JOIN USWhen interacting with my trainees whose average age is 25 years, one of the questions I ask them is what they would do if they had surplus money. It means in which asset classes they would want to invest their surplus money, many of them, inter alia say that they want to invest in life insurance. This is true for most of us who tend to confuse between life insurance and investment.
Yes, it’s true that all of us willy-nilly need life insurance in today’s world. Life is risky and contingencies may arise any time in the future which could be tomorrow, a few years from now or a few decades from now.
A contingency in non-life or general insurance may mean hospitalisation or loss of assets due to theft and burglary, among others.
On the other hand, a contingency in life insurance means death itself. Death of the breadwinner. When that happens those depending on that person will face both an emotional loss and a financial loss.
While emotional loss is difficult to replace or compensate, a financial loss can be compensated to the extent of sum assured mentioned in a life insurance policy (Or the fund value whichever is higher). And financial loss today is felt more than in the past simply because of the high cost of living. And therein lies the need for life insurance.
The need for life insurance
To reiterate, sum assured mentioned in the policy is what is paid by the life insurance company to the nominee. The idea is that the dependents can carry on with their daily lives with this amount and so at least the financial loss is compensated.
The younger the breadwinner, the more is the need for life insurance as there will be dependents who could be the parents or his own family. So the need for life insurance is more for a 30-year-old person than a 50-year-old person. There is an inverse relationship between the need for life insurance and age of the individual.
The financial dependence of dependents on an individual goes on decreasing as he goes on creating assets like investments in land, building, shares, gold and fixed deposits as he gets older.
So the need for life insurance diminishes as a person ages, though life insurance agents would tell (sell or miss sell) you that people of all ages need life insurance.
They have their own vested interest in selling policies either for commission or because their job is on the line. To repeat a cliché, life insurance policies are always sold and not bought.
Life insurance policies would have been sold to us by our neighbour or a relative or an acquaintance and most of us would have obliged these agents as we want to be nice to them (And regret that decision for the entire tenure of the policy) and don’t want to be rude to them.
How much life insurance does one need?
There is no standard answer to the above question but in insurance circles the rule of thumb is everyone must have life insurance equal to 10 to 12 times of their annual income. The idea is to financially compensate the dependents in the absence of the earning member in the family. This amount can also change based on certain factors unique to the individual.
What type of insurance should one buy? Term plans vs the rest of them
For the uninitiated, life insurance policies can be broadly classified into two types.
*Those having maturity benefits like endowment, money back, pension, child plans and ULIPs.
*Others having only death benefits like term plans.
While the premium on policies with maturity benefits are higher, the premium on policies with only death benefits are considerably lower. They are the cheapest of all life insurance policies in terms of premium paid vis-a-vis the sum assured.
The term plans bought online are even cheaper as there is no agent involved and hence no commission is paid to anyone either upfront or trail.
Policies with maturity benefits have both a saving and an insurance component built into them and policies with only death benefits have only the insurance component in the premium. The mistake that most of us do while buying life insurance is to confuse life insurance with investment. Never mix insurance with investment. The premium that we pay on life insurance plans should be treated as a cost and not as an investment.
When you look at insurance as investment, in term of returns given by traditional plans, they may give returns in the range of 6-8%.So, it does not make sense to look at life insurance products as investment.
Finally, the answer to the above question as to which policy should one buy? The answer is tricky and needs to be answered only by the individual buying the life insurance.
This is like asking a question — which car should one buy? A Nano? A Swift? Or a BMW? And what about accessories and gadgets? The choice depends on your desire, ability, need and circumstances. More often than not, in real life individuals who can afford to buy only a Nano end up buying a high end swift car. However, one can bear in mind the following points while buying life insurance policies:
*Always separate insurance and investment and never confuse one with the other.
*Treat premium paid as a cost and not as investment
*Premium paid on a policy depends on the tenure, the age of the policyholder and sum assured.
*Yearly premium payment option is cheaper than a monthly, quarterly or half yearly options
*Riders or additional benefits mean higher premium.
*Understand that signing up for life insurance entails paying premium over longer periods of time and surrendering a policy midway can be a losing proposition. It should not be an Albatross around one’s neck.
(The writer is a former banker. He currently teaches in Manipal Academy of Banking, Bengaluru)