Musing 34: Insurance- The Essential Five Part 1
MUSING
34
INSURANCE:
THE ESSENTIAL FIVE- PART 1
The
festival of lights is here, and festivities are in the air. Deepawali is not
only the time to strengthen our bonds with our family and friends but also to
let go of any festering resentment and anger towards anyone. This is also the
time to keep yourself and your family safe while celebrating with crackers and
light.
My
book, “Musings of a Financially Illiterate Father” is doing great with positive
reviews pouring in from India and abroad. A review by Gregory Sequeira is here.
This
is also the time to reflect upon another kind of safety for your near and dear
ones- Insurance. For effective and efficient financial management, a regular
income stream is a prerequisite. If the sole source of income is the
breadwinner of the family, his or her well-being becomes absolutely vital for
the financial security and indeed survivability of the family. All the tools
and concepts of financial management will come to nought if the income stream
gets interrupted due to the reasons of loss of life or health of the
breadwinner. The breadwinner thus needs protection against his or her inability
to earn for whatever reasons. Similarly, the financial assets that we
accumulate over the years also need protection against a loss. Risk management
through insurance thus becomes a sine qua non for the financial well-being of
any individual or family.
I must
hasten to add, however, that not all kinds of insurance are necessary or
desirable. There are in fact a few, five to be precise, insurances which are
totally unavoidable. Let’s take a look one by one.
1. Life Insurance
The
first and the most important form of insurance is life insurance which protects
against loss of the life of the breadwinner. Anshreya, who has just started
earning, is also contemplating life insurance. How should she go about it?
First
question to be asked is – does she require life insurance at this stage? She
is not married and is not planning to marry for the next 4-5 years. This decision
will depend upon the fact whether she has dependents like retired parents or a
sibling who is studying and banks on her income for sustenance and survival. If
yes, she must take life insurance the moment she starts earning. I would
recommend though, that she should go for life insurance irrespective of the
fact whether she has dependents at this stage or not. If she goes to purchase
life insurance after her marriage (maybe 5 years later,) the same amount of
coverage will cost her more. Also, she is absolutely fit right now. God forbid,
if she gets afflicted by an ailment in the times to come, the life coverage is
going to cost her more.
To
take an illustrative example, if Anshreya takes a term life insurance cover of
₹1 crore at the age of 25 years, it may cost her only ₹7,000 to ₹10,000 per
year. If she delays it by five years, the same cover may cost her ₹9,500 to ₹
14,000 per year, assuming that she retains her medical fitness or else it will
cost her even more. Essentially, every 5 years of delay pushes up the premium
by 40-50 percent.
The
next question to be asked is how much of life cover does one need? Let’s try
and calculate for Anshreya.
• A good rule of thumb figure is ten times
the annual income. So, if Anshreya is earning ₹6 lakhs per annum, she must get term insurance of ₹ 60 lakhs. However, keep in mind that this is the amount
required when she is still unmarried, which is bound to go up as she moves
along in life with marriage and childbirth. The logic of ten times the annual
income? “The ten-time rule of thumb is not an arbitrary number. Remember, life
insurance is designed to replace your income. “If your surviving spouse invests
that ₹ 60 lakh (assuming annual salary of ₹ 60 lakh) in good mutual funds at an
average 10–12 percent return, he or she could peel off ₹ 60,000 a year from
that investment to replace your income without ever cutting into the principal[1].”
• This coverage amount considers the
surviving spouse. We also need to factor in other liabilities of Anshreya.
Let’s say she has taken a home loan of ₹20 lakhs and a car loan of ₹8 lakhs. In
case of a mishap, paying off these two liabilities itself will polish off half
of the coverage amount. This amount of ₹28 lakhs (₹20 lakhs + 8 lakhs) must,
therefore, be added in the required coverage amount.
• If Anshreya has children, their expenses
(education, marriage etc.) as they grow up and settle down in life also need to
be catered for. As far as child education is concerned, the method of
calculation will be covered in subsequent musings. For marriage, a ballpark
figure could be assumed, which will differ from person to person. For our
example, let’s assume Anshreya has one child; she should cater for ₹70 lakhs
for her education and marriage (₹50 lakhs for education and ₹20 lakhs for
marriage.)
• The total amount thus works out to ₹1.58
crores (₹60 lakhs + ₹28 lakhs + ₹70 lakhs.) These covers are obviously not
required in one go and should be added as the major milestones are crossed in
life by Anshreya like when she gets married, is blessed with a child, takes on
a major financial obligation like a home loan or car loan and so on.
• The next issue to be tackled is what
kind of life insurance should one opt for? There is a plethora of options out
there: endowment plans, whole life policy plans, unit-linked insurance plans
and money-back plans. All are avoidable. The only plan one should go for is a
pure term insurance plan. A term insurance plan is for a pre-designated term,
say 40 years. So, if you buy a ₹1 crore term insurance plan for 40 years and
pass away during this period, the insurance company will pay your next of kin,
₹1 crore. If you survive 40 years, you get nothing. Always go for a term
insurance plan even if you are taking insurance to cover your house mortgage,
car loan, personal loan and so on. It works out the cheapest and most
effective.
There
are also some new and interesting features, called Add ons, being offered by
the insurance companies nowadays- do consider these as well.
·
Critical Illness rider- lump
sum paid in case of any critical illness.
· Personal disability rider-
lump sum or regular payment in case of partial or permanent disability.
· Rider to automatically
increase your insurance cover amount (sum insured) depending on your life
changes like marriage and childbirth.
· Waiver of Premium- in case of permanent
disability of the person insured. The insurance cover continues.
I will
stop here for you to mull over your status of life insurance and take
corrective actions if required. We will discuss the remaining four essential
insurances next week. See you next week with
more information on my new book. Till that time enjoy my book, the link is
below.
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