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Are You Adequately Insured?

Sometimes the levels of ignorance about life insurance products even among educated and worldly-wise individuals can be staggering

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"Indians tend to buy the right products, but for the wrong reasons" was one of the key inferences from an Ameriprise India survey conducted in 2013. And yes, it is in fact an unfortunate truth that we Indians tend to buy equities to make a quick buck, invest our retirement savings into bonds and PF's, but worst of all, we tend to buy life insurance policies as investments or to save taxes.

Despite there being more than 20 lakh active life insurance agents operational today, it still remains a grossly misunderstood product - sometimes, the levels of ignorance even among highly educated and worldly wise individuals can be staggering.

Scouring the internet for articles related to "how much life cover do I need?", one comes across scores of articles; but very few actually drive home the key point - that is, "why am I underinsured in spite of buying so many policies"?

The root cause is precisely the above stated - we tend to purchase Life Insurance without really giving a serious thought to "why" we are buying it. The only valid reason to purchase a policy is to de-risk your family against your future loss of income, which could arise from either death or disability. Insurance is, in fact, a truly selfless gesture. Any other reason to purchase it is in fact, incorrect - and in all likelihood, better products exist to fulfill that gap.

As a collective group, we tend to veer towards traditional policies with an assured - albeit extremely low - return, and a smaller portion of the pie (roughly 12% of all new premiums mobilized last year) flows into Unit Linked Plans. Both these policies do not address the core problem solved by life insurance - that is, having an adequate death benefit riding on your policies, so that your family doesn't suffer in the event of your unfortunate death or disability.

As a financial planner, I am no longer surprised to discover that many investors with multiple policies are not even aware of the collective death benefit that their policies have - which is in effect the most important feature of a policy. Upon introspection, it usually turns out to be a woefully low number that is far less than adequate.

Here's a ballpark estimate - if you're a 35-year-old paying a lakh a year for a ULIP, chances are that the associated death benefit is Rs 10 Lakhs or thereabouts. Add another lakh a year towards a 20-year traditional policy ("LIC"), and your death benefit probably goes up to Rs 30 Lakhs or so. In effect, you're paying 2 lakh a year to achieve a death benefit of Rs 30 Lakh.

Is 30 lakh adequate? Using a simplistic version of the income replacement method for estimating human life value, factoring in an inflation of 7% and assuming that you're earning Rs 15 lakh per annum, your adequate number is closer to 2.65 crore; a gap of Rs 2.35 crore. Fortunately, a simple term plan with an annual premium of Rs 25,000 to Rs 30,000 should do the trick.

Here's the crux: Although much maligned in recent times, life insurance is a critical aspect of your personal finances. However, when it comes to your life insurance planning, avoid piling on traditional policies and ULIP's. Work with a top down approach instead - start off by determining the actual death benefit you require, and then find the most economical and effective way to achieve this number.

Working with a financial planner rather than an insurance agent may work better in this regard, as the former will have little or no incentive to sell you products with a higher premium quantum.

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insurance life insurance personal finance