With March 31, 2011 drawing closer, the tax-saving season is once again upon us. It’s that time of the year when insurance agents and distributors of financial products start chasing potential customers with a renewed vigour . They coax customers to buy products that are eligible for deductions under Section 80C of the I-T Act.
Their enthusiasm often succeeds in pushing gullible investors into buying something that they would have otherwise bought after much deliberation. However, these last-minute choices are the ones that often come to haunt them later.
This is particularly applicable to Ulips, which have been the best-sellers during the season, thanks to insurance agents pushing them for lucrative commissions. Whether the trend will continue next year remains to be seen, given the cap on Ulip charges imposed by the Insurance and Regulatory Development Authority ( Irda )).
Nevertheless , it will not be surprising if people continue to fall prey to the so-far successful insurance-investment-tax-saving pitch. Often , they do not realise that apart from entailing huge charges, Ulips, like any other life policy, are long-term contracts for which they have to pay recurring premiums. Ulips start yielding desired returns only after around 10 years as a large chunk of charges are deducted from the premium amount in the initial years. Also, unlike other investment options, life insurance products do not provide easy exit options. So avoid buying a Ulip in a jiffy or for saving on taxes.
Too much too soon:
Consequently, most policyholders are saddled with multiple policies entailing a huge premium outgo that at times runs into lakhs of rupees. And yet, many find that even the combined life cover offered by these policies falls far short of their requirement. Take for instance the case of a 35-year-old individual whose ideal protection cover is . 20 lakh. If he has two Ulips requiring annual premiums of . 50,000 each, the total cover could amount to only . 10 lakh (the minimum cover which most Ulips would typically offer or 10 times the annual premium).
It is a difficult situation to deal with, and could call for eliminating the bad apples (which could mean letting go of certain benefits) and replacing them with good ones (leading to additional costs). But, you must take into account several factors before arriving at a decision. Here’s a guide to managing the tough situation.
To know whether your portfolio is low on life insurance despite being overloaded with Ulips or endowment policies, you first need to ascertain your ideal protection cover. “The requirement for a person’s insurance cover for his/her dependents is governed by one basic consideration — what is the amount of wealth available for the dependents in case anything untoward were to happen to the life assured compared to the present value of future expenses of the dependent family,” explains certified financial planner Prerana Salaskar-Apte , partner with the financial planning firm, The Tipping Point. And how do you calculate the available wealth?
Simply deduct the value of your liabilities from that of assets (including existing policies). Your assets , however, should not include your self-occupied house, as it is not capable of generating income. Liabilities would include your housing loan, credit card outstanding, any personal loan and so on which would be needed to be paid by your dependents in your absence.
To this capital figure, add the present value of the expected income from the earning spouse till retirement. This would be the total present value of the corpus available for your spouse and dependents in case of your demise. “While estimating future expenses , you need to incorporate living expenses as well as the cost of any aspirational goals for your children or other imperative goals,” says Salaskar-Apte .
The gap between the present value of these future expenses and the available corpus as calculated above would be your balance insurance requirement. If this gap is positive then one need not take any further insurance. “You could also consider exiting certain schemes to reduce the cost burden, since insurance (schemes with investment component) rarely proves to be good ‘investment’ ,” she adds.
The cleansing process:
You need to identify the policies that are not likely to help you meet your requirements and initiate the process of sanitising your insurance portfolio. To start with, you should evaluate existing policies and study their cost structures . The pre-September 1 policies will entail comparatively higher costs, though that alone can’t be the parameter for surrendering them. Since surrender charges are higher in the initial years, it would be unwise to terminate them.
“It would depend on when an individual has initiated the policy. If a policyholder has completed three years, then he can evaluate if it makes sense to continue the policy or switch the future cash flows in a new policy, given that charges of Ulips have been rationalised completely now,” says Anil Rego, CEO, Right Horizons. “You can continue to hold on to the earlier policies and make complete withdrawals only when no surrender charge is applicable.”
Scout for cheaper options:
Once you have shown the door to policies that do not deserve a place in your portfolio, you can look at enhancing your cover at minimal cost. This, however, need not be in the form of topping up the Ulip that you may have chosen to retain.
“Some Ulips also have the option of increasing the life cover which can also be evaluated in case of a better policy. Any gaps can be made up through term policies,” says Rego. Ideally, you should look at a term cover for the balance amount. You can also look at opting for riders alongside this term policy to enhance the total protection.
Again, rider benefits, too, require careful scrutiny. “Riders, which involve an additional cost, are advisable if the type of risk the life assured faces in his everyday life can be adequately addressed by them. For example, if he commutes by a bike to a great extent, then he can apply for an accidental rider which provides for double of sum assured in case of death by accident or to cover hospitalisation,” points out Salaskar-Apte .
Similarly, if there is a family history of critical illness, which could lead to huge expenditure on treatment and partial/total loss of income, it would be logical to buy a critical illness rider that promises a lump-sum disbursal upon diagnosis of the ailments covered. Financial planners, however, strongly advocate having in place a large basic cover before scouring for such add-ons .
Although you can always kick off a damage-control exercise as soon as you realise your folly, it is best to exercise caution at the outset. So, this New Year, when you get calls promising Ulips with ‘highest returns with the lowest risk’ , you would do well to be on your guard.
Problem Of Plenty
Stuck with too many policies? Here’s how you can deal with the situation.
Determine the ideal life insurance that will cover the needs of your dependents.
Evaluate your existing policies and identify the ones with high-cost structures.
Zero in on the policies that can be eliminated with minimal loss of benefits.
The elimination will also depend on the number of completed policy years.
Take into account the surrender charges that are applicable and the surrender value of the policy.
If you feel it makes sense to persist with a Ulip, you can explore in-built options, if any, to increase the life cover.
To make good the deficit in your life cover, you can look at buying term covers which are available at extremely affordable rates.
Here are some simple ways to determine your insurance needs.
Determine the amount that will be at the disposal of your dependents in your absence. The total value of your current assets minus your liabilities will help you arrive at the right figure.
To this figure , you need to add the present value of your spouse’s expected income, if any, till retirement.
Next, you need to factor in your future living expenses, including future goals. For example the cost of providing the desired quality of education to your children.
The gap between what will be required in the future and what you have at present needs to be bridged by taking an adequate insurance cover.