Term Insurance – First Step Towards Financial Planning

We love our life and people who are closely dependent upon us, whether financially, emotionally or both. Aren’t most of our efforts targetted towards achieving a healthy standard of living for our families with whom we cherish to spend most of our time ? Closely associated with it is the rat race of earning money, paying bills, investing funds for the future and earning again and so on ! The race never ends and along with it an important milestone of a prudent Financial Planning gets often ignored – taking a Life Insurance.

You don’t forget to get other things in your surroundings insured. Every year you get your vehicle insured – your two wheeler or your car – don’t you ? Probably you are worried what would happen if some one damages your car and hence you would love to get the risk covered so that you don’t have to bear the unforeseen charges to get your vehicle back on road ! Some people get their mobile phones insured, other get their homes insured and so on .. If you can get your minor things insured, then don’t you think that your life is worth more than a cell phone, car or a scooter? Certainly YES !

You may believe and have heard from others as well – ‘Don’t speak about death’ or ‘Don’t speak about leaving this world’. However, I firmly believe that for once it is necessary to think what would happen if one is no longer in this world. The moment this thought goes through, you may find that all the luxuries or rather necessities which your family needs costs more money than you would think of. Take for example the cost of the following items which your family would have to bear :

• School fees of your children today and further education charges;
• Rent payments for your property;
• If you are lucky to have a home, home loan EMIs;
• EMIs for your car / scooter;
• Electricity, Water & Gas charges;
• Telecommunication costs;
• Medical expenses.

If you don’t have the lumpsom funds in your pocket which your family can tap to maintain their cost of living, then you need to have a Life Insurance. This is THE MOST IMPORTANT step of your family planning. Life Insurance – as the term denotes – is the insurance of your life. If a person takes a life insurance from a life insurance company, the company would pay a promised amount to the dependents in case of the death of the insured person. The promised amount is called ‘Sum Assured’. Sounds nice – isn’t it ? Indeed ! I so much like LIC’s slogan ‘Zindagi keiy saath bhi aur Zindagi key baad bhi‘. In return the insured person has to pay to the insurance company a yearly fees, called as Insurance Premium.

What do I get if Nothing Happens to me ?

I can rather answer this question with a question. Do you take an insurance on your car and pray that your car gets into an accident so that you can claim your Insurance – Definitely Not ! Hence, strictly speaking – if nothing happens to the insured person during the policy period, then nothing is paid to the insured person. You can consider (or rather should consider) your insurance premiums as sunk cost. If the insured dies, the sum assured is paid to the Nominee of the insured person. This type of insurance is called TERM INSURANCE. I would rather pray that a person keeps on paying insurance premium and nothing happens to him. It is good to have it as a sunk cost then to get anything done to the insured person to reap the benefits of Insurance payouts.

Types of Insurance Products Available in the Market

Having said that in the previous paragraph, there are several other types of insurance products which have been designed by crafty heads to satisfy the basic desire of mankind – ‘to get something materialistic in return‘. These insurance plans have taken the pure vanilla insurance product to another dimension whereby insurance policies are no longer just provide an insurance cover but also act as a saving / investment. Broadly such insurance plans are classified into :

• Endowment Insurance Plan – Similar to term insurance, the insured person pays a regular insurance premium for the duration of the insurance policy. During this duration, the insured person is covered if a death event occurs, whereby the sum assured amount is paid by the insurance company to the nominee or the legal heir of the insured person. However, if no such event arises, the insured person is paid the sum assured after the expiry of the policy tenure. Several flavours of endowment policies exist where such sum assured is paid throughout the policy duration (in case of money back policies), or where the insured pays insurance premiums for a specific duration only and gets a life cover for an extended period of time.
• Unit Linked Insurance Plans – These types of insurance policies invest a portion of insurance premiums in stock markets and aim to generate higher return and hence a higher maturity payout. At the same time, these insurance policies also provide insurance similar to the above mentioned Endowment Plans.

Then Why Should I Go For Term Insurance Product ?

You may have heard on the financial streets that it may not be a good decision to mix insurance & investment. In order to understand this, lets understand how a traditional Investment Insurance Plans (Endowment plans / ULIPs) work. The sum assured in case of a Endowment policy for the same level of premium shall be lower than Term Insurance. For example, with an annual premium of Rs. 10,000 you can have a sum assured of upto Rs. 50 lacs or even more in case of Term Insurance. However, the same level of premium would only provide 2-4 lacs of sum assured in case of Endowment Policy. The reason being, for Endowment Policy the premium is broken down into Investment amount + Risk Cover. The amount paid towards risk cover is significantly lower as compared to Term Insurance where the 100% of the premium is directed towards Risk Cover.  Hence, with a lower amount being paid towards the risk cover, an Endowment Plan tends to have a lower sum assured. And in order to increase the amount of sum assured in an Endowment Policy you may have to shell out a big chunk out of your savings. A 50 lacs insurance cover can even require you to pay Rs. 2 lacs per year in a non Term Insurance Product.

Factors Affecting Cost of Insurance Premiums

Till now you would realise that if you want insurance protection then you would have to pay Insurance premium. The amount of insurance premium that you would have to pay would depend upon a lot of factor, some of which are mentioned below :

1. Age of the applicant – The older a person is, higher would be the premium;
2. Life Style of Person – Factors such as smoking, drinking, etc. increases the premiums.
3. Profession – risky professions attract higher premiums;
4. Medical history – for obvious reason a poor medical history attracts higher premiums;

How Much Insurance Should you Take ?

The main motive of an insurance policy is to serve your dependents once the insured person dies. The more the insurance policy pays to your dependents, the better would be their standard of living and their ability to meet their liabilities. This amount is determined upfront at the time of entering into an insurance contract while taking the insurance policy, alternatively called as the SUM ASSURED. In order to arrive at the sum assured you can refer to our article How to Compute Appropriate Sum Assured for Your Life Insurance.

Tax Breaks Involved in Insurance

I might not be wrong to say that one of the driving force behind taking an insurance protection by the common gentry is ‘Tax Rebates’. Under the clause 80C of Income Tax Act, Insurance premium of an amount upto Rs. 100,000 (combined with other eligible investments) is deductable from the taxable income. One of the prime motivation behind the Government to provide such rebates is due to a missing social security infrastructure in India. Hence the government encourages a person to take care of their finances to avoid financial turmoil in an unforeseen situation of death of the bread earner of the family.

Despite of the tax benefit currently being provided, this should not be a driving force to take an insurance. Possibly in the coming Direct Tax Code, the tax benefit may be taken away. If that happens, would you stop taking insurance cover ? The driving force should always be a sound financial planning rather than a tax planning. If Tax planning comes as an after maths of financial planning, it is good – but not vice versa.

Tax planning changes from one year to another depending upon the income of the person & the tax regulations, financial planning is long term oriented.

Insurance Based On Peer Pressure

Another common pitfall while taking insurance is – Peer Pressure. I have come across so many cases whereby a person ends up taking insurance because his office peers have also taken an insurance product from a common insurance agent. These cases were often benefitting the agent rather than the insured person. Hence avoid the peer pressure and do a sound Insurance planning before taking up an insurance.

When Should I Stop My Insurance ?

This is one of the most difficult question to answer when it comes to insurance. However, having a pragmatic approach, the answers lies hidden in the motive behind taking the insurance cover. When a person takes an insurance, he wants to leave his dependents with an amount in case of his death. If over the years, the same person accumulates an asset base which is sufficient for their dependents, he may want to stop their insurance considering it may no longer be required. Alternatively, it may also trigger a planning process whereby due to the better standard of living, the existing Insurance cover may be increased.

Insurance Without Nomination

This is a definite NO-NO. Infact most of the insurance policies make it mandatory for the insured to specify a nominee. One must make sure that the nominee details are clearly mentioned in the insurance policy to avoid any hardships. A slight mistake at this point can result in a lot of pain for the dependents to avail the insurance proceeds. You may want to read our article which details upon the Importance of Nomination.

Related Posts:

• How to Compute Appropriate Sum Assured for Your Life Insurance
• How Long Should I be Insured ?