A Tent or an Umbrella?

Whenever we buy a car, an accident policy is bought simultaneously. No hesitation, no afterthoughts. The fact that it is government-mandated aside, the rationale is that an insurance policy will compensate us for the damages in case of an accident.No one believes that they can be in an accident, and rightly so. If we worry about an accident, we will never be able to ride in a car. And yet, we buy the insurance just in case. We prepare for the unpleasant eventuality of an accident & damages, however distasteful the prospect of that event is.

The same doesn’t hold true for life Insurance. It is morbid to talk about death & it is worse to talk about young people dying. Most of us have come across tragic untimely young deaths, especially during the Covid19 pandemic.

There are reports that 88% of all Covid 19 deaths were under the age of 45.

Shocking isn’t it? There is still a belief that these things happen to others and we will not be among the unlucky statistic. Life Insurance is bought, mostly as an investment and a tax-saving vehicle.

We @ofmoneyandmoney though, believe that, pure protection policies ie term life policies without any element of savings or returns should be a part of every financial plan.

What is term life policy?

A life insurance policy that pays the sum assured to the nominees if the policyholder dies. A very cut & dried definition. No maturity benefit, no investments, just a simple compensation. A term life policy should be bought as casually as a motor insurance policy. Hope not, but just in case. Medical policies are similar. If you fall sick & have to spend on it, the policy will reimburse you. If you remain healthy, wonderful. Have a great life!!

Term Insurance is in the product portfolio of all insurance providers but is rarely pushed as it is low in cost and not very profitable for the intermediary or the Insuring company.

Who should buy Term Insurance? Any person whose death will result in a financial loss to his dependents. It can be a young man/woman with a dependent spouse, kids/ Parents.

What should be your Cover? This is the tricky part of calculating how much should be the cover of the life policy.

There are different ways to go about this.

Human Life Value Method: This method considers the economic value or human life value (HLV) of a person to the family. The concept primarily considers the value of future income, expenses, liabilities, and investments. If the goal is to sustain the current lifestyle of the insured person’s family.
Income Replacement Method: Life insurance should replace the income of the breadwinner. Current Income * years left to retirement.
Expense Replacement Method: The Policyholder should calculate their family’s day-to-day household expenses, loans, and goals such as children’s education, as well as providing for financially dependent parents for their entire lives. The next step is to deduct the present value of his investment…he should exclude assets such as the house he lives in and the car, as his family members are likely to continue using them. The figure he gets by deducting investments from expenses and goals will be the coverage he needs.
Underwriter’s Thumb Rule: Life Insurance is for reimbursement of an uncertain financial loss, not to make a profit. Typically, insurers follow a thumb rule of 10 times the annual income as the coverage they can offer. It can be higher on a case-to-case basis but typically this is the rule they follow.

Read more about this here.

When not to buy term insurance?

No dependents or liabilities: The crux of life insurance is to give financial protection to one’s dependents in your absence. If there are no dependents, there is no one to protect against eventualities. This could be the case with young earners who are not married and have financially well-off parents.
Have significant assets: In a scenario where one has built significant assets and has very few or no liabilities, one can skip taking life insurance but with carefully done calculations. Assets and accumulated wealth should be able to replace the sole breadwinner’s income after deducting all loans.
To save tax: The premium paid for the term insurance policy can be availed as a deduction from the Rs.1.5 lakh tax break available under section 80C, provided the annual premium doesn’t exceed 10% of the sum assured. Many taxpayers rush to buy life insurance for tax breaks towards the end of the financial year, even if their financial situation doesn’t demand one. You can utilise the 80C deduction through PPF, ELSS, housing loan, etc. instead of buying insurance even if your family does not need it.

A term policy is a fundamental low-cost policy with a possibility of high coverage. (Coverage = Sum assured, the amount which the nominee gets in case of death of the policyholder). There can be added benefits of higher payouts due to accidental death & also critical illness riders.

Anybody, who has availed a housing loan, will know that most lenders insist on a Term life plan. The coverage should equal the outstanding loan. The lenders are merely protecting themselves. You can do a similar exercise for yourself, to protect your family.

Typically, a healthy 25-year-old opting for a term insurance policy of 1 crore for 15 years, will shell out about Rs.8000 p.a. as a premium. As the age of a person progresses, the premium increases. A younger person should opt for as long a policy term as possible and can keep taking new policies (if additional cover is needed) for a lower term as his age advances, income increases and he comes closer to retirement. As he grows older and the earning years reduce, it is better to reduce term policies and start planning for retirement via regular income.

This post is to give a framework on how one should think about life insurance, and not be underinsured. In case of an untimely death, a surefire way to ensure that your family remembers you with love and not angst is to buy a Term Insurance policy with adequate cover.

A big sturdy tent will protect the family much better against a rainstorm than a flimsy umbrella.