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Insurance: A primer


Everyone’s talking about Insurance nowadays. What is it? And why should you, a regular salaried employee buy it? Why should the business owner buy it? Why should ANYONE buy it?

What is Insurance?
If there is a probability of something bad happening, you protect yourself from that “risk” by getting an Insurance company to pay a certain amount money if it happens. Now Insurance companies collect money from thousands of people like you, and work on the probability that only a few will need to be paid (since the probability of the bad thing happening is low).

So they can charge you only Rs. 500 per year as “premium”, but promise you Rs. 100,000 in case the bad thing happens. And they will sell the same thing to 500 other people and most likely only ONE of them will have to be paid out every year, giving them a profit.

What can you insure?
You can insure anything – your car, your house, your jewellery, and of course, your life. Businessmen can insure businesses, loans and so many other things too.

Now, let’s talk about one thing: Life Insurance.

Life Insurance
Life Insurance is a hot buy in India right now – there are so many insurance companies, and there are even tax breaks given by the government if you take Life Insurance. But there’s a problem here – there are so many plans and schemes and schedules and offers, that someone will get VERY confused and end up getting a bad deal. Additionally, insurance companies hire “agents” who can complicate matters more by selling the wrong things more aggressively and thereby confusing the pyjamas out of the average person.

So do you need Life insurance?
Answer the following questions:

  • Do you have any loans, i.e. car, house or personal loan?
  • Does anyone depend on you for income (answer yes if you have a spouse, children, dependent parents or siblings)?

If the answer to any of the above two is yes, you will want to ensure that if you die, your dependents or family should be able to pay off your debts and still have money to live a reasonable lifestyle. You don’t WANT to die, but you want to ensure that everything is ok even if you do.

Assuming you do want insurance, I will continue and explain Life Insurance from a layman’s perspective.

Basics of Life Insurance
Let’s start at the basics: There are only two parts in Life Insurance.

  • Risk Cover: this involves a payout if you die. Your nominee will get a certain amount of money, called the “Sum Assured“. The money you pay per year to maintain this insurance is called “Risk Premium“.
  • Cash value: Any sum that the Insurance company promises to give back to you on maturity (i.e. if you don’t die within the term of the policy) is an cash value return.

So every scheme of every Insurance company has one or both of the above. The premium you pay is split into “Risk cover” and “Cash value savings” parts, and the Risk cover part is part that is spent i.e. you never get it back. The Cash value part is what you will get back based on how it is invested by the Insurance company.

What do Life Insurance Companies offer?

  1. Pure risk or “term” policies: This kind of policy only covers the risk of your dying. You get no money back if you survive. This is also the cheapest kind of policy available, with rates like Rs. 350 per lakh assured for a 30 year old person.
  2. Endowment policies: Policies which cover the risk (like in 1 above) AND return your money with some gain if you survive are called Endowment policies. This involves both “Risk Cover” and “Cash value”.
  3. Money back policies: Similar to Endowments, they just ensure that you get some money throughout the term of the policy. Like you can get money every 5 years, or a Child protection plan to give money when your child is 18, etc.
  4. Unit Linked plans (ULIPs): This is part risk cover, part cash value, but the system is VERY flexible and gives you a more transparent view into how your money is split between the two, plus gives you feedback on your return on a regular basis. The difference between money-back and ULIPs is that in a ULIP you can choose where your investment goes (equity, debt, balanced etc.)

There are other kinds of policies: Whole life, Education policies and so on. These are just endowment policies in disguise.

Which one should I go for?

I only recommend Pure risk policies (also called Term Policies).
There’s a reason for this, that I think the Endowment and other kinds of plans are of absolutely no use.

Pure Risk or Term policies give you what you really need – i.e. High Insurance Cover at very low premiums. Typically, you will pay the following for different kinds of insurance (rates are for LIC, 5 Lakhs Sum Assured, 25 year term – for a 31 year old person)

Term Policy (Anmol Jeevan 1) = Rs. 2,044 per year.
Money Back (New Money Back policy) = Rs. 26,063 per year.
Endowment (Endowment Assurance policy) = Rs. 19,055 per year.
Whole Life Policy (49 years of payment) = Rs. 12,265 per year.
Unit linked plan (Future plan) = Rs. 5,000 minimum but you will expect to pay Rs. 20,000 per year (approx., and varies)
* All info from LIC website

ULIPs are not really applicable here since they are a different kind of investment product: there are different kinds of charges and you can vary the insurance amount regularly. My arguments against ULIPs is given here.

So you can see from the above data that to get a 5 lakh cover, the term policy is MUCH cheaper than the other policies, around 80%-95% cheaper!

For insurance, only consider term policies. If you want to invest, you must compare your insurance returns with the return provided by other investment avenues, such as Mutual Funds, Stock Market and Bank Deposits.

How much should I insure myself for?
Most of you reading this article will be earning more than Rs. 25,000 per month. Let’s say that’s the BARE minimum you want your family to get per month, if you are no longer there to provide the income.

Also let us say your family will put the insurance money received into a bank deposit earning 6% per annum. How much money do you insure yourself for, if you want to ensure this income for another 40 years to your family?

(Considered that inflation is at 5% per year, and interest is compounded yearly, corpus goes down to 0 after 40 years)

Monthly income to family Sum Assured needed
Rs. 25,000.00 Rs. 1,26,30,600.00
Rs. 40,000.00 Rs. 1,91,26,400.00
Rs. 50,000.00 Rs. 2,29,27,200.00

This means you have to get insurance for at least 1.26 Crores. A term policy for that amount would roughly cost you Rs. 48,000 per year.

Read more about this on: How Much Insurance Do You Need?

That’s the end of this primer. I will post later about “riders”, like accident covers, critical illness covers and so on, and further, about how tax is saved using insurance.


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