Sufficient cover = 8-10 times salary

When a 30-year-old client met with an accidental death, his claim voucher amounted to Rs 65,280, including the accident benefit. His wife was distressed when handed over the money, since it was definitely not enough for a housewife with no other income to bring up two young children. Her husband had earned about Rs 60,000 every year but he had bought only one policy with a sum insured of worth Rs 25,000. There was nothing else she could expect from the insurers.

When we buy insurance, death is just a distant possibility, which is why we look at the current costs involved in buying the policy. We try to spend as little as possible, on the life insurance policy, treating it like a dispensable expense.

It is when we are faced with a difficult circumstance that we realise the folly of our thinking. The fact was that the client was not adequately insured. Life insurance companies use a term called ‘Human Life Value’ and have a method to calculate it.

HUMAN LIFE VALUE
The concept addresses questions on adequate coverage such that in your absence, your family will not need to compromise on their yet-to-be fulfilled needs. How much will be enough to enable your family to meet various expenses in the event of a key earning member’s death? The knowledge and skill a person acquires gives him earning power. It is this earning power which is insured and not the mere life. So, human life value is the economic interpretation of life insurance.

CALCULATING IT
There are two types of capitals, human and material, and two types of economic values, life value and property value. At any time, the human life value in society is far greater in magnitude than the value of all property put together. The life values are the cause and creator of property values.

The economic value of an individual to his dependents in terms of life insurance can be estimated as accurately as possible by following these steps:

• Estimating the average annual earnings from future personal efforts
• Deducting tax, insurance premium, personal expenses and cost of self maintenance
• Determine one’s working expectancy
• Select a reasonable rate of interest to discount future earnings
• Calculate the present value with these parameters. Let’s understand this by an example.

A person aged 30 years with Rs 16 lakh annual salary wants to calculate the sum insured he should opt for.

For this purpose, he would need to calculate his annual expenses other than what he spends for his family. He will reach this amount by deducting investments, taxes and other expenses. Let’s say it is Rs 6 lakh. This also means, he spends Rs 10 lakh to maintain his current lifestyle.

The next parameter is to spell out the number of years a person will continue to earn. Let’s assume the person will retire at 60. His working capacity, therefore will be 30 years.

To calculate human life value, we will first need to know the total money he will spend on family during his working life. It is Rs 3 crore (Rs 10 lakh X 30 years).

We need to discount this amount to adjust it against inflation. This will give us the value of Rs 3 crore in the current time. At 5 per cent average inflation, the amount comes of Rs 1,53,72,400.

This is the amount of insurance the bread earner should opt for as per his current income and expenses.

In sum, the human life value approach is useful in determining the economic value of an individual to his dependents in terms of life insurance.

The writer is director, Bharat Parekh Financial & Insurance Services