Article

Ideal Type of Life Insurance
March 13 , 2013

Life insurance is a universal need for all who have dependents. Though life has no guarantee it is possible to ensure that the life of your spouse, kids or parents are not thrown out of financial gear by keeping a good life insurance cover.

Insurance works on the principle of pooled benefits. A large group of people exposed to the same kind of risk contribute small sums of money for a period to create a money pool. The few who fall in the risk get a chunk of the pool to cushion the fall. How much they get is a multiple of how much they had contributed. The fortunate others don't get any of the pooled amount.

What determines premium in life insurance
In life insurance the risk is loss of income to dependants due to loss of life of a breadwinner. Actuaries in insurance companies work out the math about how much premium a person should contribute depending on two factors. First is sum assured or the guaranteed sum of money the company promises to pay on death of the insured person. The second factor determining premium is risk exposure of the insured which can be assessed from one's age, sex, whether smoking or non-smoking, etc.

Sum assured is determined by you. How would you know how much sum assured is adequate? It depends on how much you presently contribute to your dependants- your annual CTC. It is very important to have an adequate insurance cover, not more and certainly not less. On the second factor you hardly have any control, except maybe quitting smoking, if you do.

Because insurance companies have nothing to do with either of these two factors your premium for a given sum assured should ideally be the same for a life insurance policy with any company, except a miniscule difference to account for service costs in different insurance companies. This class of life insurance policies is called 'term plan'.
 
Who needs life insurance
Understanding the principle of life insurance also tells you who needs life insurance and for how long. Those who do not earn or those do not have dependents do not need life insurance. They do need savings and investments for their future but remember we're only dealing with insurance now.

How much should be your insurance term
Similarly your insurance cover needs to last only until your retirement. Why would you want to pay larger premiums to make your policy last for periods when you would be risk-free (since you would no longer be earning)?! Post retirement your spouse and you would be living off savings and investments. It makes more sense to contribute more to your investment kit in your working years than to keep an unnecessarily long-termed policy, which any way you are unsure will ever be of use in your case!

Insurance+investment
Finally a word about 'combo packs' of life insurance and investment/savings. These are far popular in average households in our country than insurance products or investments products taken separately. We are referring to the Jeevan Anands and Jeevan Sarals of life insurance- traditional policies and ULIPs offered by insurance companies.

There is nothing inherently bad with ULIPs and endowment policies. In fact they are convenient since they combine insurance and investment in the same product but this convenience comes at the cost of losing returns big time. This is due to in-built charges in traditional policies and ULIPs by various names. ULIPs are better off than traditional policies since there is some transparency about where they invest and expose your investment to the markets which is very essential for any long term investment.

Insurance component in non-term policies is also very low. For now suffice to say that insurance and investment are better managed separately. If you buy a term insurance plan for your protection need, stick to the right products for income, tax saving and investment purposes, you can rest assured that your personal finance life will have a smooth sail.

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