Archive for the ‘Life insurance’ category

Insurance : What if something goes wrong?

August 28, 2008

Insurance – Life or General is largely about answering some questions like “What if….goes wrong”?

The fundamental objective of insurance is to provide a means to offset the burden of financial loss. Think of insurance as a premium paid for “transfer of risk” premium. An alternative method of dealing with risk. You are paying an insurance premium (small cost) to avoid paying the total cost for a catastrophic loss (such as your house burning down). So it is fairly obvious that you will not insure your mobile phone (you can afford to carry the risk on your own self) but will insure your house (the burden of this risk is too heavy to carry). So the house risk you transfer, by paying a premium. Mobile loss risk you keep on your own self. As simple as that.

A sound insurance program should answer the “what ifs” in your life. For example:

What if you were faced with a major medical expense? (health & illness insurance)

What happens if you were unable to work for a long period of time due to a severe illness or accident? (disability insurance and/ or critical illness insurance)

What if your most important employee dropped dead? (Keyman Insurance)

What if a fire destroyed many of your personal possessions? (home owner’s insurance)

What if an employee stole data from your company (D&O insurance)

What if you were involved in an automobile accident? (auto insurance)

What if you were to die tomorrow? Who will protect your income flow? (life insurance)

So if there are some more “What if” kind of questions….just see whether the risk can be measured. If it can be measured, it can be transferred. Transfer costs money (premium) and the benefits are – the insurer will pay all genuine claims. That is all.

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Life insurance premium: If you cannot pay?

August 24, 2008

When an insurance adviser approaches us, we are normally not in too much of a mood to buy life insurance! However, his persuasion (perhaps our awakening!) make us buy a life insurance policy. This is not a great product – we hardly get any “personal satisfaction” buying this product. We are now motivated enough to make the payment. Sometimes the motivation lags! Or we are not convinced that the life insurance was a necessity…so we become lax.

Unexpected expenses can catch you short at times. There comes a day when the kids need braces, the car needs a new transmission, the wife needs a new car (oops sorry!), the floating rate EMI has increased, the college bills come due or there’s a medical emergency. Sometimes it is the Options trading which has cleaned out your account. Sometimes it is the marginal call from your broker! Out-of-the-ordinary expenses can tip the budget out of balance and leave you searching for ways to keep your income and outgo in sync.

Then your life insurance premium notice arrives. What do you do?

It’s good to know the possible consequences of not making a premium payment on your life insurance policy. The effect depends on the type of policy and coverage you have and the policy terms and conditions. With a term policy, if you stop paying premiums, your coverage lapses.

With endowment policies, many types of contracts allow you to decide to allocate cash value to pay premiums. Depending on the policy and amount of cash value, the result could be a significant reduction in cash value over time, decrease in death benefit and, finally, policy lapse.

Some policies (like Unit linked endowment plans) are designed with flexible premiums, so that policy owners have the option to pay more or less than the recommended premium or to skip premiums from time to time. Even with these policies, however, policy owners should check with their agents before suspending premium payments for extended periods because there must be enough cash value to pay the monthly charges to prevent a policy lapse. Sadly thanks to some aggressive companies and their agents many of us believe that a Unit Linked Endowment policy will be permanently available to you even if you pay premium only for 3 years. This is wrong.

The biggest concern: If you stop paying premiums and let your policy lapse, you would lose valuable protection, possibly leaving your family at financial risk.

Very often, life insurance is the link that can complete your estate if you die prematurely. Death benefit proceeds from a life insurance policy can provide the liquidity to settle final expenses, pay the college fees, pay off debts and — at the very minimum — give surviving family members “breathing room” to adjust. (It takes a long time to adjust to the cash flow suspension)

Other concerns: If you want to obtain new coverage later…

  • You will likely pay more for the same coverage. A key factor in premium rates is your age. The older you are at the time of issue, the higher your rate will be. In short, if you need to buy coverage later, letting your policy lapse now could cost you more money in the long run.
  • You may not be able to get coverage again …at any price. If you experience health problems, you could become uninsurable. Under your existing coverage, changes in your health do not affect your premium. However, if you let your policy lapse and then apply for new coverage later, your health changes can mean the coverage would cost more (if you are rated as a substandard risk) …or you could be denied altogether.
  • There could be tax implications if you actually cancel coverage and take the cash value. That’s because any cash value in your policy has accumulated on a tax-deferred basis. However, if you terminate your policy and take the cash value (not the same as policy loans, which are generally not taxable), a portion of the cash value could be considered ordinary income and be taxed at your current tax rate.

Before you decide to skip premiums or let your policy lapse, ask yourself these questions:

  • Why did I purchase this policy? Was it to help protect my family’s future by replacing my income if I died prematurely? Make sure education funds are available for my children? Retire the mortgage or pay off other debts? If these goals still exist, do you want to jeopardize your life insurance?
  • Have my needs or situation changed? Have I added to my assets by borrowing more money? Has my spouse quit his / her job? Do I need less coverage? More? If so, you should consider adjusting your coverage. Let your agent know. There are a number of viable options you can pursue that will enable you to keep your protection in force without putting your current finances under undue stress.
  • What are my alternatives? You have a number. For example, if you are paying an annual premium, perhaps you would find it easier to budget for a quarterly or monthly premium. Or you might consider a monthly bank deduction. The point is that you do have options. Exercise it.

No other financial product delivers the value and advantages of life insurance in the same exact way. If you are unsure about being able to pay a premium, be aware that there are many alternatives to help you keep your life insurance coverage intact, even during demanding financial times.

Life insurance illustrations – what is wrong

August 13, 2008

It is customary for life insurance salesmen (by whatever name called) to sell life insurance by showing what is called an “illustration”. What is wrong with this “illustration” that is shown to potential customers?

Simple, it does not mean a thing!

IRDA has stipulated that the illustration should be made with 2 projected returns: 6% and 10% p.a. growth.  This leads most prospective buyers of life insurance to believe (erroneously, of course)  that the policy will pay  at least 6% per annum.

The illustration makes assumptions on mortality charges (in some cases it is not guaranteed), fund charges (normally not guaranteed to stay there), stickiness (all customers will continue to be with the company), death values (valid), tax structure, etc. while making the projections.

Though there is nothing wrong with 6% and 10% as assumptions there should also be a lower expectation – why not an illustration with a 0% assumption? Look at what happens if there is NEGATIVE return like say Jan 08 till date. No illustration making NEGATIVE return assumptions is created by the insurance companies. Why? Well this question has not been asked for far too long.

Actually why is a life illustration made? Well it is for you, as a customer, so that you can compare the costs and charges across fund houses.

Doctors need insurance! – Life and general insurance

July 22, 2008

Insurance is mandatory if you have a car!

If your car is worth insuring what about other assets ? What about your practice? Your Dentist’s chair? Your hospital?

Most doctors need at least some insurance to be in place as part of their overall financial plan.

The question is how do you work out what insurances you need, how much and what for?

And which is your most valuable asset?  If you have insured your house, car, your life, should you not have some insurance for your medical needs and your life too?

Think through what would happen to even the best laid financial plan if the doctor, at age 40, suffered a health trauma and was not able to work again. It would not matter what other strategies had been put in place, almost certainly the plan will fail and the doctor, and his or her family, would be in dire financial straits. Barring generous relatives, the financial future would look dim indeed. On the other hand, insurances are a bet you are most likely to lose.  The insured, i.e. the doctor, pays a premium to the insurer (the insurance company) in return for the insurer promising to pay an agreed amount to the insured if a specified event occurs. The process of the insurance company considering the risk and evaluating the risk is called “underwriting”, then the pricing is arrived at by the “actuaries”. The “price” so arrived at is called “premium” – which is a risk transfer fee. The probabilities are that the specified event will not occur. And the premium is calculated to be sufficient to pay out to those insured who do suffer the event, cover the insurer’s administration and selling costs, and then leave a profit for the insurer. Most of the insureds will end up paying more in premiums than they will receive back as benefits.

That is, most of the insureds will lose the bet. And I guess we are all happy losing this bet!

So some balance is needed when considering insurances. The advisors tend to be salesmen who talk up the need for insurance and the sums that should be insured. It is not uncommon for doctors to be over-insured and wasting money.

The key steps when evaluating any insurance proposal are:

(i) Identify the risk, i.e. what is the event you wish to insure against? – It could be theft, illness, disablement, death, malpractice suit, etc.

(ii) Ask what is the probability of that event occurring? – the probability of illness is far greater than death, hence a critical illness insurance which covers say 20 diseases will cost much more than a pure death (or life!) insurance

(iii) Ask what are the economic consequences of the insured event occurring? The cost of losing a mobile is negligible whereas the cost of a dentist’s chair breaking down could be much higher and more critical.

(iv) Ask what is the proposed cost of insuring against that risk and those consequences?  And

(v) To then decide if the cost worth the benefit?

This is the most difficult part. Most people do not know the cost of their family being on the roads if they are not around. Hence they think the premium being asked for is high. Only when you know the cost of “not having” a product can you compare the cost of “having” that product. A competent financial planner will guide a doctor through these key steps as part of your financial planning process. This requires a consideration of a many subjective factors and attitudes.

But it all gets down to risk management: understanding risk and being comfortable with it. Indeed a financial planner has to consider risk management when preparing a financial plan for a doctor.

This is so even if the doctor has asked the planner not to: the plan should on its face contain a statement that risk management advice has been declined. This is because a financial planner can be negligent and in breach of contract if they fail to advise on insurances.

What should the sum insured be? A basic principle in insurance is that the sum insured must be connected to the expected loss from the insured event occurring.

SIP: Misselling is easy

July 17, 2008

The easiest product to mis-sell in the markets for the past 2-3 years has been the SIP! Why do you ask?

The answer is simple. The press has been supporting and extolling the virtues of SIP – we all are guilty of this including yours truly. However SIPs work over long periods of time – the logic is you keep investing when you have cash flows and you remove when you need cash flows.

However in the past SIPs have been sold for lesser periods – say 1 year sip, or 3 year sip etc. There is nothing wrong so far. The problem now arises – the customers were told please put Rs. 25,000 in a sip, at the end of the year you will have at least Rs.  320,000  – now use  this for paying the  ULIP premium!  Vow  what a sale!

Now what has happened is that the investments made for the past 3 years also are perhaps showing negative return and the client is short of cash to pay the ULIP premium. Frankly I do not think these “advisors” have any solution. Any help from any quarter?

Life insurance: reasons not to buy.

July 13, 2008

There are many reasons not to buy life insurance!

Life insurance is one of those common-sense products that come with a number of advantages… and very few drawbacks. That’s why millions of men and women take the opportunity to purchase coverage — to protect their loved ones in the event of their own premature death.

Still, some die-hards offer interesting reasons why they will NOT buy life insurance. Insurance professionals have listened to them all. Here are just some of the things we’ve heard over the years — some serious, some tongue-in-cheek — along with my own reactions:

“I don’t believe in life insurance!” It’s not a matter of belief. Life insurance isn’t a religion or political philosophy. It is a financial tool with a proven track record for protecting loved ones and helping assure their financial security. People who believe in providing for their families believe in life insurance.

My take: “I still am to hear somebody say “I do not believe in getting claim amounts”

“I want them to miss me when I’m gone!” Don’t we all? However, wouldn’t it be nice if they remembered us fondly for having provided the funds to help pay off the mortgage on the house.

My take: KING SIZE EGO EVEN AFTER DEATH!!

“Why should I make her next husband (his next wife) rich?” Good point. That’s just one reason some people select a structured payout of proceeds. That’s also, why many people protect their spouse with life insurance. Life insurance helps create viable choices for loved ones.

My take: Do you expect a 34 year old widow to close all options? You must be morbid

“Let the kids work through college, just like I did!” There are days when, if we have children, we all feel that way. However, we really don’t mean it. We devote ourselves to helping our children get a good start in life. That means helping them to get a good education. If we die prematurely, our children’s lifestyle and dreams could be threatened, along with their college dreams. Life insurance, however, can help provide the funds to make sure your children get a good education and a strong start in life.

My take: Even if you do not provide for the luxuries, you should provide for the basic education

“You have to die to win!” In the event of your death, you lose either way. However, wouldn’t it be better to make sure that your spouse and children will be financially provided for? We don’t buy life insurance for ourselves. Life insurance is for the living, for those who must continue after we are gone. Besides, if you are fortunate enough to live to a ripe old age, it makes little sense to complain that you didn’t get to use your life insurance.

My take: Does it mean if you take car insurance, you want to meet with an accident. This is hogwash. Life insurance is not because you will die – it is because your loved ones will live.

Also, with endowment life insurance, your policy can accumulate cash value that you can use for any purpose — to meet emergencies, take advantage of business opportunities, to help pay college fees, or to help supplement your retirement income.

In fact, life insurance is one of those win-win financial vehicles that enables you accomplish a great deal with very little. It is the ONLY product available that can deliver a guaranteed sum of money (cash flow) to your loved ones at the very moment it is needed most.

Remember, we don’t buy life insurance for ourselves…but for the ones we love. We buy it to provide peace of mind for ourselves and a degree of certainty for our spouse and children. Life insurance helps you meet the commitments and keep the promises you have made to your family.

Is this much life insurance enough?

June 22, 2008

Hi Ramesh,

It was a great trip to Pune. I always thought the drive would be great but really it was scary, to say the least. It actually set me thinking about you and your risk taking abilities. To summarize, you and your three brothers are the driving force behind the family business of tyre retreading business. When I reviewed your assets, I was impressed by what I saw. However, I was stuck by the lack of financial discipline – in your financial life, your business life and in your driving. Let’s enumerate your ‘assets’. Your house in which, you are living with your nuclear family – your wife, two daughters and a son. Your new Toyota Corolla, your wife’s Honda city and your son’s Ikon. You have also committed to a new house in Mahabalipuram on which you have made a down payment.

Asset

Cost Loan Market Value
Home Rs 180 lakh Rs 120 lakh Rs 225 lakh
Toyota Corolla Rs 14 lakh Rs 12 lakh Rs 9 lakh
Honda City Rs 9 lakh Rs 2 lakh Rs 3 lakh
Ikon Rs 7 lakh Rs 1 lakh
Investment house Rs 68 lakh Rs 60 lakh Rs 74 lakh

Apart from these assets, you have a loan against property of Rs 30 lakh taken for your son’s education – for his acturial education at Oxford. His education has just started and he will complete his education in 2009, and start earning in 2010. Your daughter will start her medical education in 2009, and she wants to do it in US.

Now, let us turn to the life insurance cover that you have.

You have an endowment cover of Rs 10 lakh on which you are paying a premium of Rs 32,000 per annum. You have a life insurance cover of Rs 5 lakh (on your wife’s life) for which you pay Rs 85,000 as a premium and a cover of Rs 5 lakh on your daughter, and a term insurance of Rs. 10 lakh on your son. And lets take a look at why you bought these policies. The first policy was bought ten years ago by your father to please the bank manager who sanctioned his working capital loan. The policies on your wife and children to keep your wife’s brother happy – since he has quit this ‘business’ and the term policy on your son, because the bank giving the education loan insisted on the same.

You only have insurance of assets which are predominantly owned by the lenders – so your cars, your factory, your house, are all fully insured. Since nobody owns you, maybe you are not insured. If you are the asset creating all these minor assets, I am appalled that you are not insured.

Also read – Busted: 10 insurance myths that can prove costly I now wish to ask you the following questions:

How long are you planning to be dead?

At your current level of insurance, your wife will not be able to keep the cars or the house. So if you plan to be dead for a period exceeding 30 days, you need more insurance.

Now let us look at how much insurance, I think you need

You need life insurance cover to repay all your loans – that amounts to Rs 204 lakh. You need life insurance to cover all your children’s education that, unadjusted for inflation is about Rs 4.5 crores.

You need life insurance to cover the personal guarantees that you and your brothers have given to the bankers that is about Rs 19 crores. You need life insurance to let your family spend about Rs 3.6 lakh per month – I am assuming that the annual vacations in India will be in five star hotels and the foreign jaunts will continue. That means you need a capital of about Rs 12 crores.

In sum, you need about Rs 37 crores of life insurance. Given your current cash flows, I suggest you get your brothers also insured for a Rs 19 crores each – as a key man insurance in your private limited company, and take a Rs 18 crores in your personal capacity. Does this look too high? Lets look at the cost of not having this insurance. What will your family do if you died tonight?

  • Your son will not complete his acturial studies in UK.
  • Your daughter will have to forget her MBBS course.
  • All the three cars will be taken away by the lenders.
  • Your wife will shift to a one BHK rented accommodation; down scale the education plans of the younger kids. No IB school for sure.
  • Wife’s policy, and your children’s policy will lapse because you will not be here to pay the premium.
  • Your children will decide on how your spouse should retire. There are enough Hindi movies that you have seen to understand this option.

Weigh the premium of Rs 16.5 lakh term premium versus the cost of not having the policy, I am sure you will understand.

Have you read – If you died tonight, what will your family do?

The author, PV Subramanyam, is a financial domain trainer. He can be reached at pvsubramanyam@gmail.com