February 12, 2010 / 6:00 AM / 10 years ago

Sum assured – Understand how much you need

You buy life insurance policy for a reason. The reason is to get financial security, in monetary terms, for your dependants in case of your death. This money is what is called the Sum Assured.

An employee counts currency notes at a cash counter inside a bank in Agartala, in this January 29, 2010 file photo. REUTERS/Stringer/Files

Fixing the correct amount of Sum Assured is a crucial activity at the time of getting a life insurance policy. Here is what you should know about it.

What is Sum Assured?

At the time of signing a life insurance contract, the insurer and the buyer agree upon a certain amount of money that will be payable upon the death of insured. This amount is the Sum Assured will go to the nominee or your beneficiary as per the policy.

Fixing the Sum Assured Amount

Sum Assured depends on numerous factors such as your total net assets, family’s current and potential fixed annual income and expenditure, your age and the age of your dependents, and any loans or liabilities due.

It should ideally be sufficient to see your dependents through till they are able to fend for themselves. Most financial planners suggest that the sum assured should be 5-10 times your annual income.

If you want a more precise calculation, you can calculate your human life value. You must have adequate insurance that comfortably provides for the financial resources your dependants need to live their lives if you are no longer around or are physically disabled.

The sum total of all the obligations that you have towards your dependants is your human life value.

Sum Assured and Premium

Sum Assured is the reason why an insured pays premium. The relationship of Sum Assured with the premium depends on the type of insurance policy.

In traditional plans, including term policies, Sum Assured determines the premium. The Sum Assured is broken up into small amounts of premiums that a person pays monthly. In a term policy, one can typically pay about Rs 300 per Rs 1 lakh of coverage. So, if an insured wants Rs 50 lakhs of covered, they need to pay Rs 15,000 (50 x Rs 300).

In unit-linked plans (ULIP), because of market fluctuations, the premium determines sum assured. If you opt for a ULIP, based on your ability to pay the premium, the insurer will offer you a Sum Assured that will be a multiple of the premium.

For example if your current financial standing allows you to pay Rs 5,000 annual premium on your ULIP, the insurance company will offer you a sum assured of say 5 to 20 times the premium amount.

Your sum assured, in this case, could vary from Rs 25,000 to Rs 100,000. Within this range, you have to decide how much insurance cover you need, based on your requirements.

Riders on Sum Assured

Riders are special provisions in an insurance policy that can expand the benefits or the Sum Assured that is payable. For instance, if you have a rider for accidental death or disability, in addition to being eligible for the death benefit, your policy will also pay out an additional amount if your death is due to an accident, as defined in the rider.

In case you don’t die but an accident disables you, while the life policy might not compensate you, the rider will compensate you up to your pre-determined amount.

Revisit Your Sum Assured Regularly

It is wise to revisit your policy and review the Sum Assured, especially when there is a major change in your financial situation. Some of these changes are:

- Change in marital status - whether you get married or divorced

- Birth and death in the family that adds to or reduces the number of your financial dependents

- When you take a home loan to purchase a house

- A rise in your salary

- When your children are financially independent

(For more Personal Finance stories click here)

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