“Death” – is a topic that most of do not want to talk about, especially when the person whose demise is to be discussed is oneself. As on date, no one has managed stay alive forever! so Life Insurance does become a key consideration in making of a comprehensive personal finance plan. Given all the complexity and taboos around Life Insurance – here are Nine things that you must know about Life Insurance:
What is (Life) Insurance?
For starters it is important to remember that any Insurance tries to reduce the impact of financial loss or an asset. The asset that is insured in case of Life Insurance is the “economic value” of the insured person. A human life which is an income generating asset but this asset can be lost through unexpected death.
Insurance is not something to profit from. All Insurances cover those risks where the possibility of occurrence is uncertain.
In case of Human Beings – we know that death is certain so how does the insurance companies provide a Life Insurance policy on death? They are able to do it is because though Death is certain, the time of death is uncertain.
Risk Management via Insurance
Now that we know that Death is a risk – how can this Risk be managed? The following are are some strategies to manage this risk:
- Reduce this risk – by living a healthy life style. This reduces the risk but the risk still does not completely go away
- Retaining the risk – In this option you can decide to handle the outcome of the event on your own. This can be done if you have enough assets to cover the financial requirements of your dependents then you may choose to retain the risk by not taking any Insurance.
- Transfer the risk – By taking a life insurance policy, you can transfer the risk of an unfortunate event to the insurance company.
If you do decide to retain the risk by taking low insurance cover but do not have enough assets – in such a scenario in the event of untimely death, the surviving dependents bear the impact of the demise of the primary earner.
Insurance Contracts are Fiduciary in Nature
Insurance contracts are based on trust between the proposer and the Insurance company. In case of Life Insurance, the facts about your health, family health history, smoking, drinking habits are known to one party (ie you) and but can not be known to the insurance company unless discussed by the proposer or discovered via medical checkup.
The Insurance company depends on the proposer to disclose all the relevant information according to the principle of utmost good faith. In case of Non disclosure or Misrepresentation the insurer, who is at a disadvantage due to lack of information, can declare the insurance contract void and not pay any claim amount.
The Person Making the Claim is not the same as the Person buying the Life Insurance
If you buy a policy on your life and if there is a claim to be made – rest assured you will not be the one who will make the claim. Hence it becomes all the more important to be upfront and transparent about the current health and habits while buying a Life Insurance policy.
With Life Insurance one can not derive any immediate pleasure however it is a great liberating feeling that your dependents will be financially secure in your absence.
You need Life Insurance if you have People Financially Dependent on you
Don’t start thinking about insurance due to the “tax planning” aspect of this product.
At a high level your insurance cover should be the delta between your disposable assets and the financial requirements (like paying off outstanding loans, education, housing and living expenses) for your dependents.
Life Insurance is a not a Good Investment
Insurance tries to reduce the impact of financial loss or the asset; it is a Risk Management tool not an Investment vehicle.There are better, more transparent Investment vehicles like Mutual Funds, Stocks, Bonds, Fixed Deposits, Post Office Schemes etc which can offer you better returns.
Life Insurance does not need to burn a hole in your pocket
Simple Term Insurance plan are very inexpensive if taken early in life. The premium for a term insurance for Rs 1 crore taken by a 30-year-old non-smoking male is around Rs 9,000 per month. The same cover premium increases to Rs 18,000 for a 40-year-old male and Rs 29,000 for a 40-year-old male smoker. So if done early in life with the right amount and duration – you can get good insurance coverage relatively cheap. (the amounts here are representative from one of the leading life insurance companies in India)
How much life insurance do you need?
Insurance needs are unique to each individual based on their financial situation and dependents. However, there are many methods to derive this “magical” number and get a high level guidance on the amount of insurance required. Some of the insurance websites do a good job of identifying the insurance requirements – but you have to provide all the details like Income, Expenses, Inflation and Return Expectations, Goals and also your current assets etc. This is a good place to start however, it would make sense to review this regularly for changes in these input parameters (like goals, assets) which can change your insurance requirements. Also engaging a planner to help you make sense of your insurance requirements would also be very beneficial.
Just like Under insurance it is possible to be Over Insured
As you build your assets over your working life – you might reach a stage when you have enough accumulated assets to take care of all the financial liabilities of your dependents. Or you could be retired and with no liabilities at all, except taking care of yourself and the spouse for which you have a retirement funds. In such situation you would not be needing an insurance.
Do comment in the section below with your thoughts, experiences or questions.