Podcast | Digging Deep: All you need to know about life insurance
This week, tune into what insurance provides as a financial instrument and why it essentially functions as a friend in need.
Insurance – that thing everybody agrees we all need but we’re never going to benefit personally from. That might sound nihilistic and could sap us of all desire to get one.
But the bright side is, we will never have to worry about our kids or close ones struggling financially. Therefore, this week, we’re looking at what insurance provides as a financial instrument and why it essentially functions as a friend in need.
Investopedia.com defines life insurance as a contract between an insurance company and a buyer of a policy. In such a contract, the insurer assures the payment of a large benefit to beneficiaries named by the buyer in the event of his/her death. For such a benefit, the insured person pays a regular premium for a fixed period that adds up to a sum that is mutually agreed.
As we discussed in an earlier podcast, the purpose of insurance is to provide financial protection. In the case of life insurance, this financial protection is sought for dependents in case the insured individual/s expires. Life insurance is that friend who looks after your family should a situation arise where you aren’t around.
Santosh Agarwal, Head of Life Insurance at Policybazaar.com, says, “First, ask yourself why you need one, the aim should be clear. Once the purpose of buying life insurance is clear, you can go ahead and select the kind of life insurance you want to buy. There are several types of policies in the market, each catering to different needs of the customers.”
Buying the right insurance policy is a bit of a challenge. Yet, it is essential that a person buying life insurance analyse his financial situation and determine the standards of living he thinks are necessary for his surviving dependents before finalizing a life insurance policy.
For this reason, buying life insurance is considered one of the most crucial financial decisions an individual can make. Considering how widespread such wisdom appears to be, it is surprising to learn that merely 10% of all Indians are insured.
However, speaking of the industry, life insurance is estimated to be one of the fastest growing sectors in India currently. The domestic life insurance industry grew 10.99% for new business premium in 2017-18, with revenues of 30.1 billion dollars.
There are 24 life insurance companies in the country, dominated by the sole public sector insurer LIC. Last year, LIC had a 44% market share, with assets over 370 billion dollars approximately. Well, I did say life insurance is like a friend, so I guess that makes LIC the most popular friend then.
Anyway, those are basic stats regarding the life insurance industry. But we’re more interested in how life insurance helps you and I. Why is it like a friend? Especially considering we have to pay a premium to keep such a friend. It really comes down to this fact: regardless of how much we earn, we do not know for certain what the future holds. If the sole breadwinner in a family passes away, it has a devastating fallout on his loved ones. We know how that story goes – many are unable to meet household expenses, pay off debts or, in some cases, struggle to even sustain their basic standard of living. It is for such contingencies that life insurance is considered a vital investment tool.
One of the most compelling reasons to buy insurance is the achievement of long term goals. Since insurance is a long term investment, it can help achieve long term financial goals like buying a house, or planning your child’s wedding, or planning your retirement. Insurance premiums are paid over decades, and it is in the nature of the thing to be a failsafe as far as long term financial prudence goes.
We have covered the basics of insurance in the podcast on health insurance, so in this one, let’s look at the important information you need in hand before deciding on a policy that suits your requirements.
First off, the different types of insurance policies. There are two broad categories of life insurance policies in India – plans that offer only death benefit, and those that offer maturity & investment benefit in addition to death benefit.
Insurance that offers only death benefit is called Term Insurance. These are pure protection plans that offer a large cover at lower cost. However, they do not provide any profit or savings components. This is life insurance at its most basic. If the policyholder expires before the policy term is completed, a fixed sum of money is paid to the holder’s beneficiaries. So, term insurance is like the close friends you made throughout your life, who step up when your family most needs them.
Then there is the Whole Life policy. This differs from term insurance because it has no fixed term and covers the buyer’s entire life. This, too, is a pretty straightforward life insurance policy. The policyholder pays regular premiums until he or she expires. Upon demise, the corpus is paid to the holder’s family. This one’s like a childhood buddy: will stick with you right to the end.
Then comes a type of insurance that is popular. Endowment plan. The Economic Times defines endowment plans as life insurance policy that, besides covering the life of the insured, helps the policyholder save regularly over a specific period of time.
This helps you receive a lump sum amount when the policy matures. Rushabh Gandhi of IndiaFirst Life Insurance says, “The… benefits of any endowment plan include financial protection, goal-based savings, tax benefits under section 80C and 10(10D) of the Income Tax Act.” You can also obtain a loan against an endowment plan, should the need ever arise.
Dr P Nandagopal of OpenWorld Money recommends that “people who are risk averse and do not mind settling for lesser return than taking additional risks should go for endowment plans. In that sense, endowment plans are essentially for the common man rather than for the super rich.”
Another popular type of insurance is the ULIP, or Unit Linked Insurance Plan. We have all had that friend or colleague who has recommended ULIPs to us at some point. A ULIP is a plan where the premium you pay is invested by the company in equity, debt, or money market instruments. A ULIP allows you to choose your preferred asset class.
If you are feeling adventurous, you can choose a high-risk high-return strategy of investing in equities. If you want to play it safe, you can choose to invest in a combination of equity, debt, and money market investments which can provide higher returns at minimal risk.
What’s the right analogy here? Endowment plans and ULIPs are like adventurous friends, perhaps? Tread wisely, my friend. What you put into it is what you get out of it. Be clear about what results you seek.
Another type of life insurance is the Money Back Policy. This one is similar to an endowment policy, but with a crucial difference – such a policy provides periodic payments to the beneficiary over the duration of the policy.
The final type of life insurance is the Annuity Plan. This kind of plan tries to cover the policyholder’s income loss post-retirement. The premiums collected are accumulated as assets and distributed to the policyholder – either in the form of annuity, or a lump sum. This one’s the friend you can kick back and unwind with, knowing you are safe. Alright, my analogies aren’t the best. But you get my drift.
The reason for dwelling at length on the various types of insurance is, many people end up buying a life insurance policy that provides the highest sum assured. They pay little attention to whether they even require that large a cover or not. Which brings us to a basic point – it is prudent to calculate overall annual expenses. For instance, you should buy a cover commensurate with your financial situation, else you might end up paying a heavy regular premium that could prove to be a financial burden.
A smart financial plan could entail not keeping all your eggs in one basket. See if you can diversify your investments into different types of life insurance policies. Buying a simple term plan could see you lose out on opportunities to make steady extra income.
Another factor to keep in mind is that every insurance plan has differing premium paying terms, or PPTs. These change from policy to policy, so keep a keen eye out for such details. Knowing the PPT will help the policyholder know the precise amount he or she is going to pay out regularly.
Then comes the all-important settlement ratio. This is the number of claims paid to customers by an insurance company against the total claims received by the company. Settlement ratio is written as percentage. A higher settlement ratio is what you want to look for.
If you can, also look out for persistency ratio. When we are looking to buy an insurance policy, we wonder which one people trust most. Persistency ratio is one parameter that could help you decide. This number helps you understand how persistent customers have been in renewing their particular policies every year. A higher persistency ratio indicates a larger number of satisfied policy holders. Conversely, try looking at Lapse ratio. The Financial Express writes, “Lapse Ratio not only helps you understand the new trend of insurance companies, like which life insurance is high in demand, but also assists in choosing the right insurance company that you can trust.” With lapse ratio, lower is better. A higher lapse ratio tends to indicate poor servicing.
One mistake that we see is policyholders allowing their insurance to lapse. Typically, this happens when the holder stops paying premiums or decides to exit the policy before the policy term is completed.
Shalabh Saxena of chief distribution officer with Canara HSBC OBC Life Insurance Company, wrote in Moneycontrol that “After lapsing, you may not be in good health to take a new policy or your policy might be declined on health grounds.
All these are avoidable scenarios and will ultimately lead to your family being deprived of these benefits in case you were not around.” He adds, “…hold on to the policy without compromising on the objective for which it was bought. In case there is a financial exigency, there are facilities available like partial withdrawal or loans against policies which can be availed.” Pretty strong opinion there from an industry expert.
As discussed in other podcasts, with insurance, the earlier you start, the better. Consider this instance – if you are aiming for a 30-year term cover of 50 lakh rupees at age 30, your annual premium will be approximately 5,200 rupees per year. That is less than 500 rupees per month. If you purchase the plan at age 40, your premium rises to over 10,000 rupees. And don’t forget that insurance comes with tax advantages. Under Section 80C of the Income Tax Act, an individual can avail the entire 1.5 lakh rupee maximum deduction available for premium payment for Term Insurance.
And that’s the winning bit about insurance – you’re securing your family’s future at a cost that doesn’t really make a dent in your finances. Why wouldn’t you opt for such a family-friendly investment?