There are different ways of calculating the right amount of term insurance coverage amount. Some of them are as follows5 –
● Basic method
Under this method, the coverage required is calculated as a multiple of your annual income. The basic rule is that you need 10 to 12 times your annual income as your term insurance coverage amount. So, if you earn ₹10 lakhs a year, a coverage of ₹1 to ₹1.2 crores would be suitable.
● Financial need analysis
Under this method, your financial needs are analysed and then the coverage is determined. Your average annual expenses are considered along with your existing liabilities and specific financial goals. Then the coverage is determined which should be sufficient enough to provide your family with the funds needed to cover their expenses, pay off the loans and also create a fund for the goals that you have.
● Human Life Value (HLV) method
Under this method, the overall value of your life is ascertained in financial terms. The method seeks to calculate a sum assured which would be sufficient to provide your family with regular income for their financial needs.
For instance, if your annual personal expenses are ₹3 lakhs and you earn ₹10 lakhs, you can provide your family an annual income of ₹7 lakhs. In your absence, your family would stand to lose this annual income of ₹7 lakhs. So, the sum assured should be such that it can generate a regular annual income of ₹7 lakhs for your family. If the risk-free rate of return (return on government security) is taken to be 6% per annum, the corpus which can generate ₹7 lakhs at 6% would be ₹1.17 crores.
● Underwriter’s thumb rule
This rule also uses the multiple of your annual income to calculate the ideal coverage amount. However, the multiple changes with age. It starts at 15 times of your annual income if you are aged 20 to 30 years, then starts decreasing to 14 times if you are 31-40 years, 12 times in the 41-45 year bracket, 10 times in the 46-50 year bracket, 8 times in the 51-55 year bracket and 6 times if you are aged 56 years and above.
