How to really buy life insurance

When faced with the prospect of figuring out how much insurance to buy, most people pluck a figure out of the air - something that just seems adequate. Or another common practice is to rely on insurance agents to decide a policy and sum assured. This is obviously not the way to make this important decision.

The only reasonable way of deciding what and how much insurance you need is to unemotionally create a financial plan that your family should follow if you die suddenly. Families also have to consider the impact of both parents passing away in an accident. The impact of such a tragedy could be greater than just the sum of two deaths occurring separately. Here are five things to consider.

Time left to retirement:
Before buying any term insurance plan, an individual must assess the time left to retire and what 'sum assured' will be sufficient. Time remaining to retire here does not necessarily mean retirement from your job, but rather the time till your family members will depend on you for their financial needs. Once you know the number of years for which you have to stand as the financial support, look out for policies that offer the matching policy term and maturity age. For instance if you are supposed to retire after 20 years, make sure that you take a minimum policy term of 20 years. It is important to be insured at least until you pass on the baton to another family member.

Loans and debts:
As far as possible, take debtors' insurance so that your debts can be paid off straight away. If you have a housing loan, the lender would have probably made sure that you already have insurance for that loan. Other loans need to be considered. While you can add these to your main term insurance, taking a policy where the insurance company will directly pay off lenders has the advantage that your survivors will not have onus to carry the loans. Do not waste money in insuring unsecured personal debt like credit card debt. The card issuer cannot make your family pay so there's no need to cover that, unlike say vehicle loans where you wouldn't want the family car to be possessed by the lender.

Future expenses:
The hardest part of providing for future expenses is estimating and allowing for inflation. Take a reasonable, at least 7 per cent, inflation rate into account.

Education:
Insurance companies are making some attempts at designing policies that will ensure that your children's education is paid for. What you ideally need is a policy that is conceptually term insurance, that is which does not have any payout if your children get educated during your lifetime. In other words, avoid endowment plans and stick to term plans.

Living expenses:
Estimate what your family's living expenses are going to be and the investment needed to yield that much return. Your term insurance should be for this amount. Make a realistic financial plan. Perhaps your spouse would need to start working if he/she doesn't now. Take into account the investment needed if he/she were to start a small business.

When it comes to 'how much sum assured' it is better to avoid thumb rules, as the sum that would be adequate would differ for different people. The best person to decide on the amount will be the one to be insured. Sum assured should be purely based on current lifestyle, annual family income, annual expenses, current investments (if any), and liabilities like home loan or education loan overhead. The final value after considering these figures will be the Life value of prospective insured. Most insurance companies provide a 'Human Life Value' calculator on their website to ease the task of calculations. Do not forget to consider inflation, as the purchasing worth of Rs 100 today will erode with time.

It is very important to figure out the apt cover, because a higher cover would make you pay for protection that was actually not required, while a lower 'sum assured' may not be able to take care of the financial needs of your family in an adverse situation. Most insurance products come with a minimum and/ or maximum sum assured under their products. It is important to check if the sum assured on offer matches your requirement.

Also, one must compare the price of policies from different insurers and their claim settlement ratio. Some policies give discounts on a higher sum assured or charge a lesser premium from females. However, sometimes discounts can also be a marketing gimmick, with the premiums for these policies weighing on higher side.

This kind of unemotional, careful and realistic thinking is really the heart of making a sudden-death financial plan. Don't shy away from it. The fact is that Indians have a deep-set cultural antipathy against planning for their deaths. A minuscule number of Indians make a will. Even the country's most successful and rich entrepreneur, who organised everything else about his business so carefully (and whose death was not sudden), died without making a will and left his two sons to fight public battles for their inheritance.

This story first appeared in November 2014.