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BW Businessworld

Are You Adequately Insured?

Sure, you have bought one or more life insurance policies — but is your life cover enough? If you are not adequately insured, get a simple term plan for the shortfall

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Would it surprise you to know that like most Indians, you’re most likely under-insured? Considering that as a group, we purchased close to Rs 3.67 lakh crore (Rs 3.67 trillion) of life insurance premium in the last financial year, this might strike you as counterintuitive and confusing.

Trouble is, not all life insurance policies are alike. Some are market linked, some provide fixed benefits, and some provide no maturity amount whatsoever. The associated “life cover”, unarguably the most critical feature of a policy, often takes a backseat as agents focus on its savings or investment aspect as its key selling point. And it’s a well-known fact that in our country, life insurance is sold, not bought.

“In India, commissions drive what gets sold,” says Shyam Sunder, Managing Director, PeakAlpha Investment Services, Bangalore.“After ULIP commissions shrank drastically, agents, particularly in the bancassurance channel, have shifted their attention to endowments and other traditional plans, although yields and amount of cover on these plans are very low.”

Policies that score on the life cover front invariably require much smaller premium payments, thereby limiting the commission incomes arising from their sale. This creates a conflict of interest that orients agents towards the questionable practice of recommending only high-premium policies, without really paying attention to the client’s actual coverage requirement. Hence, the baffling trend of a nation of insurance-oriented savers being under-insured.

What’s more, a disturbingly large cross section of insurance buyers remains blissfully oblivious about how much life cover they’ve already accumulated till date; this is a classic case of “buying the right product for the wrong reason”.

A 2012 Harvard Business School study on the Indian life insurance market summed up the root cause of this problem succinctly, providing conclusive evidence that “agents appear to focus on maximising the amount of premiums (and therefore commissions) that customers pay, as opposed to focusing on how much insurance coverage customers need”.

Dilshad Billimoria, a SEBI registered investment advisor, also attributes the problem of under-insurance to a poor understanding of the actual purpose of life insurance. “Many clients come to me with a bag full of insurance policies that are essentially worthless,” she admits.
Considering the above dynamic, it would be prudent to take matters in your own hands this year. Collate all your life insurance documents and prepare a simple spreadsheet with the details of your annual premium payments, one-time premium payments made, and the duration and quantum of life cover that each policy provides. Knowing how much cover you’re already achieved is the first step towards insuring yourself adequately.

How Much is Enough?
There are two approaches to estimating how much life cover is optimal; the first being the “Human Life Value” or HLV method. Simply put, an individual’s HLV is the amount of money required to replace all future projected income streams arising from that person, were he or she to unfortunately pass away today. The HLV approach contrasts with the “Needs Based” approach, which is more of a reverse-calculation of the quantum of money that would be required to continue financing dependent needs, pay for the fulfilment of their future goals, and pay off their liabilities, were one to meet their unfortunate demise today. Either one of the two approaches may be used.

Most life insurers carry coverage estimation calculators on their websites, and most of them use a combination of both approaches to arrive at this number. These calculators will typically consider factors like your current monthly income, personal expenses, personal liabilities, existing cover, the value of your liquid assets and the future value of your financial goals. For instance, SBI Life estimates the life cover requirement for a 30-year-old earning Rs 1 lakh/month to be Rs 1.4 crore, under a typical set of assumptions.

“There are also thumb rules that people apply, such as 10 or 20 times gross annual income based on age bands, but these are very crude methods,” cautions Billimoria.

About Pure Term Insurance
Continuing our previous example, it turns out that the individual in question will need to pay approximatelyRs 15,000 per year for a pure term insurance plan called “SBI Life Smart Shield” to achieve this life cover for a period of 20 years. The caveat is that at the end of the policy term, no pay-outs will be made to the insured person.

While term plans with returns of premium do exist, they generally cost nearly twice as much as pure term plans; you’d actually make a lot more money by investing the differential amount in a mutual fund SIP for 20 years.

Traditional plans provide you with a maturity benefit; but the rates of return, although guaranteed, are abysmally low. The strategy of combining a pure term plan with a portfolio of top-performing mutual funds stands out as a clear winner.

Start 2017 by accurately taking stock of your life cover requirement; depending upon your unique life situation, this would most likely range from Rs 1.5 crore to Rs 4 crore. Having done the math, look no further than a simple term plan to achieve the shortfall.

Consulting with a conflict-free and trusted advisor can help you weld your insurance plan together with a more holistic goal-based financial plan. As Sunder notes, “While the average Indian is indeed underinsured, we find that those receiving quality financial advice are often adequately insured. The gap in insurance can be said to be directly related to the gap in financial advice”.