What is the Price of Life (Insurance)??
Thank you guys for the overwhelming response to this new series about Insurance. In the last post, we had discussed what exactly is insurance, the brief concept about how the premium is determined and most importantly why should we consider insuring anything valuable. Therefore, the logical progression in this post would be to talk about the most precious of our possession which is our ‘life’ and hence life insurance. We also briefly touched upon the subject of who should consider insuring their lives and the brief answer for that was, if after you, your immediate family is likely to face financial hardships because of drying up of source of income, you certainly must take life insurance from a strictly financial viewpoint. Therefore, it may not be financially beneficial to take life insurance for non-earning members of the family for whom better-paying investment options are available.
OK…I hope by now most of you are convinced about taking life insurance. Then the next obvious question is what should be the sum insured? Unfortunately, there are no direct answers for this question too, similar to questions we discussed during Solution Mutual Funds. However, we can consider a few basic parameters such as the size of the immediate family, basic monthly expenses, planned few mega ticket expenses such as children education and their marriages and finally the most important parameter — what is the expected time for this family to be on its feet financially? As we can see that there may not be any easy answers for such questions and therefore, it basically boils down to how much premium you would be able to sustain over a long period of time. But, don’t get disheartened by the difficulty of these questions and at least do this exercise once to know your financial strengths and weaknesses. If paying premium is not the concern, then the basic thumb rule may be taken as one year’s average expenses extrapolated for inflation for at least five years, should be your sum insured. For example, if your average yearly expenses are around 5 lakhs then extrapolate it with 6% inflation for five years, which will become 6.7 lakhs. Simple so far……….. isn’t it????? Please feel free to extrapolate to 10 years or 20 years, if your fortune teller says so (ha……. ha…….. ha……. ) but it can’t be lesser than 5 years.
Now comes the tricky part….… which product to choose? As we saw in the mutual funds too that there are so many types of products available that it might be little confusing for a person to choose the right product. The way around this is to know all kind of products available in the market and match it with your insecurities or greed and then pick the one which appeals to you the most. If you see insurance as an expense and consider it separate from investment then you may choose Term Plan where the premium is least and it offers insurance for a particular period. This on one side offers the much higher sum insured for the same amount of premium but on the other hand, it is a pure expense as you get nothing back. If you want to mix the benefits of insurance as well as investment then you may consider Unit Linked Insurance Plans (ULIP), Money-Back Policies or Endowment Plans which while providing insurance also offer some component of savings or wealth creation. If you are inclined to Term Plans but want your money back at the end of the term, you may consider Term insurance with Return of Premium. However in this case the premium amount will certainly be more than the simple Term Plans. Or lastly, you could simply take the classical Whole Life Insurance, which will pay the sum assured along with some saving components to the beneficiary once you are gone. Confusing??? Then……. let’s group them for ease of understanding-
Pure Insurance + Payout at the end of term
Term Plans — Sum insured will be paid only if you do not survive the term insured.
Term Plans with Return of Premium — If you do not survive the term, full payment of the sum insured, however, if you survive the term the entire premium paid will be returned to you at the end of the term.
Whole Life Insurance — This is the classical insurance policy and the sum insured will be paid out only at your demise irrespective of the period or your age. It may also include some component of savings or bonus.
Insurance + Investment
Unit Linked Insurance Plans (ULIP) — Good investment and insurance tool for those who are looking to combine both. However, keep in mind that the premiums are much higher and the returns may be a shade lesser than pure investment options but it offers convenience.
Endowment Plans — Again a good option for those who are looking for insurance but want to use this as a means of investment too. It is more classical in approach than ULIP as the endowment amounts are generally fixed with a minor variable component of survival benefits given at the end of the policy term. This variable component or the bonus is generally driven by the mechanics of financial markets and may be considered as the dividend of profit generated by that scheme.
Money-Back Plans — This insurance scheme offers periodic pre-defined payouts (for example every fifth or fourth year) and the remaining amount with the maturity benefits are paid at the end of the term. Ideal for people who are looking for regular payouts to meet their planned expenses while also enjoying the benefits of insurance.
There may be many more customised schemes which may be a combination of two or more basic plans covered above ….therefore, go ahead and choose the plan which appeals to you the most. The only caution is to read about the scheme first before considering it.
Thats all for this post guys….. since the insurance premiums at times may become the source of misery for many, next week I will be covering a few quick fix hacks to cover this subject as to how to plan your insurance premiums.
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