Cover It Well

My friend Sandeep, a 34-year-old finance professional, had five insurance policies for which he was paying a premium of Rs 60,000 each year against each of the policies. With such a huge premium outgo, he was under the impression that he was adequately insured, his unit-linked policy (ULIP) schemes offering a protection of Rs 3 lakh each (total cover of Rs 15 lakh.) However, little did he realise that his actual insurance need was 10-12 times his annual salary which worked out to over Rs 1 crore. The need for insurance emanates from the various obligations that the breadwinner is expected to fulfill such as children’s education, retirement, health and savings.

 

These change with the changing life stages and are driven by the individual’s specific needs. Thus, each individual should put a money value to each need and thereafter conduct a self-risk assessment. This may sound very difficult, but is quite easy. Assume a complete stoppage of your income and evaluate the implications of that on your family. This self-assessment needs to be coupled with the current life stage and responsibilities towards the family. For example, children’s education, marriage, retirement plans and various liabilities such as home loans will help you asses your insurance needs. A ball-park figure of 10-15 times your salary should be the size your insurance cover.

 

In this regard it is well worth considering a step-up insurance policy - a policy wherein you can opt for an option which increases the value of the sum assured over a period of time. This comes at a higher premium as it proves to be more cost-effective than buying multiple policies. For example, SBI Life offers a term product called Shield in three variants. The first one is called a level cover, which is a fixed sum assured throughout the term of the policy. In the second and third options, a customer can increase the sum assured by 5 per cent every year and 50 per cent every five years.

 

If you have a large home loan, it’s a wise option to cover the liability as the borrower wouldn’t want the financial burden to pass on to his/her spouse or dependent parents in case of an unexpected demise or even a disability and hence the loss of a job. Life insurance companies have designed home loan insurance covers in alliance with banks to cover this risk. However, a simple term plan could be a better back-up than these home loan insurance covers, as many experts advise. Let us assume a borrower has opted for a home loan of Rs 30 lakh. Now, in case of a term cover, an individual of 35 years can opt for a term cover of Rs 30 lakh and pay an annual premium of around Rs 8,000. If an individual would have opted for home loan insurance, he would have had to pay an upfront amount of Rs 1.52 lakh as an insurance cover on the Rs 30 lakh home loan.

 

Now, this could prove to be loss to a customer if he prepays the loan within 10 years. Secondly, the insurance amount is calculated on a reducing balance basis. So the value of the cover falls with every passing year. One of the basic tenets of insurance is that it is a vehicle to protect near and dear ones against unforeseen occurrences. It is thus essential to ensure that the life cover or sum assured is large enough to compensate the loss of income of the departed person.

Thus, for an individual earning say about Rs 6 lakh per annum, ideally, the sum assured should be an amount which if invested would at least generate an income of about Rs 3.5-4 lakh annually. Assuming the interest rate of 8 per cent, this individual thus needs a life cover of about Rs 50 lakh to ensure that his or her near and dear ones are not forced to alter their lifestyle dramatically in the unforeseen event of the death of the breadwinner. This assumption is however far removed from what actually happens on the ground.

 

Over the past few years ULIPs have taken away the focus from insurance and people are beginning to forget that buying insurance needs a staggered approach and one has to review/expand the cover as s/he assumes more responsibilities such as marriage, having children or dependent parents. These days, while single-income families are making way for more double-income families, it doesn’t absolve the financial responsibility for either of the spouses. Insurance is an important cog in the wheel when it comes to financial planning. Individuals, thus, need to allocate certain portion of their savings to buy pure term plans that guarantee adequate cover on life, while the rest may be invested in various other investment products, which may or may not be insurance-linked.