Business Today

A paltry price for protection

Your life is not cheap, but term policies are. They make the best sense if you are looking for peace of mind.

Babar Zaidi        Print Edition: December 26, 2010

How much would you spend for peace of mind? The assurance of knowing that your loved ones will not face money trouble if you were to die suddenly? If you are around 30 years old and earn about Rs 50,000 a month, you can buy this peace of mind for about Rs 4,250 a year. For less than the price of a soft drink a day, you are insured for four times your annual income. This is the bare minimum insurance cover that experts recommend.

The implications of this arithmetic are not lost on Gwalior-based Deepak Kumar. The 29-year-old bank executive has no financial dependants right now, but will have one when he marries next year. This is why a term plan figures high on his New Year's shopping list. He already has a unit linked insurance policy, or ULIP, but the cover offered is negligible.

How much cover?
Insurance needs are defined by an individual's age, current expenses, existing assets and financial goals

"I realise that the Rs 1.5 lakh cover offered by my ULIP is insignificant compared with what I need. I had bought the ULIP to save tax," explains Kumar. This is the most common reason for buying life insurance. But tax laws are changing. In the coming years, Kumar may not get any tax benefit for the Rs 30,000 he shells out every year for an insurance cover of Rs 1.5 lakh, courtesy the Direct Taxes Code, or DTC which is pending before Parliament and is likely to come into effect from April 2012. The DTC could change the rules of the game: tax deduction will be available only if an insurance plan offers a cover of at least 20 times the annual premium.

Not many people share Kumar's eagerness to be on the safe side. Faridabad-based Shiv Pratap Singh is a software engineer, but he likes skating on thin ice. This 37-year-old sole breadwinner finds it a breeze to service a home loan and a car loan, given his income of Rs 1.5 lakh a month. But ask him how his family (homemaker wife and child) will cope if something happens to him and Singh has no answer.

He has an insurance cover of Rs 9 lakh and outstanding loans worth Rs 7 lakh. This would leave his family with Rs 2 lakh - enough to sustain them for 4-5 months. Singh needs a cover of at least Rs 60 lakh (see box) to ensure that his family's current lifestyle is maintained and future expenses are taken care of in case of his untimely demise. Take the case of Ghaziabadbased Mayank Sharma (see box).

Two years ago, an analysis of his financial portfolio showed that he did not have adequate life cover. Since then, Sharma has bought three term plans that together cover him for Rs 45 lakh. The cost comes to Rs 20,000 a year. That is equal to the premium he pays for a ULIP and a money-back policy, but which cover him for a piffling Rs 2.5 lakh. "I bought the ULIP and moneyback policies when I did not understand insurance," says Sharma. Now, he swears by the costeffectiveness of term plans. Sharma pays just 1.33 per cent of his annual income to get a cover worth three years of income.

 

Shiv Pratap Singh, 37
Income: Rs 1.5 lakh a month
Financial dependants: Homemaker wife and son
Outstanding loan: Rs 7 lakh
Insurance cover: Rs 9 lakh
Assessment: Singh is grossly underinsured. If something untoward happens, his family will be left with just Rs 2 lakh after settling the outstanding loans. This would be sufficient for only 3-4 months
Insurance cover required: Given his income and financial position, Singh should have an insurance cover of at least Rs 60-70 lakh
Cost: A cover of Rs 60 lakh for 33 years will cost him Rs 16,000 a year. For Rs 25,000 a year, he can get a cover of Rs 1 crore
The premium for the life insurance cover he needs works out to less than one per cent of his annual income
Now, while these low-cost covers are the best way to insure yourself, keep in mind some things before buying a term insurance plan.

Take adequate cover
One of the first things you should know is the amount of cover you need. This can differ from person to person. As we have mentioned earlier, financial planners suggest a minimum cover of four times an individual's annual income. This rudimentary approach assumes that all individuals have the same financial circumstances. For instance, a 25-year-old unmarried professional earning Rs 12 lakh a year may not need a Rs 48 lakh cover so early in life.

However, a 40-year-old salesman with two children, a homemaker wife and earning Rs 5 lakh a year, may need more than Rs 20 lakh as insurance. Simply put, the insurance cover should be large enough to replace the income of the deceased.

Cover your loans, too
The insurance cover must also take into account any big loans taken by the insured person. If a person has taken a loan of Rs 40-50 lakh to buy a house and dies suddenly, his family would be saddled with a huge liability. Lenders may also insist on foreclosing the loan if they think that the family of the deceased will not be able to service the loan. Therefore, home finance companies nudge borrowers to take loan cover term plans.

In these plans, the insurance cover is linked to the outstanding loan and comes down progressively as the loan is repaid. The term of the insurance plan is crucial. Go for the maximum term offered by the plan. This is usually 30-35 years, but depends on your age. Most insurers do not offer insurance beyond 65 years. If you have cut a cake with 45 candles this year, the maximum term available to you will be 20 years. Some plans, such as the iProtect online term plan from ICICI Prudential Life Insurance, offer to cover you till you are 75 years old, but not everybody finds it useful to pay for an insurance cover well after they have stopped earning. Remember, the objective is to replace the insured person's income, not gain from his death. So there is little utility of taking insurance when you are not earning any longer.

Watch Inflation
A term plan for Rs 30 lakh may seem adequate right now, but with inflation creeping up steadily, pushing up the cost of living, it may not remain so. In five years, even a nominal inflation of six per cent will reduce the value of Rs 30 lakh to Rs 22 lakh. In 10 years, it will be worth only Rs 16 lakh. Besides, when you have a child and an extra dependant, your responsibilities will increase sharply as more expenses are lined up. You could buy a fresh term plan to cover every stage of your life. This can, however, be more expensive because the premium goes up as you grow older. And if you have developed a medical problem, you may even be denied an insurance policy.

A better option would be to take a plan that automatically increases the life cover. There are term plans in which the insurance cover increases with time. Under the Life Shield plan from SBI Life, the cover increases either by five per cent of the base sum every year or by 50 per cent every five years. So, if you buy an insurance cover of Rs 10 lakh in 2010, it would grow to Rs 25 lakh by 2025, increasing by Rs 5 lakh every five years.

 

Mayank Sharma, 34
Income: Rs 1.25 lakh a month
Financial dependants: Homemaker wife and child
Outstanding loan: A home loan of Rs 15 lakh
Insurance cover: A ULIP, a money-back plan and three term
insurance policies that together cover him for Rs 47.5 lakh
Assessment: The three term plans cost him Rs 20,000 a year. He should consider switching to a cheaper, online plan
Insurance cover required: The outstanding home loan has pushed up his insurance needs. He needs a cover of at least Rs 60 lakh
Cost: A cover of Rs 60 lakh for 26 years will cost him Rs 9,500 a year. This is less than half of what he is paying right now
I am covered for up to three times my annual income
for the rest of my working life
Competition is always good for the consumer. See how it has pushed down mobile telephony tariffs over the last decade. Now it is the insurance market. De-tariffing has triggered a price war, with new players offering lower rates in a bid to attract customers. Also, term plan premiums have come down because many private insurance companies are no longer relying on the mortality data of the government-owned Life Insurance Corporation.

Advances in medical science and improved access to health care mean that Indians are now living longer. Life expectancy has gone up from 58.5 years in the previous decade to over 66 years now, which reduces the risk borne by insurance companies. This also explains the huge difference in the premium charged by various insurers.

With all insurance companies offering online premium calculators, it is not difficult to find the cheapest plan for your age and financial profile.

Do not expect returns
You do not get anything back when you insure your house, vehicle or any other valuable. Yet, most people are fixated on returns when they buy life insurance. "The typical mindset is, 'how much will I get back from this policy?'," says Amitabh Chaudhry, Managing Director and CEO of HDFC Standard Life. Some insurance companies have restructured term plans, wherein the entire premium paid is returned to the policyholder after the term ends. But this is not a good idea because you pay a higher premium than a basic plan and get only the principal premium back without any interest. A plain term cover without the frills is better.

When Aegon Religare Life Insurance Company launched the first online term plan in November 2009, few had imagined that it would become a roaring success, with over 10,000 iTerm policies sold since then. This has opened the floodgates for such offerings by other insurance companies. In the past few months, at least five other insurance companies have come out with online term plans. The obvious draw of the online insurance plans is that they are cheaper than those bought through agents.

Courtesy: Money Today 

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