Life Insurance – a silent guardian, a watchful protector – Reading between the lines

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A life insurance policy is the cheapest and safest mode of making a certain provision for one’s family. Everyone in the family can sleep peacefully without having to worry about the future.

A person who dies without adequate life insurance should have to come back and see the mess he created.

Will Rogers

So what is a Life Insurance policy?

Life Insurance is a contract between the policyholder and the insurance company. The policyholder pays a premium to the insurer for a certain time period or for life, and in return the insurer promises to pay the assured sum to the nominee upon the death of the policyholder. A life insurance cover is intended to ensure that, in the event of your death, folks who depend on your income are not left financially unsupported.


Who does not need a Life Insurance policy?

  • Students
  • No income yet
  • Homemaker
  • No dependents yet (parents or children) or have partners who are self sufficient and can take care of their needs
  • People nearing their retirement and have sufficient savings and investments for retirement
  • Retirees
  • Rich people with net assets in Crores of Rupees

What are the different kinds of Life Insurance?

  • Term Plan – Purest form of Life Insurance. You pay a premium for the specified number of years. Your nominee gets the benefit upon your death anytime during the term specified in the contract. Your nominee doesn’t have to pay the premiums after your death. On maturity of the plan (or expiry) and if you still alive, you don’t get any benefits.
  • Whole Life – Pay the premium as long as you are alive. It has some additional savings benefit.
  • Endowment Policy – Apart from covering the life of the insured, helps the policyholder save regularly over a specific period of time so that they are able to get a lump sum amount on the policy maturity in case they survive the policy term.
  • Unit Linked Insurance Plans (ULIPs) – The goal is to provide wealth creation along with life cover where the insurance company puts a portion of your investment towards life insurance and rest into a fund that is based on equity or debt or both and matches with your long-term goals.

The concept of Life Insurance is that – During your career, if something happens to you, your family should have a safe future and not struggle because of loss of the primary breadwinner. The insurance cover will replace your salary / income for the family. Ideally, your family will need the insurance cover only for the duration of your career – be it business or profession. Beyond that, your savings and investments should cater to your retirement needs. You shouldn’t rely on insurance for your retirement life. The best product for life insurance – Term Plan! Say you are 30 and you want to retire by 60, you should take a term plan for 30 years – till you retire and not for 40 years because your insurance agent says so. During the next 30 years or till you retire, split your income into 4 parts – Insurance Premium (both Life & Health, max 5%), Savings / Investments ( at least 35%), Daily Expenses (needs) and Luxury (wants). The last part should happen after the first 3 is taken care of. The insurance will provide cover to your family for the next 30 years. The savings / investments will provide for the retirement life. This is also the reason why I don’t recommend Whole Life policies where you pay a higher premium. Instead you could save that money and make better returns.

I am ignoring Endowment and ULIPs because these plans make more money for the insurance company than the policyholder. I have experienced them first hand and I have done enough research. The problem with these plans is that they try to combine insurance and investment into a single product which never achieves the purpose. Endowment combines insurance and savings. ULIPs combine insurance, investments and tax saving. The sum assured is very low. The returns are very poor, sometimes less than the savings account interest rate provided by the banks in case of Endowment and less than the market returns (mutual funds) in case of ULIPs. Instead, you can take a term plan for a significantly lower premiums and invest the excess in avenues which give you better control and returns. Never mix insurance, tax saving and investment. Keep it simple. My parents bought them without understanding the product and had paid premiums for few years. One had returns of 2.75% (SBI Savings Account was giving 3.5%) with a cover amount 10% of a Term Plan. I had to stop it and convert the policy to a paid up plan, i.e. stop the premiums immediately and just get the cover for an amount proportional to the premiums paid till date. If you have any endowment or ULIP policies running, I suggest you talk to the agents and check if you can convert it to a paid up plan. If yes, stop paying the premium. Take a Term Plan.


How much insurance cover do you need?

  • Amount equal to your family’s regular Annual Expenses till the end of Term Plan
  • Goals – Children’s Education and Marriage
  • Net Assets = Assets (Savings & Investments) – Liabilities (Liabilities are Home & vehicle EMIs or any personal loan)

Ideally, the cover amount should be the sum of these 3 components adjusted for inflation. Start with the following example and get into the nitty-gritties and other details.

Sample calculation for Insurance cover

Sit with your family and discuss. Involves serious decisions like number of children. If you feel that your children will fund their higher education by themselves through education loan or have a simple wedding, then make the necessary reductions. In any case, your family will need at least 2.5 Cr cover for basic expenses. The problem with this is that, insurers will give a maximum cover of 20 – 22x your annual income. Therefore, it’s not enough to buy a term insurance plan once in your life and pay premiums faithfully. You need to re-visit and add to your life insurance after significant life events, to ensure that you have enough cover to keep your family protected. Mind you, I have used a conservative inflation rate of 4%. Education and Health expenses are growing exponentially these days.

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When should you take an insurance policy?

Fun is like Life Insurance; the older you get, the more it costs.

Kin Hubbard

If you do not fall under any of the categories mentioned earlier, the best day to buy a term plan was before your last birthday. The 2nd best day to buy one is before your next birthday. Most insurers give 20 – 22x of your current annual income as cover. I don’t think that will be sufficient to meet your family expenses in future. So take a second term plan after maybe 10 or 15 years when you will have a better idea of your expenses. Go to each insurer’s website and keep track of premiums. Calculate how much you will end up paying extra if you take it a year or two later. Premiums are not likely to come down in future. In fact, they have gone up post Covid.


Until what age should you get cover?

Ideally, your retirement age!

Life Insurance is a product to secure a backup regular income for your family during your working years. IT IS NOT A RETIREMENT PLAN. For retirement, you have to save and invest regularly to build a huge corpus. Like I said before, your pension, PPF, FD, Gold and equity investments should provide for your family beyond your retirement.

The first problem with taking a policy for beyond the age of retirement is that premiums rise exponentially due to higher mortality risks. Instead, you could invest that excess amount in FD or an instrument of your choice which will grow into a corpus for your family.

1 Cr cover for a 35 yr old till the age of 60
1 Cr cover for a 35 yr old till the age of 80

Almost 10500 Rs. difference every year for 25 years which when invested at 7% will grow into a corpus of 20 Lakhs, whereas the cover itself is only 1 Crore. Yes, the differential is only for 25 years. After that, you wont’ add just the differential, you will have the entire premium of 80 year plan to invest. Which means, if you opt for a 80 year plan, you will have to pay premiums even after retirement when you won’t have any income. This is the second problem with a longer term plan. Why extend expenses beyond retirement? Expenses are gifts that keep on giving. If the excess premiums of the longer term plan are invested in gold or equity, you might end up getting the cover amount as your investment returns. Power of compounding. If you are an investor, then you can even take a term plan for the duration of your liability if any (like Home Loan) and invest the excess to get better returns.

So I wouldn’t recommend anything more than your retirement age. If you still feel it’s just few lakhs extra, then go ahead with a cover till 75. But make sure you find a source of income for paying the premium from your retirement age till you are 75. Even USA with the excellent health infrastructure has average life expectancy of 78.5 only.


What should be the type of premium payment?

Pay every month or year (small discounts if you pay annually). Do not opt for limited payment term. The insurer / agent will lie to you that you save money in limited payment term. Even in the ICICI screenshot below, you can see the “save up to 65%” trap. Why is it a trap?

They do not tell you about the time value of money.

Payment Options

In the above scenario, you pay Rs.16424 every year for 30 years which is equal to 30 * 16424 = 4,92,720 or Rs.36909 for 10 years which is 369090. They sell these plans by using this number that you are paying more in the regular payment term.

Time value of money = money in your hand today is worth more than money in your hand tomorrow. Due to inflation, money loses it’s value (purchasing power) every day. I use the example of coffee to explain this concept.

In 1970, you could have bought a cup of coffee for $0.25. For the same amount, you could have bought only a quarter cup of coffee in 2010 and approximately 1/7th of a cup today. Applying this concept to the insurance premiums you pay, the regular payment term is cheaper than the limited payment term. To know the present value of future cash outflows, I discounted the cash flows by 7% which is the prevailing FD rates. In simple terms, if you had to make one lump sum payment today for both these policies, you will have to pay 2.6 Lakhs for the limited term whereas you will only have to pay ~2 Lakhs for the regular term resulting in savings of 22%. I will post the link to the calculator and few links to read about this concept at the end of the post.

Also, 16424 Rs. every year now might be 1% of your annual income today but 20 years down the line it can be 0.1% of your annual income. It will be easier for you to pay in future than today.

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Another important point – in the regular term, the premium payment is spread across the policy term. In limited payment, say you are 35 and have taken a policy for 30 years, you end up paying the entire premium amount in 10 years. So if you die when you are 50, you would have already paid all the premiums. Whereas, in regular payment you would have paid only half the premiums.

The same concept also applies to “Return of Premium (ROP)” policy. Since policy holders do not get any benefits on maturity of the policy (survival during the term of the policy), many do not opt for a Term Plan. Insurers wanted to make use of this and milk money. They started selling ROP policies by charging 75 to 100% higher premiums while guaranteeing the return of those premiums.

Consider the case of a Rs 1 crore term plan for a 45-year old man which covers him until age 75. In his case, a normal term cover would cost about Rs 35,000 a year in premiums for the next 30 years, while a ROP plan would cost about Rs 62,000 in premiums. Let’s assume he opts for the plain vanilla option and invests the Rs 27,000 thus saved in FD earning modest returns of 6%. Thirty years later he would be able to withdraw Rs 22.7 lakh from this, far more than the Rs 18.6 lakh he would have got back as return of premium on the ROP plan.

Remember – Insurance is not an investment. 5 Lakhs you pay over the term will give your family 1 Crore if you die during the term. What more returns do you want? If you do not die, you and your family would have slept peacefully during the term.


What additional benefits (also known as riders) should I opt for?

  • Accidental Death
  • Disability
  • Critical Illness
  • Premium waiver on Accidental disability or Terminal illness

In the first 2 options, you get a certain one-time additional amount on occurrence. In 3rd option, you get a one-time lump-sum amount as a proportion of your basic sum assured (cover), on your being diagnosed with a critical illness. 4th option allows the policyholder to stop premium payments upon disability or being diagnosed with a terminal illness.

The problem with these additional benefits is that the premium shoots up if you opt for any of these. There is no standard or rule to be followed by insurance companies to set these additional premiums. Hence, it varies a lot between various companies.

Also, the insurance companies have lots of terms and conditions for these. You will get to know only when you read the fine print. Know what you are paying for. I would recommend Critical Illness benefits if your family has a history of any of the listed illnesses. Like, ICICI provides cover for 34 and Tata for 59 illnesses. Within each illness category, the cover is only applicable for certain types. Like certain types of cancer are excluded. The use of words matter a lot in the policy. There is a huge difference between “Cancer” and “Cancer of specified severity”. Pre-existing conditions and diseases are excluded. If you don’t have family history, I would recommend a full fledged health insurance with a higher cover instead of this additional benefit. Accidental or disability benefits might apply only when death occurs within the specified number of days from the date of accident. So read the policy document carefully.


How should my family receive the benefits upon my death?

ICICI has 4 options to choose from and so do other insurers. I leave it up to you to decide. It depends on the financial literacy of your family. So educate them about the policy details and personal finance framework to help them make use of the funds they would receive.

Types of Benefit

Which insurance company should I choose?

There are 24 insurance companies in India. Choosing one is a headache. Worry not, as PrimeInvestor has done the basic filtering out process for us.

Criteria:

Assets Under Management (size of the investment book of the insurance company) > 10,000 Crores

Experience – Track record of atleast 10 years.

Solvency Ratio – The biggest risk to any insurer’s survival is that it will receive a flood of claims that it is unable to service with its available investments. The Solvency Margin is a metric designed to ensure that this doesn’t happen. It is the amount by which an insurer’s assets exceed its policy liabilities. Assets for an insurer usually consist of its investment book and fixed assets. Policy liabilities are the present value of future claims plus its own future expenses, minus the premiums it is likely to collect. Solvency Ratio is the insurer’s actual solvency margin measured against the required margin. Insurance Regulatory and Development Authority (IRDA) prescribes a minimum Solvency Ratio of 1.5 times for insurers in India.

Latest Market Share – The percentage of the premiums collected by an insurer during the latest quarter as against the total premiums collected in the entire sector. Market share confers disproportionate advantages in every financial business including the insurance space.

Persistency Ratio – A ratio that measures the proportion of customers who chose to renew their policies at the end of the year. This is a good proxy to measure an insurer’s service standards and selling practices as it shows how much confidence customers have with the insurer. It also indicates the stability and continuity of cash flows from existing customers of the insurer to pay the claims that will arise in future.

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Claims Settlement Ratio – A measure of the percentage of claims settled by an insurer in a given financial year as opposed to the number of claims received. This is a key metric to gauge the ability and efficiency of an insurer to settle claims and is used as a primary decision-making guide to choose an insurer.

I considered AUM of 30000 Cr and 5 Yr Persistency ratio of at least 40%. I got 9 companies. I added a basic ranking for each of these parameters and then took an average to arrive at the final ranking. 1 being the best and 9 the worst. Premiums are based on a 35 year old Male, term plan for 40 years with a cover of 1 Crore. Age will affect the premium value but will not affect the ranking as the amount will be proportional.

Insurance Company Ranking (Data source – PrimeInvestor, IRDA Annual Report, PolicyBazaar)

There is no significant difference between the top 6. The top 3 ranked are part of the groups which own the largest private banks in India. LIC has the Sovereign (government) guarantee and SBI is a government bank but both have high premiums. Although I personally have ICICI Prudential policy, I would recommend Kotak’s e-term. It has the cheapest premium with the highest 5 year persistency ratio. It only lags behind in AUM and market share which I think will change in the coming years. The claim settlement ratios are taken from IRDA’s annual report for 2018 – 19. I looked up Kotak’s latest settlement ratio (FY20) and they have declared it to be 99%! I am also biased because I am a huge fan of Mr. Uday Kotak and his bank – Kotak Mahindra Bank.

Please make your decision based on your needs – term, payment structure, payout structure, government guarantee, insurance company management quality, total premiums including any accident or critical illness rider, free waiver of premium for disability or terminal illness. At the end of the day, you are responsible for your family. Not me.

Final thoughts

It’s better to be 5 years too early, than be 5 minutes late.

Given that life insurance premiums increase with your age, please take one before your next birthday if you don’t have one already.

Answer all the questions in the application form and don’t let the agent fill it up. Read the documents thoroughly. After the Policy starts, if for some reason, you find that the details that you identified earlier is not covered in the policy or the response provided earlier by the agent when taking the policy was not correct, where by you took an unsuitable product or you were mis-sold, you must use this free look-up window and return your policy. It is usually 15 – 30 days after the policy term starts.

Give the truth. If you smoke or drink, mention it. Your premiums will increase. But it is better to pay now than regret later when the insurer rejects your claim stating smoking or drinking as a reason.

Insist on a medical test. One less reason for insurer to reject your claim.

If you already have a policy, check if the cover is adequate enough. If not, take additional policy. A policy without adequate cover does not serve the purpose.

Do not mix Insurance and Investment. Have separate plans for Life Insurance, Health Insurance and Investments. Death occurs once but accidents or different illness can occur more than once during a lifetime. If you opt for riders in a term plan, you will get paid only once on occurrence of accident or illness. Hence, the need for a separate Health Insurance. Will write a blog soon.

Of course, Premiums paid towards a term insurance plan qualify for a tax benefit under section 80C of the Income- tax Act. You can claim a deduction up to Rs 1.5 Lakh a financial year for the premium paid (premium should not exceed 10% of the sum assured) for yourself, your spouse, and your children. But do not buy a term plan for the sake of tax saving. Also, since the Government has come up with a new tax regime, we do not know for how long they will continue to provide tax benefits.

Life Insurance gives you the opportunity to be the Dark Knight. It’s not for you. It’s for your family.

I will leave you with this:

An ounce of prevention is worth a pound of cure.

Founding Father of America & Insurance – Benjamin Franklin


Disclaimer – I work for a consulting firm in their valuation team. I have an MBA in Finance. I am also an investor. Hence, you might see a certain bias in my post. Please do your own research before you buy a term plan. Read the terms and conditions of the policy. I am not registered with SEBI or IRDA. I am not responsible for your losses.

Excel sheet I used for the ranking and insurance cover calculation:

Time value of money – https://corporatefinanceinstitute.com/resources/knowledge/valuation/time-value-of-money/

Data Source:

A huge shoutout to the all women team at PrimeInvestor research – https://primeinvestor.in/term-insurance-comparison/

They are doing a wonderul job in providing unbiased, research-backed recommendations that help you invest right and stay right.

IRDA Annual Report – https://www.irdai.gov.in/ADMINCMS/cms/frmGeneral_NoYearList.aspx?DF=AR&mid=11.1

PolicyBazaar – https://termlife.policybazaar.com/quotes/MjMzMDk1MTU1?refId=MjMzMDg3MTI3&isProgressiveJourney=true&isMobileDefault=true&iscom=1&payType=1&page=1&isDefaultCity=false

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Sanjay Elangovan
Figuring out what works in the markets.
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