95% questions associated with insurance planning can be answered with much clarity if the enquirer has clarity on this one thing – What exactly do I need to get insured for? Typically the reasons for getting insured at an individual level are:

[1] Losing your life so that those you love can stay comfortable in your absence.

[2] Loosing earning capacity so that in case you can no longer work, you still live a comfortable life.

[3] Medical or health insurance to cover any emergency operations/ surgeries and other unforeseen medical issues.

[4] Protection of money making assets and property.

[5] Protection from travel related accidents including motor vehicle accidents.

Of course there are many other types of insurances – corporate liability, cell phones, laptops and other electronic devices etc. However, every individual should think about the 5 factors mentioned above before deciding upon the correct amount and type of insurance.

[1] & [2] – Life & Disability (personal accident) Insurance

The first two points above cover the type of insurance which everybody should consider having. If a person does not have any dependants and is young, then a personal accident insurance may be all that he needs. For those who have responsibilities of others, they should definitely get a life insurance policy, irrespective of age. So do not wait until you are over 40 or 50. Stay insured at all times.

Within life insurance products, there are only two types of insurances – ‘term life insurance plans’ and ‘endowment insurance plans’. Based on these, there are various hybrid mixed plans of insurances but essentially they are off shoots of these two.

(a) Term Life Insurance – Term Life Insurance is a 100% risk cover in that it pays benefit only in case the insured person dies. Since there is no saving element in case of a term life insurance, and it only covers the event of death, the premium payment is relatively low. Also in case of pure term life insurance, there is no cash value left once the insurance period is over.

Insurance companies keep coming up with new and innovative products to attract customers. For example, by charging slightly higher premium amounts they often add a saving component to the term life policy such as return of all premiums paid upon expiry of the policy. That said, life insurance policies with a saving feature are called endowment life insurance policies.

(b) Endowment – Endowment policies have a saving component to them. At maturity there is a survival benefit to be paid. The sum assured would naturally be lower than in case of a pure term life insurance OR the premiums would be higher.

Whether you choose a term policy or an endowment or a hybrid minx of the two is of course a matter of personal choice. For me the only purpose of insurance is to safeguard against things that I hope never happen. An insurance policy is the last place where I am trying to save or make money. I do fairly well with all my other investments for my saving and capital appreciation needs. I would for that reason prefer a pure term life policy than be attracted by any saving component.

A word on ULIPs

ULIPs are Unit Linked Insurance Plans in which the premium has two components- (i) life cover and (ii) investment into equity and/or debt markets. While I find them a waste of your time and money, ULIPs remain a fairly popular investment product as they help the investor in not only staying insured but also in earning a market linked return. The value of the policy plan will reflect the value of the underlying asset in addition to having an insurance component. The insured can select a ‘sum assured’ and chose that the balance of the premium be invested in equity/ debt or similar focused funds.

ULIPs in many ways have features which are similar to a mutual fund scheme.

Maturity Benefit In case of Death
the value of the fund as on that date calculated by multiplying the number of units in policy holder’s account by the Net Asset Value (NAV) on that date. Higher of – Sum Assured or the fund value OR Both the Sum Assured and the Fund Value. Read terms of the ULIP scheme carefully.

Key Terms Related to Insurance

Premium – Premium could be collected as lump sum, annually, quarterly or even monthly. The policy terms will specify in this regard.

Sum Assured – Sum assured is the amount of insurance or the benefit amount which the policy holder will receive upon the triggering of the insured event. As per Insurance Regulatory and Development Authority (IRDA) regulations, for policies which have a term of over 10 years the sum assured should be at least 10 times the value of the annual premium for individuals below 45 years of age and 7 times for those who are above the age of 45.

Bonus – There are various kinds of bonuses which insurance companies may pay. Commonly it is a percentage of the sum assured added to the value of the sum assured from time to time. It could also be based on the overall performance of the insurance company and is mostly paid right at the end along with the sum assured. An example of a bonus term in the policy – “in addition to the sum assured, the insured will get as bonus an amount equal to 3 times the value of the premium paid in case death occurs in the first three years”.

Understanding Surrender Value – this is the amount that the insurance company will pay to the policy holder in case the holder voluntarily terminates the policy before its maturity OR when the policy lapses because of non payment of insurance premium. Keep in mind that in case the policy lapses because of non payment of insurance premium, then the policy will have no surrender value at all UNLESS full premiums have been paid for the first 3 years of the policy. The surrender value could range between – 30% up to 90% (in case the lapse in payment happens in the last 2 years of the policy). It is very important to check this clause of the policy on day one, irrespective of how disciplined you have been with making payments in past. Further, each policy may differ in terms of the timing of payment of the surrender value i.e. whether the surrender value is paid at the end of the year in which the default happens or it is to be paid upon the expiry of the full term of the insurance period.

Note: In case of lapse, most policies can be converted into a paid-up policy whereby the sum assured can be reduced in accordance with the amount of premium paid. This is done by spreading the premium proportionately over each premium instalment of the original policy term and then reducing the sum assured in the proportion in which the premiums are received.

[3] [4] & [5] Medical and Motor Vehicle Insurance

The big difference between life insurance and non life insurance products is that premiums and cover in this case is based on risk assessment with respect to age of person/ vehicle, history of disease, condition of health/ vehicle etc.

(a)  Medical Insurance – Medical insurance is the first insurance policy which you should buy even before a life insurance. Key things to consider when buying a medical insurance policy is to check that the policy covers 3 things:

  1. Cashless claims so that bills are directly settled with the hospital;
  2. Accidental or naturally occurring illnesses;
  3. Covers – Surgery/ treatment costs, Doctor’s consultation and most importantly – hospitalisation i.e. room costs.

The amount of cover under each head in point (3) could be set at the time of taking the policy and the premium will be based on that. It is always a good idea to start with a health insurance policy while you are still young. This ensures that your premium keeps decreasing for each subsequent year on good record of no-claim bonus.

(b)  Motor Vehicle Insurance – If you own a motor vehicle, you should be aware that having it insured is not a choice, it is in fact mandatory to have a third party insurance for all personal and commercial vehicles. This policy should be read most carefully to understand exactly what your premium payments will cover. Often people do not pay attention to such facts – whether bodily injuries as a result of accident will get coverage, coverage on repair, replacement of parts damaged as a result of an accident, theft, natural calamity etc.

A prudent and reasonable person should allocate his money in such a way that he remains insured at all times for (in order of importance)– (i) medical emergencies (ii) car accidents (in case you drive) and (iii) life insurance, particularly once you have the responsibilities of others. In addition there are many other types of insurances which may be relevant to you such as – liability, travel, plant and machinery and insurance against business loss, property damage etc.

In my next post, I will discuss how to calculate the correct amount of insurance based on your individual circumstances.