The idea of life-insurance will probably first come your way when you are planning your tax returns. That’s how it is for most Indians – 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.
(filing your tax returns can be done by just a simple (FREE) download that is available at www.myirisplus.com)
Selecting the right life insurance plan:
Life Insurance in India is offered by a number of players, including:
•Aviva Life Insurance
•Birla Sun Life Insurance
•Future Generali India Life Insurance Company Limited
•HDFC Standard Life Insurance
•Kotak Life Insurance
•Life Insurance Corporation of India
•Max New York Life
•Reliance Life Insurance
•Sahara India Life Insurance
•SBI Life Insurance
•Shriram Life Insurance.
•Tata AIG Life
Each of them offers many different types of policies. Broadly, you can choose from Term Insurance or Endowment policies. In addition, there are Unit Linked Insurance Plans that offer the twin objectives of risk protection and capital appreciation.
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 benefit gets paid only if the holder dies during that period. So what happens if he lives beyond the term period? Well, the holder gets nothing.
Perhaps the simplest form of life insurance, the only purpose of this type of insurance is protection. It was developed to provide temporary 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.
Within term insurance, you can opt for either an annual renewable term or a level term life insurance.
Annual renewable term means you renew the term every year and you pay an increasing premium every time, since obviously the likelihood of dying will increase with age. Sooner or later, the premiums paid will become unviable and exceed the cost of a permanent policy. But of course the likelihood of payout will also increase commensurately.
Level term life insurance makes the same costs more even on your pocket by averaging them out over the entire term, which means the higher costs do not accumulate towards the end.
An endowment policy helps you meet the twin goals of savings and protection. You get life cover for a certain period here too, but if you do not die during the term, you still get certain the sum assured plus any bonuses, upon maturity. Premium is generally 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.
The good news about ULIPs is the two-in-one package, plus flexibility in altering your premium and sum assured. But the bad news is that the charges for a ULIP plan often far exceed what you would have paid if you had invested separately in a term insurance plan and a mutual fund scheme.
In mutual fund investments, expenses charged for various activities like fund management, sales, marketing and administration are subject to pre-determined upper limits as prescribed by the Securities and Exchange Board of India.
When it comes to ULIPs though, insurance companies do not have an upper limit and have complicated expense structures. The percentage of your premium allocated to investment in the first two years is typically anywhere between 20% to 80%, given the high premium allocation charge during these years. This means, all your money is not invested, and this is something you ought to know, even if your agent might not inform you.
Tax benefits under section 80 c are available to both ULIPs and mutual funds, but you should take a call only after you carefully study all charges associated with the ULIP and determine if it is more profitable than a pure insurance plan in combination with a mutual fund investment.
A combination of plans
Always remember though, you can mix and match plans till you have adequately covered risk and invested well. You don’t need to confine yourself to a single type of policy. You could take a term insurance policy from the cheapest source for a short period, and then add endowment policies every year as a way to keep up with the inflation.
Deciding on coverage
Don’t use ‘thumb rules’ while deciding insurance cover. If you are going to be paying hefty premiums, you might as well spend some time calculating how much insurance you need rather than multiplying your income by 7 (or 15 depending on how aggressive your agents’ pitch is!), and buying approximately that amount of insurance, like most people would suggest.
Here are a couple of ways you could do it.
The Human Life Value Approach
This approach calculates how much life insurance a family will need based on the financial loss the family will incur if a person passes away. Using the insured individual’s age, gender, planned retirement age, occupation, annual wage, employment benefits, as well as 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 of the income that’s 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 10,000,000. This corpus will allow withdrawals of Rs 800,000 every year for at least 20 years, a comfortable situation.
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, legal fees, estate duty (currently nil in India) and gift taxes, business buyout costs, probate fees, medical deductibles, 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.
Also read How much you should insure for? -elsewhere in the the blog.
Selecting your nominee
Once you have decided on your sum assured, you will need to select a nominee who will receive the sum assured in the event of death. This has to be a very careful exercise, leaving no room for misinterpretation, given the money involved.
Indicate your beneficiaries by name and designation and review your choices regularly, at important occasions in your life – marriage, childbirth, divorce, career change, economic change, etc. Your nominee list, for example, might need to expand to include the newest addition to your family.
You could consider naming beneficiaries by class or group – for example, ‘All children of insured’ could be your specification. But if this is not such a homogenous class – the case if you have had more than one marriage – well, remember to specify who exactly you are referring to. For a complete understanding of implications your nominee designation might have, discuss the laws applicable to you with your consultant and get specific recommendations on what to do.
keep watching this space on further basics of life insurance!
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