Insurance: An expense or investment

September 26, 2015, Chennai

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The most interesting discussion in all my workshops are around insurance.

Audience from all walks of life finds it difficult to comprehend that their endowment and money back policies are the biggest hurdle on their path to wealth creation.
Insurance is a tool to manage financial risks and is an important part of individual’s personal finance management system. It becomes a wealth drainer when it is sold as an investment and goals’ planning tool. Insurance distributors sell these policies as structured products, investment products, goals planning tools along with the insurance towards any untoward incidence. In reality insurance is meant to protect against the financial implications of a mishap.
 
Term Insurance is a pure insurance tool, that provides life coverage for a premium, for a limited period of time (the Term). After this term expires, coverage at the previous rate of premiums is no longer guaranteed and the client must either forgo coverage or potentially obtain further coverage with different payments or conditions. 
If the life insured dies during the term, the death benefit will be paid to the beneficiary. As this is a  a pure death benefit, its primary use is to provide coverage of financial responsibilities for the insured or his or her beneficiaries. 
This insurance is the least expensive way to purchase a substantial death benefit on a coverage amount over a specific period of time. It provides a high cover at lower costs. The premium paid is just a portion of the amount you give to purchase a money-back policy or unit-linked insurance policy with same coverage, just because it doesn’t have an investment component. It is not advisable to combine insurance products with investment component due to following reasons:
 
High cost and lack  of transparency: 
Combination products (money back, endowment and ULIP plans) have various charges, that reduces the investible amount from the premium, thus resulting in lesser wealth. Because a portion of the premium is directed towards fixed income instruments, the insurance cover is a fraction term insurance policy of same cost.
Funds locked in for long term in low income producing assets:
Insurance policies are typically long term products and the contributions are locked in for a long time, hurting liquidity. Long term investment in fixed income securities hurts the wealth creation process. Money blocked in fixed income securities for  a long term gets eroded with inflation.
An endowment or money back plan becomes a double whammy for an investor who neither makes enough money nor gets sufficient life cover. 
When Jacob (name changed) joined me as a client he was spending more than four lakhs per annum in insurance and his life cover was a meagre sum of Rs.40 lakhs, though given his liabilities and expenses he needed an insurance cover of 1.75 crores. After analyzing his insurance and restructuring the risk management plan not only could he afford the required coverage, but also freed money for future wealth creation.
There are factors to be considered before buying term insurance: 
Life to be insured
Amount to be insured for
Term of the insurance.
As a thumb rule, only the life whose absence can have financial impact should be insured. In plain English: If a person is not earning, no insurance should be bought on his life. 
The amount of life insurance should be enough to provide for the dependents in the absence of the bread winner. This will include the basic annual expenses that the family will incur, major life expenses like education, marriage etc. and the liabilities like  housing loan, car loan or any other liability. The amount should be enough to create a corpus, which when invested in risk free securities should be able to take care of the expenses. If the life cover is inadequate, it will defeat the whole purpose of insurance if the life cover is inadequate. Be sure to factor the inflation while calculating future expenses. As your wealth increases, the sum assured can come down.
Term of the insurance is as important as the amount. Ideally the insurance should last up to retirement age. There is no need for an insurance after retirement as there will be no financial impact of loss of that life. At the same time it is advisable to buy term insurance for a longer term because the premiums will be much lower. Life insurance at a later age may cost too much and even denied in case of some major illness. 
For queries and doubts you can reach the author at enquire@finscholarz.in

The most interesting discussion in all my workshops are around insurance. Audience from all walks of life finds it difficult to comprehend that their endowment and money back policies are the biggest hurdle on their path to wealth creation.

 

Insurance is a tool to manage financial risks and is an important part of individual’s personal finance management system. It becomes a wealth drainer when it is sold as an investment and goals’ planning tool. Insurance distributors sell these policies as structured products, investment products, goals planning tools along with the insurance towards any untoward incidence. In reality insurance is meant to protect against the financial implications of a mishap.

 

Term Insurance is a pure insurance tool, that provides life coverage for a premium, for a limited period of time (the Term). After this term expires, coverage at the previous rate of premiums is no longer guaranteed and the client must either forgo coverage or potentially obtain further coverage with different payments or conditions. 

 

If the life insured dies during the term, the death benefit will be paid to the beneficiary. As this is a  a pure death benefit, its primary use is to provide coverage of financial responsibilities for the insured or his or her beneficiaries. 

 

This insurance is the least expensive way to purchase a substantial death benefit on a coverage amount over a specific period of time. It provides a high cover at lower costs. The premium paid is just a portion of the amount you give to purchase a money-back policy or unit-linked insurance policy with same coverage, just because it doesn’t have an investment component. It is not advisable to combine insurance products with investment component due to following reasons:

 

High cost and lack  of transparency: 

Combination products (money back, endowment and ULIP plans) have various charges, that reduces the investible amount from the premium, thus resulting in lesser wealth. Because a portion of the premium is directed towards fixed income instruments, the insurance cover is a fraction term insurance policy of same cost.

Funds locked in for long term in low income producing assets:

Insurance policies are typically long term products and the contributions are locked in for a long time, hurting liquidity. Long term investment in fixed income securities hurts the wealth creation process. Money blocked in fixed income securities for  a long term gets eroded with inflation.

 

An endowment or money back plan becomes a double whammy for an investor who neither makes enough money nor gets sufficient life cover. 

 

When Jacob (name changed) joined me as a client he was spending more than four lakhs per annum in insurance and his life cover was a meagre sum of Rs.40 lakhs, though given his liabilities and expenses he needed an insurance cover of 1.75 crores. After analyzing his insurance and restructuring the risk management plan not only could he afford the required coverage, but also freed money for future wealth creation.

 

There are factors to be considered before buying term insurance: 

Life to be insured

Amount to be insured for

Term of the insurance.

 

As a thumb rule, only the life whose absence can have financial impact should be insured. In plain English: If a person is not earning, no insurance should be bought on his life. 

 

The amount of life insurance should be enough to provide for the dependents in the absence of the bread winner. This will include the basic annual expenses that the family will incur, major life expenses like education, marriage etc. and the liabilities like  housing loan, car loan or any other liability. The amount should be enough to create a corpus, which when invested in risk free securities should be able to take care of the expenses. If the life cover is inadequate, it will defeat the whole purpose of insurance if the life cover is inadequate. Be sure to factor the inflation while calculating future expenses. As your wealth increases, the sum assured can come down.

 

Term of the insurance is as important as the amount. Ideally the insurance should last up to retirement age. There is no need for an insurance after retirement as there will be no financial impact of loss of that life. At the same time it is advisable to buy term insurance for a longer term because the premiums will be much lower. Life insurance at a later age may cost too much and even denied in case of some major illness. 

 

For queries and doubts you can reach the author at enquire@finscholarz.in