Lets answer a time honored pest of a question for all insurance purchasers: How much coverage is enough? In this post we shall examine a few methods to determine your generic cover required.
By generic cover we mean the trio of Death, Total Permanent Disability and Terminal Illness cover, which usually comes together for any term, endowment, and whole life plans that you might purchase. There might be other types of cover you are looking for : Critial Illness, hospitalization, disability, personal accident, the list goes on and on.
But lets use the holy trinity as a base for estimating the basic cover and leave the rest for another day. In the following methods we outline, rest assured there is only simple calculation involved, so leave your supercomputer shut down for the time being. (we just love simplicity)
Method 1: Calculation by Expenses
The gist: I spend X dollars a year on average, and I need to cover myself for another Y number of years. Total cover required: X multiplied by Y
Ella is a 31 year old executive and she estimates her monthly expenditure at $3k. She intends to get cover till she is 65 and works out her death, TPD and TI requirements to be $1,224,000 – give or take. (36k annual expenses and a 34 year period required)
This means that if anything untoward should happen to her, she will have enough cover to sustain her lifestyle till age 65. This also means that her coverage requirements actually decrease with each passing year she survives to age 65.
Woah woah I hear you say! Her expenses might change! Things might be different after a few years! How about depreciation? What if Singapore makes it into the world cup?
Which is why at this point, we will be the first to point out: There is absolutely no fool proof way of determining how much cover a person really needs. We cannot even forecast our activities for the week after, let alone the events across a lifespan. Hence Financial Planning is more like an art than science – there are simply too many other factors to consider.
Method 2: Calculation by Income
The gist: I earn X dollars a year on average, and I need to cover myself for another Y years. Total cover required: X multiplied by Y
Ivan is a 45 year old company director and earns 250k a year. He would like to receive cover for the next 15 years till he retires (thats when he has enough to retire). Ivan’s coverage requirements would then be a cool $3.75 million.
Again of course, there is a fair amount of uncertainty in this method – his income might change, his retirement nest egg investments might perform spectacularly well etc etc. But by now you know the drill: There are too many uncertainties to account for, each being able to influence the outcome positively or negatively so let us just stick to something simple (and no less accurate).
Method 3: Calculation by Presumption
The gist: I just obtain an estimated “comfortable” amount of cover based on my budget and other financial circumstances. Agar-ism would be the second name for this method, but Calculation by Presumption just sounds a little more credible.
Peter has fluctuating income and expenses (he is a freelance designer). When the going is good, he makes good money and splurges on caviar and champagne. During the lull months he doesn’t have many projects and makes do with cream cheese and crackers. He thinks: since I am single without any dependents, I should be alright with $500k cover. Besides, half a million is a convenient number.
Each method has its inherent pros and cons – but we stand by this: The future is too uncertain for us to predict. There is simply no sense in calculating down to the last cent by means of complicated formulas or tables, so a simple estimation would be as valid as a complex one (This is also known as Occam’s Razor – pretty smart and pretty sharp).
Whichever method you choose or prefer, it boils down to your own choice and financial situation. These methods provide a baseline guide to the cover that you actually require, and the final number will be determined largely by your budget for insurance (not everyone wishes to dedicate 40% of their income on plans)
In the words of Swiss Philosopher Henri Frederic Amiel: Common sense is calculation applied to life.
Let that be the ultimate guide.
Which do you think is the best way to come up with coverage requirements? Let us know in the comments below!
www.ClearlySurely.com aims to eradicate the knowledge gap between consumers and Life Insurance. Our Vision is that one day, every Man, Woman, and Child will be properly insured.
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