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What you MUST know about insurance

March 22, 2006 12:20 IST

'All things are non-permanent and interconnected,' said Gautam Buddha. In the case of financial needs too, this is true.

Your needs are not the same when you are 25 as when you are 50. The common thread is that you do have financial needs at any age. If you plan well at 25, you will not need to struggle too much at 50. Choose your advisor well and the struggle will be minimal.

Young people today earn more at 22 than what I earned at 48, not too long ago. In my previous article, I mentioned how, even at a lower income level, you can save and create wealth for yourself by adopting a good saving habit. The headline did mention how to become a crorepati!

Nonetheless, at any level, by systematic savings and systematic investing, you can attain an asset base that would seem unbelievable to you.

One reader asked how on a take home salary of Rs 13,000 and with 9 years to go for retirement, he can achieve an asset level of Rs 1 crore (Rs 10 million) or more. My answer is that this is not possible unless he is able to save 10% of his gross and invest regularly for obtaining a return of 55,000% p.a.

However, if he is in a position to save 20% of his income, and invest in avenues fetching him a return of 15%, he would end up with an amount of Rs 9.68 lakh, not a small sum. It could be a very handy sum.

Another reader asked me actual tips on investment to get the best returns. A third asked how he can save on an income of 15,000 p.m. and what investments can he make. For all these and more, let me say that I am not a magician nor a mutual fund manager. I can only advise people and my clients on the best way they can build their assets through proper planning.

My article was written with the idea of letting people know that by putting aside a certain portion of their earnings every month, they can build a tidy nest egg that would be useful for them in their twilight years.

For more information on which mutual funds are doing well consistently over a longer time horizon, check out Web sites and newspapers and take your pick from the funds based on their performance over periods ranging from 1 month to five years!

As also mentioned, I am not into hot tips either. Please go through all my caveats before you invest and if safety is your preference, put a sum of money in 5-year fixed deposit every month and claim tax exemption every year. Depending on your marginal tax rate, the return would range from 8% to 12% p.a, if the interest you earn is 6% on the fixed deposit itself.

Having got all this out of the way, let me get to the main topic of this article, viz. how to get the best out of insurance. The consumer is KING and should act from a position of strength. However, there are people looking for the quickest route to your bank account and like good batsmen, to use a cricketing analogy, you have to watch out for the googlies, the flippers, the top-spinners, the slower ones, the outswingers and so on.

This should not be the case, but let's face it, it would be a dull world without a challenge. Your challenge is to ensure that you get the best deal and show the door to those who cannot give you what you seek.

What do I mean by 'best deal'? Is it the best price or the best policy that meets your needs. I would say, choose the person who understands your needs and gives you the product(s) that meet them.

Insurance is all about service and your agent or advisor is the only link to the company. He or she who is aware of what you want or need can help you best in the long term as most policies go for ten years or more.

Saving a few bucks on charges may make it costlier for you in the long run. To start with, please be aware of your objective in buying insurance. Firstly, how much protection do you need? If you had gone through my previous article, I had mentioned 200x, where 'x' is your monthly household expense, including rent.

Add to this the amount you need to set aside for meeting expenses related to education and marriage of children. Also the remaining part of the home loan. Unpleasant as the thought is, face up squarely to the fact that we are mortal and insurance is for meeting the unexpected.

So should something happen to the breadwinner, the family should be protected at least from financial vicissitude. Get rid of the 'this cannot happen to me' thought. It is precisely because it can happen to you that you buy insurance and if you love your family, you will ensure above all that they are protected.

Never lose sight of being insured for the sum of the above (i.e. 200x) and add another 30 per cent to pay Mr Chidambaram, should he decide to go EET (exempt-exempt-tax)! Ridiculous, of course that we have to think that tax will be levied on social security, but c'est la vie!

In the United States, and, to the best of my knowledge, in other countries, there is no tax on death benefit or maturity proceeds of insurance policies. But our creative mandarins see no limit to taxing the middle class, who cannot get insured in 'black.'

I come back to the time when I was still serving in the State Bank of India. My total insurance was just for a sum assured of Rs 100,000. And what makes my blood run cold is the fact that I never perceived any risk! A life insurance advisor has to ensure that all who are served by him or her are always well insured. The client also has a responsibility to himself and his family to see that the sum assured is commensurate with his or her needs identified by the above process.

If your insurance agent does not even do a rudimentary need identification exercise, throw him or her out. Do this yourself and if the result scares you, call up your insurance agent who can help you to insure yourself adequately on the budget you can set aside for the purpose. As one wise person said, 'No widow ever complained that her husband had too much insurance.'

Here are the various options:

Type of Insurance

Advantages

Downside

When to take

Term

Maximum bang for the buck, lowest cost

Premium once paid is gone forever. This is like car insurance

On a low budget when one has no insurance whatsoever and needs to get protection. Take the longest term available. Combine with whole life and ULIP for best results

Whole Life

Most flexible, especially that of Max NY Life. Allows payment for a period of 11 years or so and keeps you insured for life with growing sum assured as well as increase in cash value. Allows payment of premia from accrued bonuses and current bonus. So if you have accrued bonuses for around 5 years you can skip payment of premium for a year or two depending on amount accrued and yet stay insured

Higher cost than term. Lower returns than ULIP

Take this at an early age and stay insured for life. This can function as a pension plan as well as a legacy instrument. Has provision for increasing sum assured by way of top up. Identify your need and allow this policy to meet 50% of the sum assured. With a top up your sum assured and cash value can grow  fast. Understand all the nuances of the policy and choose the best. Work out all possibilities.

 

ULIP

The most popular policy. Allows flexible investnment with a choice of funds from secure to growth. Choose from low risk and returns to high risk and high returns. Allows loan and withdrawal of units in times of need

As most of your money goes into equity or other investments, sum assured is lower. This is term insurance tacked on to a mutual fund. The capital is entirely held at your risk. Only the sum assured is guaranteed and that does not benefit you during your lifetime!

Use this as you would use a mutual fund. Allow this to be an investment vehicle and invest only such sums that are available after making secure investments. Choose a maturity of 15 years or more to get the best results. Since the risk is yours, be in touch with the market and get ready to move your money from one fund to another.

Endowment Plans

Low risk and low return. Hard to think of any.

There are better ways to insure yourself and invest!

Good for children's needs where a certain sum is required at the end of a certain period. Allied with a payor rider or waiver of premium, this is useful

Pension Plans

None really

Earlier additional tax advantage has been neutralised as it has been clubbed with the rest of the crowd

When you do not have any other avenue for investing.

Single Premium

OK, if you have a lumpsum and wish to put it all into insurance. My question is Why?

Beware of I tax. If the premium exceeds 20% of sum assured, the maturity proceeds will be subject to tax. Some companies have devised a policy where the sum assured is reduced so that tax would not be applicable. Bad Deal in my view, but it takes all kinds to make the world!

Stick to regular payment policies.

Now here is one thing you should understand. Insurance is not an investment. Use it for protection and be ready to pay the price. However, do not try to compare the returns with investments such as mutual funds, etc.

Keep your sum assured above all requirements and meet that objective first. Go for ULIP (Unit-Linked Insurance Policy) last of all. Use Term and Whole Life policies to meet most of your sum assured and the rest through ULIP.

Beware of companies that push only ULIPs. They do not have your interests at heart. Like I said earlier, get yourself insured for the sum you need to be insured inclusive of a ULIP.

IRDA regulations forbid showing illustrations which project a rate of return higher than 10% p.a. Ask your insurance agent a few awkward questions if he is showing you a rosier picture.

Investment is like a one-day cricket game. The more wickets you have in hand the more risks you can take. Insurance is like having Rahul Dravid at one end and Whole Life is like having him for all the 50 overs! You can afford to do a Sehwag or Dhoni with a large part of the rest of your money thereafter!

Happy investing and au revoir!

Do you want to discuss stock tips? Do you know a hot one? Join the Stock Market Discussion Group.

R A Krishna