The third pillar of financial planning: insurance

Sakal Times
Wednesday, 10 January 2018

Here are some basics of parking your money in insurance and common terms one should know.

If there’s one mistake most rookie investors make, it is that of mistaking insurance for investment only to gain tax benefits. Though insurance forms one of the three pillars financial planning stands on — the others being savings and investment — these pillars are independent of each other. By clubbing insurance as an investment product, you will neither get adequate insurance coverage, nor will you invest properly to maximise returns. We’ll discuss this in detail later, but for now, let’s get familiar with the basics of insurance and common terms one should know while buying one.

WHY BUY INSURANCE?
Insurance helps us prepare for unforeseen circumstances such as accident, disability, and in the worst case, death of a family member. Though you can’t attach monetary value to human life, some financial help can ease day-to-day trials and tribulations of a deceased or disabled person’s family. This is more true if the person is the bread-winner of the family.

COMMON TERMS
A policyholder is an individual/organisation under whose name the insurance policy is held or registered. A nominee is the person, nominated by the policyholder, who will receive the capital insured from the life insurance company in the eventuality of the policyholder’s demise. It’s worth noting that a policyholder can nominate more than one nominee and the sum will be divided between all nominees in the proportion pre-decided by the policyholder. For each nominee, the cover, or coverage, is the total amount a nominee will get when the policyholder dies.

Premium is the amount the policyholder will pay to the life insurance company for the policy. The premium amount will vary depending on the age of policyholder, cover amount and the type of insurance policy. Maturity benefit is the amount paid to the policyholder after her/his survival of the entire policy term. Rider is an add-on protection feature provided by the insurance company, and accidental death, permanent disability, critical illness, premium waiver are few common examples of riders. Exclusions are certain scenarios in which the amount will not be given to nominee and suicide is one example of exclusions.

TYPES OF POLICIES
Term insurance offers higher insurance coverage to the policyholder at very low premium for a specific time frame. In whole-life policy, the policyholder pays regular premium until his death, upon which the amount is paid out to the family.
Unit-linked insurance plans (ULIP) is a combination of investment and insurance, which provides insurance cover for the policyholder coupled with investment options to invest in equity or debt.

Endowment plans pay out the sum assured in both scenarios of death and survival. Money-back plan provides periodic returns as a percentage of sum assured to the policyholder at regular intervals instead of lumpsum amount at end of the term in an endowment plan.

CALCULATING LIFE INSURANCE COVER
This is the most important step in buying life insurance policy. Most of us end up buying more coverage than required thinking we are getting more cover at a lower premium along with tax benefit, or end up taking a low cover while opting for money-back insurance plans where premiums are very high.
While calculating life insurance cover, the policyholder should keep the following things in mind —current income and monthly/annual recurring expenses of the family. Then, you must add the expected future inflation rates to your expenses and calculate how much monthly/annual expense amount will be required in future.

It is important to keep the number of family members in mind while calculating life insurance cover. It is of utmost importance that you increase your insurance cover when the family is expanding.

If the policyholder has a home loan or personal loan of higher amount, then the policyholder should also cover for the same. In case of sudden death, the outstanding loan liability will be transferred to family and eventually major insurance cover amount will be gone to bank to repay loan leaving very little capital with the nominee/s. You can also use online calculators to calculate life insurance cover based on your income, expenses and outstanding loan amount.

In the second part of this topic, we will understand all types of insurance policies in detail, why insurance is not an investment, and things to bear in mind while buying an insurance policy.

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