Most insurance companies are advertising on TV and YouTube channels that an individual needs to have term insurance equal to or more than 10x of their annual income. Even a simple google search will throw up this result. When something is repeated so often by all companies and agents, most people looking for a term policy would assume 10x as the holy grail to buy a policy. Now as a thumb rule 10x can be used; however there are just multiple factors that need to be considered before zeroing in on your policy coverage.
We will cover a few scenarios here to understand how a factor like 10x can be an inaccurate factor. Let’s take an example of Mr. A aged 35 years who has an annual income of INR 10 lakhs, expense of INR 6.5 lakhs p.a and investible corpus of INR 60 lakhs other than their owned house. Now if Mr. A would believe in the 10x rule, he could go online and buy a policy of INR 1 crore. This would be an appropriate amount if we take inflation @6% p.a, investment returns of 9% p.a. and the fact that Mrs. A would need the money till she is 80 years old.
Scenario 1: Mr. A and his wife do not plan to have children at all. In this case, at the demise of Mr. A, the total expense of the house is expected to be only INR 4 lakhs. So, in this case Mr. A may not really need an INR 1 crore cover and could go for a lower plan. Of course, he can choose an INR 1 crore plan to ensure there is adequate buffer for his wife in case of his sad demise. On the other hand, if they were planning to have children and estimate their expenses would actually increase by INR 2 lakhs p.a., they would need an insurance coverage higher than INR 1 crore.
Scenario 2: In another scenario let’s say, Mrs. A is the only child and is expecting a large inheritance of INR 2 crore from her parents. Now this is already more than 10x of her husband’s salary and Mr. A may not need an insurance cover for Mrs. A at all, if there is certainty of her inheriting her parent’s wealth. Factors such as expenses of parents, their income, when they are expected to transfer wealth, etc would need to be considered as well to know the insurance cover Mr. A would need.
Scenario 3: Mrs. A has no experience of investing and is unaware of any financial instruments other than bank savings and FD. Hence if all investments were left to her at Mr. A’s demise, she would invest them all in debt instruments only and hence the investment returns post tax would fall to less than 7%. In this case, Mr. A would need a higher amount of insurance coverage as compared to if his wife was more financial savvy and would have an appropriate asset allocation plan.
There are numerous additional factors beyond those briefly outlined here that must be taken into account in order to determine the appropriate level of insurance coverage needed. Therefore, when purchasing an insurance policy, it is essential to thoroughly assess various aspects, rather than solely relying on a simplistic income multiplier of 10x.
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