the product rather than the need. The need for risk coverage / the need to provide for untimely death is more difficult to explain and hence has been till lately ignored.
Aggravating the situation is the fact that term insurance was expensive until recently.
Basically, the amount of insurance one should buy is directly dependent on his/her economic value, otherwise known as the 'Human Life Value'. This varies from person to person.
'Human Life Value' is the capitalised value of the net earning of an individual for the rest of his working span.
It is, in short, the present value of the total income of the individual, which his lost to the family in the event of his untimely death.
Let us take an example:
Mr X, aged 35, earning a gross annual income of Rs 200,000 today, will retire at the age of 65.
| Age of a Person | 35 |
| Age of Retirement | 65 |
| Years to Retirement | 30 |
| Annual Gross Income | Rs 2,00,000 |
| Personal Expenses + IT | Rs 56,000 |
| Net Disposable Income | Rs 1,44,000 |
| Annual growth in Income (10% every yr) | 10% |
| Total Income till Retirement | Rs 2.36 crore |
| Rate of discounting | 6% |
| Net Present Value | Rs 41.24 lakh |
If he doesn't return home today, his family will have lost this amount forever.
Therefore, Mr X's Human Life Value = Rs 41.24 lakh.
A simpler way of looking at it is as follows:
Suppose,
| Monthly income of a person = | Rs 10,000 |
| His personal expenses per month = | Rs 2,000 |
| Monthly income provided to family = | Rs 8,000 |
| Therefore, annual income provided = | Rs 96,000 |
| Amount of money to be put in the bank to earn Rs 96,000 pa at 6% interest rate = |
Rs 16,00,000 |
| Hence, HLV is = | Rs 16 lakh |
Please note that we have not even taken into account the future income growth of the person. This is, therefore, not an exact way of calculating the Human Life Value. This is only a representation to give the customer a fair idea of how this works.
Normally, when the Human Life Value concept is used, the amount arrived at is much more than what the prospect would have normally thought of.
The advisor, therefore, must necessarily suggest a package, which covers this amount at an affordable premium.
For example, if we calculate the premium amount for Rs 16 lakh pure-term cover for a 32-year-old man, the amount will be roughly around Rs 6,000 per annum for a term of 20 years.
This works out to just 5 per cent of his annual salary (annual salary equal to Rs 1,20,000).
Thus, dying too soon or rather planning for uncertainty of life is the most important need that life insurance fulfils.
However, there are other objectives that one could have in mind, which can be achieved through life insurance.
The important ones being:
- Living too long: Retirement planning.
- Living Death (physical disability, etc).
- Children's education and marriage.
- Wealth and estate creation.
Hence, depending on his objectives, the quantum of life insurance can vary.
The author is Managing Director, OM Kotak Life Insurance.
This article forms a part of 'Money Simplified -- Life Insurance: Hear it from the experts,' a free-to-download online guide from Personalfn.
To download the entire guide, click here.
