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News & Views

Monday, Nov 7, 2011

How to choose the right insurance policy for different stages of life

[Source : The Economic Times]

Every insurance policy is designed to meet a specific need. Find out the policies that will suit you at different stages of life.

The phone rings. It's a wealth manager with an offer of a triple benefit investment plan. You can save tax, grow wealth and even enjoy life cover. The best part is that the plan guarantees the highest NAV achieved during the next seven years. Even if the markets fall in later years, you get the historical high rate.

Before you latch on to this golden opportunity, ask yourself three questions.

- Do you need life insurance?

- If you do, how much cover do you need?

- Finally, does the plan fulfill your financial requirements?

Your answers could help you take a better decision on what experts say is the lynchpin of any financial plan.

Buying life insurance is a national pastime in India. After bank deposits, it is the most favoured destination for household savings, accounting for almost 25% of the wealth of small investors. Noida-based software professional Gaurav Tiwari has been buying life insurance since the time he started working in 2002. "My parents advised me to invest in insurance policies," he says. He has picked up 12 endowment policies in the past nine years.

Much as Indians love to buy life insurance, they are not buying the insurance they really need. Tiwari's dirty dozen gobbles up Rs 71,000 in premium every year, but offers a cover of Rs 14.4 lakh. This is very low, but better than the national average of about Rs 1.16 lakh per policy sold till now. The figure is improving but has a long way to go.

The average life insurance cover of policies sold in 2010-11 was Rs 1.93 lakh. "Investors need to strike a balance between the risk cover and investment in their insurance portfolios. Most of the time, there is a skew towards investment, while insurance gets neglected," says Deepak Sood, CEO and managing director of Future Generali Life Insurance. Every life insurance policy is designed to serve a specific purpose. Some offer a large risk cover at a low price. Others help in saving for specific goals or create wealth over the long term.

At the root of the problem is the advice given to the investor by the insurance agent. "The customer's choice is largely determined by the agent's incentives rather than the pull of the product," says Jayant Pai, vice-president of Parag Parikh Financial Advisory Services.

Till a little over a year ago, Ulips were being peddled as the best investment you could ever make. But after the new guidelines issued by Irda in September 2010, agents have started pushing traditional policies. A distributor earns 30-40% commission from selling a traditional policy compared with 8-12% from a Ulip.

The essential covers

The basic purpose of insurance is to serve as hedge against risks. Therefore, pure protection plans should be the foundation of your insurance portfolio. A term plan, for instance, is your protection against the risk of early death. It provides the family of the policyholder with a corpus that can replace his income. Experts say that a term plan should be an individual's first life insurance policy. "It is even more important than a bank account," says TR Ramachandran, managing director and CEO of Aviva Life Insurance.

The earlier you buy a term insurance plan, the better it is for you. At a young age, when your health is in fine fettle, the premium is unbelievably low. At 25, a man will pay about Rs 7,500 a year for a cover of Rs 1 crore for 35 years. As he grows older, the premium shoots up exponentially . If he buys the same cover 10 years later for 25 years, the premium is higher by 50%. Within the next 5 years, it will shoot up by another 50%. "This is why it's best to buy early and lock in at a low rate," says V Srinivasan, CFO of Bharti AXA Life Insurance.

Mumbai-based finance professional Sujeet Joshi, 28, and his wife Rohini, 25, know this only too well. Sujeet has taken a Rs 1 crore cover, while Rohini is covered for Rs 25 lakh. Their total premium bill is Rs 9,400 a year for the covers they bought online this year.

A term plan alone isn't enough to cover the basic risks that life throws at us everyday. You also need a medical cover to guard against high expenses due to an illness or injury. Health insurance is perhaps more important than even term insurance because the chances of someone in the family requiring medical care is higher than a person dying. Also, while the term plan covers only the breadwinner, the medical policy covers the entire family.

It helps if you have medical insurance from your employer, especially if you are well-settled in your job. If you intend to switch jobs, you may need to buy a medical insurance plan on your own so that there is no break in the cover when you leave one job and join another. In some cases, one may discover that the cover provided by the employer is not sufficient.

Buttress it with a top-up plan at a low cost. So, if your employer gives you a family floater cover of Rs 2 lakh, buy a top-up plan that will pay for expenses above Rs 2 lakh. Since these plans cover costs beyond a threshold, they are far cheaper than a normal medical insurance policy. Keep in mind that a top-up plan is meant to be an additional plan to increase the cover. It should not be seen as a replacement for the basic mediclaim plan.

Covering against disability

The roads are full of idiots. Unfortunately, even the best tyres can't avert accidents. According to the World Health Organisation, India is the road accident capital of the world. The National Crime Records Bureau statistics show that every three minutes, an Indian dies in a road mishap. An equal number of people is grievously injured. An accident can leave a person bed-ridden for months. Worse, he may be disabled for life. Why only extreme road mishaps? You can get hurt even at home-miss a stair, slip in the bathroom, trip in the garden. Are you covered against the income loss due to a disability even if it is partial or temporary?

A personal accident and disability cover is inexpensive, but a critical part of your insurance portfolio. You can choose the extent of the cover you want. While the basic policy will cover death due to accident, you can enhance the scope of the policy to include permanent disability or even a temporary one. The wider the cover, the higher it costs. The payout in each case will depend on the nature of the injury. Incidentally, a personal accident cover comes bundled with a comprehensive home insurance policy.

The size of the cover depends on your income profile. Since it is difficult to ascribe a value to human life, companies apply different yardsticks. The New India Assurance Company, for instance, restricts the cover to 72 months' income. If your income is Rs 50,000 a month, the maximum cover you will get is Rs 36 lakh. Also, the disability must result in loss of income. If you break your leg and proceed on paid sick leave from office, you can't make a claim for the temporary total disability. You will be compensated only if your employer deducts your salary for the period you do not attend office. This also prevents a moral hazard, where a policyholder wilfully injures himself to claim the insured amount.

Insurance as a saving tool

Almost every investor above 40 will have an endowment or money-back policy in his portfolio. However, financial planners balk at the thought of endowment and money-back policies because they offer very low yields in the range of 6-7%. "Endowment and money-back plans were a necessary evil when investors had few options. Only indolent investors continue to opt for such opaque, low-return products with a low insurance cover," says Pai of Parag Parikh Financial Advisory Services.

Yet, these plans can be a good way to build up the debt portion of your portfolio. Think of them as a PPF contribution without an upper limit of Rs 70,000 a year. Chandigarh-based Dhiraj Gupta bought an endowment plan to save tax when he started working. He has realised the mistake and bought a term plan that covers him for Rs 50 lakh. However, he has not let go of the endowment policy. Instead of surrendering the policy or turning it into a paid-up plan, he is using the investment to buttress his debt portfolio. "If I terminate it now, I will lose many of the maturity benefits," he says.

Traditional insurance policies suit risk-averse investors, who are content with the low returns as long as the capital is safe. "Other fixed income instruments can also serve the same purpose, but endowment plans offer the additional advantage of a risk cover, however small it may be," says Radhey Sharma, chief financial planner of the Pune-based Wealth Wisher Financial Planners.

Don't also forget the tax efficiency. Under Section 10(10D) of the Income Tax Act, any income from a life insurance policy is tax-free if the policy offers a cover of at least five times the annual premium. The Direct Taxes Code, which is likely to come into effect from April 2012, has proposed to raise this to 20 times the annual premium. However, existing policies are not likely to be affected.

Market route to protection

Saving for their children's education and marriage is one of the most important goals of an Indian parent. What if something untoward were to happen to the parent? Child Ulips are designed to cover the life of the parent as well as the goal he has in mind for his child. These policies have a higher mortality charge because they are essentially two policies wrapped in one. One gives out a lump sum amount to the nominee on the death of the policy holder. The other pays the remaining premium on behalf of the deceased and gives the corpus to the child on the maturity of the plan.

To be sure, one can save for a child's education through much simpler products. A mutual fund is more transparent and simpler to understand than a Ulip. Besides, you have the freedom to move to another scheme any time you want. If you are averse to market risks, you can use bank deposits to save for junior's college. You don't need to buy a high-cost

Ulip for this.

Yet, if you understand how a Ulip works and are ready to bear the high charges, you can use the policy to your advantage. It also suits investors looking for the convenience of triple benefits in one product. Find out if you are fit to invest in a Ulip by taking the test on page 5.

The September 2010 guidelines for Ulips have removed some of the reasons that were responsible for the mis-selling of these policies. Not only have the charges been reduced, but the mandatory lock-in period has been extended from three to five years. In the coming months, the Direct Taxes Code will usher in more changes. The insurance aspect of the policy will become more prominent. Also, a policyholder will have to remain invested for the long-term if he wants the tax benefits.

More than the tax rules and insurance guidelines, the mindset of the Indian buyer needs to change. He needs to look beyond tax breaks and returns while assessing his insurance needs. "The overwhelming desire is to get something back from the policy, not look at the cover that it provides," says Amitabh Chaudhry, CEO and managing director of HDFC Life.

In this backdrop, the spread of online term plans over the past two years is a welcome development. Almost 18,000 Indians have bought online term plans till now, with an average cover of over Rs 60 lakh. Finally, a small but growing number of Indians is looking at insurance as a risk mitigation tool, not an investment plan. One only hopes this trend continues and spreads to smaller towns as well.

What to look for in a term plan

Some increase the cover, others return your premium. Here are a few things to know when you buy one.

Buy sufficient cover

Make sure your term plan gives you a sufficiently large cover. Experts suggest that one should take a minimum cover of 5-6 times one's annual income. If your monthly income is Rs 50,000, you need a cover of at least Rs 30 lakh. This figure can vary depending on the financial circumstances of the individual. If you have large outstanding debts, such as a house loan or a car loan, you need to cover these as well. Don't go for a home loan cover that is linked to the outstanding loan. It works out to be costlier than a plain vanilla term cover for the same amount.

Get the right tenure

Your term insurance policy should cover you at least till you retire. Don't take a short-term insurance plan that ends when you are in your 50s. At that age you will need life insurance the most, but it could cost you a bomb. If you have not been keeping well or have developed some illness, you might even be denied the cover. The good news is that insurers are now offering term plans for longer durations of up to 30-35 years.

Mind the inflation

The rising cost of living may render your insurance cover inadequate in a few years. Right now, a Rs 50 lakh life insurance cover might appear big enough. But five years of 8% inflation would reduce its value to about Rs 33 lakh. In 10 years, it would be less than Rs 22 lakh. Taking insurance afresh might not be feasible in your 50s. You can avoid this by buying a plan where the cover increases every year. Aegon Religare offers a plan where the life cover increases by 5% every year. Bajaj Allianz too has such a policy on offer.

Don't expect returns

Some policies offer to return the entire premium paid over the term. Cool, isn't it? Not really. The premium you get after 20-25 years will have virtually no value. Being a pure protection plan, a term plan only covers the risk without offering any returns. If you opt for a return of premium policy, your returns will be an abysmal 4-4.5%. "Such policies are offered just to make the buyer feel as if he is getting the insurance for free," says a senior manager of a private life insurance company.

Do you need a Ulip?

Even if one of these is answered with a 'No', reconsider your decision to buy a unit-linked insurance plan.

You already have enough life insurance cover.

A pure protection plan is an absolute must for everyone. Only if you have bought yourself enough insurance cover (roughly 5-6 times your annual income) should you consider buying a Ulip.

You are aware of the high charges on these policies.

Though Irda has put a cap on the charges levied by a Ulip, these policies are costly compared to other investments. You are still paying far more than you would for mutual fund charges. Also, unlike in a term insurance plan, the mortality charges of a Ulip keep rising every year.

You understand that Ulips are market-linked.

Like mutual funds, Ulips also invest in the markets. Their NAVs move with the fluctuation in the prices of their holdings. When you buy a Ulip, be prepared for the market risk that the investment will be exposed to. Not only equities, even the debt portion carries a downside risk.

You realise that exiting a policy in 5-6 years will not yield desired results.

Till a year ago, agents were selling Ulips as something you could exit within three years. This is not incorrect, but it wouldn't have yielded the expected returns. Now the mandatory lock-in period is 5 years, but to get the best out a Ulip, you need to hold it for 12-15 years.

You are ready to pay for the convenience of a bundled product.

All these can be achieved through separate investments at a lower cost. Mutual funds are a simpler and cheaper option for wealth creation. Save tax through 5-year bank FDs or PPF. And buy a term plan for a bigger insurance cover.

You know how to use the switching facility.

The switching facility in a Ulip is a key feature that differentiates it from a mutual fund. You can use it to shift money from debt to equity, and vice versa, depending on your expectations of the market movement. An investor who proactively changed his allocation to equities would have earned higher returns than one who kept a static asset allocation during the past 12 months.

You can afford to pay the premium for the entire term.

As mentioned earlier, it is important to continue investing in a Ulip through the term of the plan. Of course, this is possible only if the premium is at a reasonable level. If it is very high, the policyholder may find it difficult to pay it year after year. Buy a policy that you can continue without impinging on other financial commitments.

You are aware of the imminent tax changes related to insurance.

Tax rules regarding life insurance are set to change drastically. The Direct Taxes Code proposes to reduce the tax-saving limit from the current Rs 1 lakh to Rs 50,000 a year. This will include medical insurance premium and school fees. Also, if your policy does not give you a cover of 20 times the annual premium, the premium won't get any tax deduction and the income from the policy will also be taxable.

You don't need life insurance if...

Not everyone needs life insurance. Here are the four situations in which an individual can do without covering his life.

You don't have dependants

Life insurance provides the dependants of the policyholder financial support if the breadwinner suddenly passes away. If you are not married and nobody depends on your income, you don't need to take a life insurance cover.

You have enough assets

This may not be applicable to a majority of the Indians. If you have built up substantial assets that can take care of your family in your absence, there's really no need to pour money into buying life insurance for your dependants.

Your spouse earns well

If your spouse has a good income and can sustain on that, you don't really need to buy life insurance. For instance, if both spouses work and there is no liability, such as a home loan or a child, life insurance will not have too much significance.

You have stopped working

Life insurance is supposed to replace the income of the policyholder. If an individual has retired or has stopped earning, his death will not have any financial impact on his family. There is no need to insure yourself beyond your working years.

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