Quora Answer: How Do We Calculate the Coverage for Term Insurance?

The following is my answer to a Quora question: “How do we arrive at the amount for which term insurance must be taken?”

Term insurance covers three areas: death, disability and critical illness.  The primary reason we get insurance for disability, and illness is for income protection.  Your proposed coverage is the amount your family would need in the event of your death.  This is especially important if you are the sole breadwinner, or the principal breadwinner.  The whole idea is to have enough set aside that their standard of living is not severely affected.  Things to consider include funds set aside for the future education of your children, for the maintenance of the house and for the settlement of debts.

The Formula: (Monthly Amount Required x 12 x No. of Years) + Immediate Expenses + Outstanding Liabilities + Emergency Fund - Existing Death Coverage

The monthly amount required is the amount needed to pay the monthly bills, with a little more set aside to maintain the standard of living.

The number of years refers to the time these funds need to last before someone else in the family is able to address the imbalance in the family income stream.

The immediate expenses are the expenses of a funeral, the estate expenses and the hospital bills, if any.

The outstanding liabilities include debts in the name of the deceased, or undertaken on behalf of the family.  They include housing loans, student loans, bank loan and car loans.

The emergency fund refers to the buffer amount in the family savings account that might mitigate this loss of income stream.

The existing death coverage includes any and all arrangements that would pay out upon your death into your estate.

The calculation for the accident coverage also uses this formula, since the considerations are the same upon death.  If they lead to disability, then they use the formula below.

Disability protection is the amount required by you to maintain your standard of living in the event of a disability, as well as the costs involved such as the acquisition of wheelchairs, walkers and such; the modifications needed to your living space to accommodate your unfortunate inadequacy; the cost of a caregiver, and the immediate and ongoing treatment which may not be covered under a hospitalisation plan.

The Formula: (Monthly Account Required x 12 x No. of Years) – Existing Disability Coverage

The monthly amount required is the same as the above.

The number of years here refers to two things.  It refers to the time these funds need to last before someone else in the family is able to address the imbalance in the family income stream.  It also factors the number of years you will live with this disability.  In general, 20 years is a reasonable period to consider.

Critical illness protection factors two things.  It factors the amount required by you to maintain your standard of living in the event of a critical illness.  And it considers the cost of treatment.  This is important because even though you may have a hospitalisation plan, your condition may require innovative forms of treatment that may not be covered in the schedule of treatment.

The Formula: Total Lump Sum Benefit Required – Existing Lump Sum Benefit Required

$700,000 is a reasonable amount required in Singapore for a comprehensive treatment plan for cancer, a major killer.  This amount may vary, depending on where you are in the world.

That aside, if you are young enough, I suggest you get whole life.  It is much more expensive than term life, but the policy has a surrender value, and the coverage is until age 100, or 101 years.  A term policy renewed throughout your life will eventually become much more expensive, because at each renewal, premium is calculated on the age of policy inception.