In
this article I would cover various aspects related to insurance like different
types of insurance products, which ones to choose and especially which ones to
avoid. Also will touch upon why one must keep insurance separate from
investment.
Insurance basics
Insurance is
required to cover the risk of certain undesirable events like loss of life,
loss of income due to accident or illness, loss of property etc. Financial
planning is not complete just with identifying goals and doing investments to
reach those goals. You need to ensure that those goals are reached even if some
undesirable event occurs. Since we can't control such events, we need to
mitigate the risk by taking insurance.
How insurance
companies work is, they insure many people for some amount called sum assured
and take small amount called premium from each one of them. This way they get a
large pool of money which they can invest somewhere to generate returns. They
assume that not everybody will encounter those undesirable events hence they
will be able to pay those unfortunates souls from the pool of money and still
make some profit.
Main point to note
here is that the aim of insurance is to mitigate risk and not wealth generation
or savings.
Different types of insurances
Most popular form of
insurance that most of us know is life insurance, i.e. that protects against
loss of life. Those who own a vehicle, they might be aware of motor insurance
that they are forced to buy in order to avoid penalty in case traffic police catch
them. That pays when vehicle is stolen or damaged due to accident.
Then there is health
insurance which pays for hospitalization for more than 1 day, accidental
insurance & critical illness insurance that pays in case of loss of income
due to critical illness or accident respectively and home insurance which pays
in case of theft or fire that damages home.
How much sum assured is reasonable
For life insurance
the amount must be large enough to pay for your liabilities (say home loan or
any other kind of debt), financial goals (kids education, marriage etc) and
finally your dependents must be able to invest it in some safe avenue to get
interest which is enough for taking care of their monthly expenses. Hence this
must be a very large amount (say Rs 1 crore for somebody who has 25 lakh home
loan and his family has monthly expenses about Rs 50000 per month).
Similarly health
insurance also must be large enough to take care of hospitalization expenses in
case of some serious disease or procedure like kidney transplant. Basically a
cover of modest 2-3 lakhs may not be good enough. Prices of medical treatments,
medicines are going higher and higher hence insurance amount must be enough for
future needs too.
Life insurance
In it's purest form,
insurance is to insure against loss of life for the payment of a small premium.
Hence no benefit in case of survival. This is what is called term insurance.
However chances are that many people might not have heard of it ever. What insurance
companies try to sell is endowment plan (in which some money is paid at the end
of period), money back plans (very similar to endowment plans but they pay in between too) or unit linked plans (much costlier but promises better return as money is invested in stock market). They sell
it because as these are much costlier for consumers. Hence not only companies
make much more profit out of it, they pay very high commissions to their agents
for selling these aggressively. I hate these products because they offer very
little sum assured hence fail to mitigate any real risk and returns from them
are meager (like just about 6% from typical LIC policy hence one is better off
investing that money in FD).
Let me give a
concrete example of what I am talking about. I went to SBI Life's site and
calculated premium for an endowment plan ShubhNivesh.
For a 30 year old male, yearly premium comes out to be Rs 105830/- for sum
assured of Rs 10 Lakh for 10 year. Now consider what good that 10 lakh do for
the dependents of that poor guy if he dies!! In case of survival, they promise
to pay Rs 10 Lakh plus non guaranteed payment which in the example is mentioned
as Rs 345000/- assuming 8% pa return. Hence for the total payment of Rs
1058300/- over 10 years, one gets about Rs 13.5 Lakh.
Now consider term
insurance premium from the same provider for a plan called smartshield.
For the sum assured of Rs 1 crore for 10 years of coverage, yearly premium is
only Rs 11686/-. Now if the balance of Rs 94144/- is invested in mutual funds
through SIP for 10 years, assuming 12% annualized return, the corpus would be
about Rs 18 Lakh.
Similarly ULIPs are
as bad products as endowment/money back plans if not worse. They are much complicated to understand, provide very
little insurance cover and have very high charges. Also they are far less
transparent compared to mutual funds.
I hope it's amply clear with
this example that by taking term insurance not only one gets a sufficiently large insurance cover which actually
mitigates the risk, one saves much more on premium that can be invested for better returns elsewhere. Hence the bottom line is that endowment plans, money back plans and
ULIPs must be avoided.
For the premium paid for life insurance, one can claim tax deduction under section 80C for amount upto Rs 1 Lakh.
How to select provider and plan
There are various
sources that provide information & comparison of various providers,
premiums etc. One can visit sites like valueresearchonline, policybazaar
to compare and get quotes.
One can buy a term
insurance policy through an agent or online. Online buying from providers site
is much cheaper as no commission is paid to any agent.
A very important
factor to consider while choosing the provider is claimsettlement ratio. It was highest for LIC (97.73%) but much lower for less
known providers. One can go for LIC's term insurance plan but premium is higher
because one must have to go through some agent as there is no completely online
option. Good news is that the ratio is high enough for other private providers
too like ICICI, HDFC, Max & Kotak.
Health insurance
As I mentioned
earlier, health insurance pays when somebody gets hospitalized for more than a
day. Everybody knows how high hospital charges are now a days and an
hospitalization of somebody in the family can upset the financial plan & destruct significant amount of savings.
For most salaried
people, company provides health insurance. However one must assess if the
amount is sufficient enough. Once you are out of job, health insurance cover cease to
exist immediate. If you change job, new employer might offer even smaller
amount or no health insurance at all. Also when you retire, you would be more
prone to health risks and it will be difficult to get health insurance or you might end up paying way too high
premium.
You must insure
parents too if they don't already have a health cover.
You can go for
individual health cover but better idea would be to cover whole family under a
floater plan which covers individuals as well as whole family. For example
there is "Family first" plan by max bupa in which every individual in
the family would be covered by amount upto 5 Lakh and there will be additional
cover for upto 15 Lakh which could be utilized for any member. Also watch out
for policies that do not allow life long renewal.
Same sites mentioned
above (valueresearchonline
& policybazaar)
can be used for finding out a health insurance plan.
There is tax benefit
available OUTSIDE of 1 Lakh under 80C for health insurance.
Under section 80D one can claim tax benefit for upto Rs 15000/- for
self/spouse/kids and an additional amount of Rs 15000/- for parents. If parents
are senior citizen, deduction could be Rs 20000/-. Hence for health insurance
premium one can get upto Rs 35000/- additional tax benefit.
Read following
articles from Manish Chauhan of Jagoinvestor for more information on health
insurance:
Conclusion
For a smooth
financial journey, insurance plays a very important role by mitigating risks.
Even if life insurance & health insurance is provided by employer, one must
take additional policies personally as the cover cease to exist after changing
jobs. Avoid mixing insurance & investment and go for plain term insurance
plans.
Please feel free to
ask questions or share feedback on this or any of the previous articles.
