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Demystifying Life Insurance!

By Author: Prof. Sandeep Sahasrabudhe
Total Articles: 5

Friends, there are 7 most widely accepted safe jewels of investment. They are life insurance, public provident fund (PPF), national savings certificates (NSC), postal monthly income plan (MIP), Bank fixed deposits, Non-Convertible Debentures, debt and liquid mutual funds. Amongst them I rate Life Insurance amongst the best ones, because it is the only savings plan, which comes with a silver edge (inbuilt life cover protection!) It is an investment, which ensures the dignity and quality of life.
Prevention is better than cure:
Siddhanth and Pranav are 2 colleagues working in a software company in Pune. Both are at decent positions drawing annually Rs 21 Lakhs each (Net salary). Siddhanth is married with 2 kids a son aged 8 and a daughter aged 5. Pranav is also married with children of similar age. Both are good savers and have accumulated around Rs 2 crore worth investments each during their 18 years of service. Siddhanth does not believe in Life Insurance and never opted for one. Pranav however aware of its importance got himself insured for Rs 4 crore. One day while going to office Siddhanth and Pranav both met with a car accident, resulting in their death. Both the families lost their bread-earners. Now let us analyze their situations: Siddhanth: Savings in investments worth Rs 2 crore. Life insurance NIL. Earlier Siddhanth used to contribute Rs 18 lakhs towards family costs p.a. Suppose his family liquidates his investments and invests his entire savings worth Rs 2 crores in a nationalized bank fixed deposit. Rs 2 crores at the rate of 7 % p.a. will fetch annual interest of Rs 14 lakhs, which is taxable. Post tax interest will amount to Rs 11.80 lakhs which shall reduce the standard of living of the family by Rs 6.2 lakhs.
Pranav: Savings in investments worth Rs 2 crore. Life insurance, which shall be, paid by the insurance company Rs 4 crore. Earlier Pranav used to contribute Rs 19 lakhs towards family costs. Rs 4 crore invested entirely in a nationalized bank fixed deposit will fetch annual interest at the rate of 7 % p.a. this comes to Rs 24 lakhs p.a. After deducting tax it will amount to Rs 18.80 lakhs. Thus, life insurance helped Pranav, ensure the continuity of the standard of living of his family, even in his absence. (Inflation rate and likelihood of further fall in bank rates ignored)
The concept of Human Life Value
Human life value, expressed with a monetary valuation, should be carefully appraised and capitalized. The human life value is based on the fact that every person, who earns more than is necessary for his self-maintenance, has a monetary value to those who are dependent upon him. It may therefore be defined as the Capitalized Value of that part of the earnings of the individual devoted to support family dependents, business associates and others who benefit from his economic earning capacity. It is an established part that Life Insurance Policy ensures a Life as much as fire Policy insures a House or a Property.
Determination of adequate life cover:
The question now arises as to how much life cover does a person need? Let me explain this concept of adequate life cover with the help of a simple example: Rs 19 Lakhs are needed by your family to maintain their present standard of living, and you contribute that amount towards family expenses per annum. Rs 19 Lakhs / 4.9 % p.a. (post tax nationalized bank FD rate) = Rs 3.87 crores. Suppose you already have investments (in the form of bank FD`s, savings and current account balances, nsc`s, ppf, gratuity accumulation, pension fund accumulation, mutual funds, equity shares etc.) worth Rs 2 crores, then you need life insurance for the balance: Rs 1.87 crores. Add : Existing loans. E.g. if existing housing loan is there of Rs 1 crores life insurance requirement shall be Rs 2.87 crores. Investments such as oneself occupied house and vehicles are not included in the above list, since those are not supposed to be liquidated in order to maintain the present standard of living. Supporting argument: Suppose Pranav had retired at the age of 55. Considering his present age 37, he would have contributed to family costs for at least next 18 years. 18 years multiplied by annual contribution approx. Rs 19 lakhs (considering 5 % increase in salary) comes to Rs 5.34 crores. Hence, truly speaking he must have (Existing Investments + life insurance coverage = Rs 5.34 crores). ( He has Rs 2 crores Investments , 1 crore of housing loan and Rs 4 crores life insurance coverage so that suffices the purpose i.e Rs 4 crores + 1 crore loan – 2 crores assets = Rs 3 crores) In Pranav’s case Rs 4 crores will amount to adequate life insurance coverage.
Term Plans:
If the question involved is that of affordability, or otherwise the person should opt for pure life cover (i.e. term plans). Here the sum assured shall be paid to the family members, only incase of death of the Life Assured. I recommend going in for a term policy, without return of premiums paid at the end of the term: Age of life assured male – 30 Term i.e tenure of the policy – 25 years Retirement age – 55 years Life cover – Rs 1 crore Approximate annual premium: Rs 9,086/- Rs 757 per month. Sparing Rs 757 per month (i.e Rs 25 per day) should not be a big task if the person is convinced of “the need for life insurance “. This premium shall remain the same throughout the term (The actual life cover charges may vary from company to company, the above figure is just an approximate figure)

Should one mix insurance or go in for a pure term plan?
One school of thought is that Insurance is a necessity and as such one should keep Investments and Life Insurance separate. This school of believes only in term insurance. Term plan premium is very low and that’s the advantage of not mixing insurance and investment. On the other hand for those who are not disciplined at saving money, life insurance is the apt product since it leads to compulsory savings the reason being there is no surrender value before 3 years i.e. funds are compulsorily locked in for 3 years in investment oriented life insurance policies such as Unit linked insurance policies, Endowment policies, money back policies. Here you need to pay premium for a longer term leading to long term wealth creation. Unlike fixed deposits, shares, mutual funds where there is immediate liquidity whenever you redeem in investment plus insurance plans immediate redemption is not possible before crossing a certain period and surrender charges are also higher to discourage the life assured from redeeming his insurance policy.
Life insurance is the only thing in the world, which you can’t get when you need it the most! The statement sounds unbelievable but is true. E.g. A persons knows that he is going to die by cancer after a couple of months. If he had not taken insurance earlier his fSiddhanthe of mind will be why didn’t he take large sum insurance earlier, so that his family would have had benefited. No life insurance company will insure him at this point of time! He can get the treatment from the best doctors; he can get admitted in the best of the hospitals, but life insurance NO! It seems that life insurance is the only financial product, which is to be taken when you don’t need it! Friends death is certain, its time is uncertain being a matter of fate, why not insure ourselves today and secure our family’s future? Better late than never, BREAD – EARNERS let’s get ourselves adequately insured as soon as possible

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