Decoding life insurance: Which is the best option?
PV Subramanyam, CA, Financial Trainer, runs www.subramoney.com
Academically speaking you may have heard of insurance while doing your graduation or during your higher studies also. Or you may have seen some advertisements perhaps?
If none of your family members, classmates, neighbors, or bank manager is a life insurance agent, then idea of life-insurance will probably first come your way when you are planning your tax returns.
Well this is difficult, because half of the Indian population is a life insurance agent � and it is busy selling to the other half! For most of us though � insurance is a tax saving device. Well, there is a lot more to life insurance that it pays to know. Let�s begin by looking at every step of getting insurance.
Selecting the right life insurance plan:
Life Insurance in India is offered by a number of players and all of them big and powerful players. Each of them offers many different types of policies. Broadly, you can choose from Term Insurance or Endowment policies. One variant of the endowment plan is the unit linked endowment.
A term insurance policy is the most inexpensive type of insurance policy. As the name suggests, it covers the policyholder only during the term of the insurance. The compensation (called benefit in the insurance parlance) gets paid to the nominee only if the holder dies during that period. So what happens if he lives beyond the term period? Well, the holder would have got peace of mind during the said period.
Perhaps the simplest form of life insurance, the only purpose of this type of insurance is protection. It was developed to provide life insurance on a limited budget. Since a large amount of cover can be purchased for a small initial premium, term insurance is good for short-term goals such as providing extra protection during child raising years.
Level term life insurance means a particular amount is paid as a premium for the whole term. This means for a premium of say Rs. 2300 a 30 year old gets a life cover of Rs. 10,00,000 � and you pay this premium from age 30 to age 50 years. In an ideal situation with increasing time your premium should keep rising. For example a 30 year old should pay say Rs. 300 per annum, but a 50 year old should be paying Rs. 14,000 per annum.
An endowment policy helps you meet the twin goals of savings and protection. You get life cover for a certain period here too, but on living through the term of the plan, you still get certain the sum assured plus any bonuses, upon maturity. Premium is generally far higher than term insurance.
Unit Linked Insurance Policy
ULIPs are a fairly new entrant in the insurance space. They are plans that offer a mix of protection and investment. Meaning, part of your premium goes towards mortality charges and the rest gets invested in an investment plan of your choice. This investment plan is a mix of debt and equity, and you get to choose what percentage each will be.
Tax benefits under section 80 c are available to all life insurance plans but you should take a call only after you carefully study all plans.
What should you do:
ONLY TERM LIFE INSURANCE. Repeat ONLY TERM LIFE INSURANCE.PURE TERM INSURANCE � NOT EVEN TERM WITH RETURN OF PREMIUM.
All other types of life insurance tie you to a sub optimal investment plan from which you cannot get out for the rest of your life. Any product which is a combination pack is packed attractively and does not help you as a customer.
How to take the plan:
Since all life insurance companies offer term insurance (and term insurance is easy to understand and really a generic product) take the cheapest plan on offer. Just pick up the companies you trust and see who offers the cheapest possible plan. There is no good trustworthy website which gives you the comparative rates � so sorry you will have to do the shopping yourself. Do not trust articles or website which say Rs. 2334 is the premium for a 30 year old for a 20 year plan. Rates keep changing, so do your shopping the day you need to buy.
If after a week you see rates have dropped, re-price and go to the cheaper company. It is your right to seek the best rates for your money, please exercise it. However take the new plan before you throw away the old plan.
Let us say you are 33 years of age and you trust LIC, SBI Life, HDFC Standard life and Icici Prudential Life insurance. It should not matter to you that currently Religare or Birla has a cheaper plan! However if you do trust IRDA and feel all the companies will pay the sum assured (as death claim) then seek to take it from the cheapest source.
How much of life insurance should a person choose?
Should you choose Rs. 10 lakhs as a life cover or Rs. 500 lakhs? Well it is not an easy question to answer, but here is an attempt!
The Human Life Value Approach
This approach calculates how much �amount of money� (corpus) a family will need based on the financial loss the family will incur if a person passes away. Using the insured individual�s age, occupation, annual income, personal expenses, and the personal and financial information of the spouse and/or dependent children, one can determine the financial contribution from the insured to the family. This approach is usually used for a working member of the family.
In the human life approach, one tries to replace all the cash flow that is lost when an employed family member dies. The income will include after-tax pay, less expenses incurred while earning that income. Health insurance or other employee benefits also help in augmenting income, and need to be factored in as well.
Once the income is determined, you need to decide the sum assured based on assumptions of return on the corpus. Suppose you decide an income stream of Rs 800,000 has to be generated in a year for your family to get by. Assuming a 5% return per annum on your corpus, after taxes, you can aim for a sum assured of Rs 12,000,000. This corpus will allow withdrawals of Rs 800,000 every year (along with some inflation adjustment also) for at least 20 years. However if your children are already earning and your spouse has enough corpus to live comfortably, your insurance needs could be lower, much lower.
The Needs Approach
The needs approach contrasts with the human life approach, in that it calculates how much life insurance is required by an individual/family to cover their needs (i.e. expenses). You work backwards from the required expenses to arrive at the income stream needed to support this, rather than track previous income streams and seek to maintain it, like in the human life approach.
Needs include funeral expenses, business buyout costs, probate fees, emergency funds, mortgage expenses, rent, debt and loans, college, child care, private schooling and maintenance costs.
It is crucial in the needs approach to overestimate your needs a little. After all, the cost of being over- insured is not so substantial compared to the risk in being under-insured and being left with an inadequate income stream.