One of the commonly misunderstood and mis-sold products is Life insurance.

Basically, life insurance product pays the beneficiaries of the policy a lumpsum amount or an annual income in case of death of the policy holder.

Let’s start with the purpose of life insurance, life insurance is to provide income support to the family members if the income generator dies. Though it is called a life insurance – basically it is a product that tries to replace the lost income in the case of death of the insured.

We can also call it “income ensurance” because it ensures that the depends of the earner will be ensured some income in case of the death of the earner.

Let’s come to the basic question – who needs insurance. Any person who has people who are economically dependent her/his income should consider buying life insurance. The reason being if the person were to die, then the dependents will not have the income that the person would have provided. If a person has no dependents on her/his income, then the person does not need a life insurance. For instance,

• A single person who no dependent children or parents should not get an insurance.
• A person whose children are not dependent on her/him does not need life insurance if she/he has no others finically dependent on her/him.
• A person who has no income doesn’t need a life insurance, as there is no loss of income from the death of the person. (Insurance company usually does not issue a life insurance policy that pays out more than the income potential of the person.)

Other case where a person does not need insurance, is that person has enough wealth to support the members who are dependent of her/his income. The person’s wealth is expected to become the source of income to support the dependents.

• For instance, Bill Gates, Warren Buffett, Azim Premji, Narayan Moorthy, Mukesh Ambani, Kiran Mazumdar Shaw etc. don’t need life insurance as they have enough wealth to sustain their dependents.

We have taken extreme examples of people who have way too much wealth or who have no wealth. Most people are somewhere in the middle of this spectrum, i.e., they have some wealth but not enough to sustain their dependents. In such cases Life insurance is a very good product. The amount one should insure should be the difference between their current wealth and their target wealth (where target wealth is the wealth that would not require them to buy insurance as the wealth itself can support the dependents).

There are no specific formulas for computing and managing insurance, here are a few useful thumb rules

• Target wealth should be 25 to 30 times the annual expenditure that is required to support the dependents.
• Insurance amount should cover the gap between Target wealth and current wealth.
• As one’s wealth increases one should reduce the insurance cover.
• One of the goals of persons financial journey should be to not require life insurance.