Article

A Comprehensive Life Insurance Guide
November 19 , 2012

Why life insurance

Life insurance is something every bread-earner needs. After all, who has seen tomorrow? Wouldn't you want your family to have a similar lifestyle even if there were to be an eventuality? Very likely your kids have several years of studies to go before they can stand on their own feet. Some of your may have retired and dependent parents. Some of your assets like home and car may have loans running.

The thought of an eventuality is so unpleasant that we don't want to think / hear about it. In the process, we often miss out on life insurance. But in reality, as a popular ad goes, it is insurance that will make us more worry-free and hence help us live healthier and longer!

Contrary to what you may hear in some misleading ads, you don't need life cover for children or for the aged in the family. They will often be nominees, not the life being insured. After all, life insurance is about protecting the income of the bread-earner - it is not about making a financial profit from death. Thus, the prime working age of between 25 and 55 years of age is when people require the maximum insurance. In this period, several people depend on you. You are still in the process of building assets and retirement savings. Thus, it is crucial to protect your life.

How Much Insurance You Need

The important thing in insurance is (obviously) the life cover you have. Majority of the people in India who have purchased some kind of life insurance policy are actually underinsured. There is no need for detailed calculation of how much insurance you need. Since life insurance protects income for dependents the appropriate insurance cover for a person depends on his/her income. 

There is ample reason to have about 4-8 times your annual income for ideal life insurance cover. For an unmarried person without liabilities like loans a cover of four times his/her annual CTC would be sufficient. For a person with liabilities or a person who is married but doesn't have a home loan a cover of about six times his/her annual CTC is advisable. If a person is married and has home loan to pay a cover of eight to ten times the annual CTC is desirable.

As your income increases don't forget to top up your life insurance. You can actually factor in anticipated pay raises and inflation while calculating your insurance cover requirement.   

Your sum insured must be sufficient to meet your dependants' requirements post your death which includes i) medical and other such expenses, ii) a lump sum required to clear your debt obligations, if any, and  iii) a steady cash flow for future money requirements. Estimate the number of years your dependants will remain dependant on your income after your death. 

Choose the Right Policy Offering Sensible Features

A huge variety of plans are available in the Indian insurance market. Some of them combine insurance with investments which we advise must be avoided. Every policy comes with certain exclusions which are conditions the insurer will not cover you against. The common ones are in case of suicide, war, terrorist attack, driving while under influence of alcohol, etc. Below we list the popular life insurance policy types.

Term Insurance

Term insurance covers life for a specified term chosen by you (usually 5-25 years). No benefits are paid if the insured survives the policy term. This is the cheapest of all insurance policies since no cash value (which increases with each premium, accrues interest and can be withdrawn) is received by the insured.

Whole Life Insurance

It covers a policy holder throughout life till death and pays out the benefits to the nominee. Beside guaranteed death benefit, cash value is also guaranteed. The premiums are fixed at the time of contract and have to be paid throughout the life of the insured.

Endowment Insurance

This policy combines risk cover with investment. In case of death the sum assured is paid to nominees or if he/she survives the policy term the premiums along with investment returns are paid back.

Money Back Policy

A percentage of the sum insured is regularly paid out to the policyholder. The balance amount along with accumulated bonuses is paid at the term's end. On death of the policy holder the entire sum assured is paid to the nominee without deducting the amounts that were paid out earlier.  

ULIP

Unit-Linked Insurance Plans are a combination of life insurance and mutual fund giving (less) benefits of both. A part of the premiums goes toward investment in equity/debt/bond mutual funds.

Pension Plan

They pay regular income after the vesting period. Endowment plans invest in fixed income securities and offer low rates of return. Unit-linked pension plans allow investment in equities or take the balanced route. Premiums can be paid lump sum or in installments till the contribution period. On maturity (or retirement) at least two thirds of the proceeds must be mandatorily invested in an annuity either with the same insurer or any other. The annuity will yield returns for you.

Traditional policies and ULIPs are utterly bad ideas. One mistake you must not make is to club your insurance goal and investment goal. If you club these, justice will not be done to either of them since investment in other avenues can earn better results and the insurance component of your investment in these plans will be low as compared to term plans.

Term insurance plans are a great idea. Here, you pay a small premium every year, in return for a large life cover. All life insurance companies have a term insurance plan on offer. While they are great for the customer, they do not give your broker much commission. So do not be surprised if your agent/broker never mentions term plans to you, or tries to downplay their utility!

There is no concept of investment or returns in a term plan - you get no money back as long as you live. While this sounds strange, the fact is that insurance plans are not meant for returns anyway! They are there to cover any eventuality. Since term plans do not mix insurance and investment, they end up being cheaper, simpler and more flexible for you.

Premiums in life insurance

Life insurance premiums can be paid annually, bi-annually or quarterly. Premiums of online policies are lesser because there are no agent commissions involved. A number of factors affect life insurance premiums. These include:

  • The age you purchase your policy. The older you are, the more expensive the premiums.
  • Your overall health. Life insurance companies typically ask you about your medical history, request access to medical records and even obtain blood and urine samples for testing.
  • Pre-existing and/or chronic health problems, such as diabetes, heart disease, cancer or sexually transmitted diseases may prevent you from getting life insurance or place you in a high-risk pool at greater cost.
  • Poor health habits, such as smoking and excessive drinking. Be aware that insurance companies may look back and consider these behaviors for the past five years.
  • Engaging in dangerous hobbies, such as skydiving, skiing or rock climbing.
  • Your geographic area. Life insurance companies have access to regional data that document mortality rates and life expectancy, and they use that data to calculate the rates they offer.

Some of these factors are in your control. Others are a function of your genetics, occupation or location. Either way, it's important for you to be educated on these issues so that you can make the best insurance decisions to fit your lifestyle.

Useful Riders

Life Insurance policies come with many colorful riders not all of which are of really useful for you. Here are three useful riders:

1. Accident and Disability Rider

If the policy holder dies due to an accident the rider sum insured is paid in addition to the sum insured of the life insurance policy. While this may appear to sound like extra payments for someone who has adequate life cover the real benefit comes from Disability part of the rider. If the accident leads to permanent total disability or even permanent partial disability in case of some insurers the benefit is paid out to the insured.

2. Waiver of Premium Rider  

On total permanent disability of the insured due to an accident or due to specified critical illnesses all future premiums on the policy and riders, if any, are waived till the death of the insured or end of term of riders, whichever is earlier

3. Critical Illness Rider

This is a good-to-have one on reaching middle age. It pays you a flat amount if you are diagnosed with one of the 8 critical diseases covered under it.

However riders offer less coverage. You should rather buy a stand-alone Personal Accident cover and Critical Care cover. As stand-alone policies their scope of coverage increases and premiums are cheaper comparatively.

Pay Premiums, Avail Tax Break

It is a fact that more people buy life insurance to avail tax benefits than to insure their life. Money spent on premiums of life insurance plans, health insurance plans and pension plans can be deducted from the taxable income to lower your net taxable income. Under section 80 C up to Rs 1 lakh can be deducted for premiums paid on life insurance. This cap is subject to all investments under this section.

All proceeds received from an insurance company on life insurance including sum insured as death benefit and bonuses, if any, can be deducted for income tax under section 10 D.

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