Ramesh Goel, 38, was having a great party. To celebrate his promotion he had invited his friends over. His new package was Rs 30 lakh per annum. During the course of the evening talk turned to the sudden demise of a colleague who was about their age. As discussion on the uncertainties of life continued, Goel said that he had taken care of his family financially with life insurance—he paid premiums of Rs 1 lakh a year. At that point a friend asked him how much his life cover was. That was the moment of truth for Goel. Some mental maths later he came up with a figure of about Rs 15 lakh, despite the hefty premium he paid. That cover was clearly not enough. So, would that mean he would need to pay more to get a bigger cover? Actually he could pay less. For, a term insurance cover of Rs 3 crore is available in the range of Rs 35,000-40,000 to cover him till his retirement.
The problem is people like Ramesh do not buy term insurance covers because they get nothing in return for the premiums they pay when they survive the policy term. Since nobody thinks they could die early, they want to invest in policies that offer them something on maturity. But this math is awry. If, say, Goel buys a term insurance cover of Rs 3 crore at Rs 37,000 annual premium, he will still have Rs 63,000 to invest every year. Putting it in a Public Provident Fund (PPF) account at the current rate of interest of 8.7 per cent per annum would fetch him Rs 20 lakh in 15 years. And all this while he will have a life cover of Rs 3 crore. Investing the same amount in investment-based policies of life insurers would fetch him around Rs 25 lakh, assuming a net average yield of 6.5 per cent, but the sum insured would remain at a paltry Rs 15 lakh that he now has.
Life insurance is India is largely sold through agents. The thrust is on selling policies, especially during the tax-saving season with no check on financial background of the client. Policyholders are equally indifferent, as, for a typical Indian household, financial planning is just about ensuring that the cheques coming in should add up to more than the cheques going out. The immediate concerns of families are to service their home loan EMIs, meet the education cost of children, deal with physical and medical crises of aging parents, and, yes, constantly twisting their budgets to deal with rising cost of petrol and vegetables. While short-term needs have to be dealt with, so do the long-term ones that we tend to ignore.
According to experts most of the families do not buy sufficient amount of risk cover in India, making it one of the most ignored aspects of financial planning. Says Yateesh Srivastava, chief operating officer, AEGON Religare Life Insurance: “Most people believe that having an insurance plan is the same thing as being adequately insured. This is a myth. One has to assess current earnings as well as debt obligations before buying a cover. A multiple of eight times the gross annual income, plus the amount of loans outstanding is a reasonable benchmark against which one can assess the current insurance cover.” Anything less exposes the family to the risk of future financial uncertainty if the earning member dies suddenly.
WHY A Rs 3-CRORE COVER?
Under need-based approach, (see Your Life Cover In Numbers) you first add up all your liabilities, one-time future expenses (such as education and wedding costs of your child) and present value of all your future expenses till retirement. The figure arrived at tells you the right size of insurance cover to have.
Then there is human life value method. It is defined as the present value of all your future income, less personal expenses, life insurance premiums and taxes, through to your planned retirement date. So, if you are 35 now and your annual salary is Rs 35 lakh, then your insurance cover needs to support your family for the next 25 years (assuming retirement is at 60 years) if you died today. If your personal expenses, taxes and life insurance premium is Rs 15 lakh, then your family will face a shortfall of Rs 20 lakh. If this shortfall is capitalised at an expected rate of 8.5 per cent per annum (after factoring in inflation at 6 per cent) for 25 years then your cover size should be around Rs 3.8 crore.
One of the easiest ways to decide on the cover size is to multiply your annual income by 10. For example, if your annual salary package is Rs 30 lakh, then your insurance cover should be at least Rs 3 crore. The interest income earned on Rs 3 crore at assumed rate of 8.5 per cent will fetch your family an income of Rs 25.50 lakh every year.
But above all we recommend you to go by need-based method for arriving at the right size of risk cover. It is important to include loans in your calculations if your home loan is not covered by a separate policy. Just a home loan can require you to bump up your cover by Rs 1 crore if one assumes that a moderate 2-3 room apartment in a major city nowadays costs Rs 1-crore-plus and a loan at 80 per cent of the property value will amount to Rs 1 crore. A family can go through very harrowing times in repaying the loan if it remains exposed to the risk of you dying early. Again you need to revaluate your insurance coverage whenever your situation changes. For example, upon birth of your child you need to figure out how much you want to save for your child’s education and marriage. Accordingly that figure needs to be added while estimating the size of your risk cover. Moreover, foreign education is getting costlier, thanks to the depreciating rupee. The more aspirations you have the more you need to insure.
WHY TERM INSURANCE?
It is a pure risk cover. With other plans an investor gets return on maturity if the insured survives the term, but term insurance policies do not offer any return. They are also the cheapest plans in the market. It is for this reason it always makes a sense to go for term insurance plans. Not only do they offer you a chance to buy a bigger cover much cheaper, they also give you a chance to invest in other products after covering your risks. It is good to buy a term cover and invest the rest in mutual funds. The combination tends to give you higher returns than investing in investment-based insurance policies. Return on investments is, generally, lower in traditional and unit-linked insurance plans because after covering their expenses they also need to pay commission to agents from the premiums collected.
To deal with inflation there are increasing term insurance policies. In these, the sum assured increases by a certain percentage every year. With every increase in the sum assured, some plans may also charge you an additional premium as well. The big advantage of these policies is that it allows one to increase the cover without having to go through medical tests and procedural formalities again and again—something that one would have to do if one were buying an altogether new plan.
THE CHEAPEST OPTION
Online term plans are much cheaper when compared with plan sold offline. For example, an online term insurance cover of Rs 1 crore is available at an annual premium of Rs 7,300 for a 30-year-old male for a 30-year term. For the same parameters, the same company offers an offline plan for an annual premium of Rs 14,300, that’s about double the price. In case of a smoker, the online rates can go up by 40-60 per cent. But so would offline rates.
But remember that what is quoted on the website may not be the final premium because if you do not fit into the threshold risk cover of your insurer, you are likely to be asked to go for a medical test. That, in turn can move up your premium rates—substantially. Also, online policies are not available in all cities. So, check out if it is available in your city.
Getting your risks covered is the first base of financial planning. It’s time to recalculate your liabilities and responsibilities and buy the right size of risk cover.