Why is life insurance the most important financial product you will ever buy?

By | 05/11/2016

imagesYou may think that life insurance is not important for you and that your savings and investments alone will take care of your family’s future requirements. But just consider this: if you fill up Eden Gardens stadium with 60,000 people, around 420 of them will die in this year alone. Of this, some 130 people would be in the age group of 15-60 years. Now, what will happen if you are one of those unlucky ones? Who would take care of your aged parents or your spouse and children in your absence?

This is where life insurance comes in. The basic objective of a life insurance plan is to provide a replacement of your income in your absence. Life insurance plans are perhaps one of the most important financial products you must buy. Add to it, they are simple and cheap, especially term plans.

Now that you understand the importance of a life cover, the question arises: How much life cover should you buy? Generally, your life cover should be large enough to act as a substitute of your monthly income. So, suppose you are earning Rs 50,000 per month, your life insurance plan should provide anything that covers Rs 50,000 per month plus a little extra to take care of the inflation.

A good thumb rule on life insurance cover is that it should be at least 15 times of your annual income. So, if your monthly income is Rs 50,000 per month or Rs 6 lakh per annum, your life cover should be bare minimum Rs 90 lakh. You should also include your existing debt obligations, such as your car loan or home loan in your life cover. Also include your child’s educational or wedding expenses while calculating your life cover.

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After having determined the amount of life cover, the next thing that you will have to decide is the type of life policy that will cover your needs. The most basic and cheapest form of life insurance plan is term insurance plan. Under this plan, the insurance company will only pay if you die by a certain date. Otherwise, the company will not make any payout.

In the event of your death, the payout can either be a lump sum amount or a staggered payout option, which will be a combination of lump sum and monthly payout. Staggered payout option is particularly suitable for people whose survivors lack financial awareness. They would not have to worry about how to invest the death benefit. Nowadays, most life insurance companies offer the staggered payout option.

The table below shows the premium payable by a 30-year-old man for a life cover of Rs. 1 cr:

Now, there is another segment of customers who prefer to get returns from their insurance policy. To cater to such customers, life insurers have come up with term return of premium (TROP) plans. Unlike the standard term policies, in TROP, insurers will pay you back the premiums if you survive the term.

However, their main drawback is that their premiums are substantially higher than the standard term plans. You can also consider Unit-Linked Insurance Plan (ULIP) schemes if you want your insurance policy to take care of your investments too. Depending on your risk appetite, you may opt for ULIPs investing in equity and/or debt instruments. Equity ULIPs would allow you to beat inflation, something that debt ULIPs or bank deposits often fail to do. Do you know an item worth Rs 1,000 in November 1995 would have cost Rs 3,854 in September 2015?

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The decrease in the purchasing power of rupee is due to inflation. Contrary to this, Rs 1,000 invested in NSE Nifty on 3 November 1995 would have amounted to Rs 7,949 on 30 September 2015. Note how equities beat inflation by a huge margin over the long term.

Now, what if you develop some critical health issue, such as cancer or paralysis? To take care of treatment costs and possible loss of income arising due to the illness, many life insurance plans also come with riders for critical illnesses.
If you are diagnosed with a critical illness listed in the rider, then the insurer will pay you a lump sum amount, irrespective of whether you opt for treatment. You can add additional coverage to your life insurance policy by opting for such riders as waiver of premium, accidental disability and accidental death.

For example, you can opt for accidental disability rider with a term plan, which will pay you 1% of your sum assured as monthly income for 10 years. If you are a 30-year old man and have a 30 year-term period for a cover of Rs 60 lakhs, you can avail accidental disability rider by just paying an additional annual premium of around Rs 1,800.

However, all your premiums, riders and financial planning will come to naught if you are dishonest with your insurer. Always be frank with your insurer regarding your health and lifestyle issues. While withholding important facts such as smoking or tobacco consumption or any present physical ailment may reduce your premium outgo at present, it may also leave your family without any protection when they will need it most.

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One thought on “Why is life insurance the most important financial product you will ever buy?

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