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Pure risk cover. it's a must

November 17, 2003 13:04 IST
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Life Insurance is bought for several reasons. Tax benefits, of course, are a key driver for taking life insurance.

Some people 'invest' in insurance, thinking that returns are attractive. Very few, however, buy insurance for the right reason, i.e. the life cover.

Let's take an example of an individual, 30-years-old. For this individual who is probably married and has kids, a big fear is the financial security of the family in his absence. The purpose of pure risk insurance is to address this need.

To underscore this point again, the purpose of pure risk insurance (what we also call Term Assurance Plans) is to address the need for financial security of dependents in case of the premature death of an individual (whose life has been insured). It is not a 'savings' product where you get your premiums back along with bonuses. And this perhaps is what makes these plans a little unpopular with many individuals.

Consider this. This individual is probably earning Rs 500,000 p.a., of which 80% is spent on household expenses. And these expenses are growing every year - due to inflation and a rise in standard of living. How much insurance would the individual need to take today to secure his family's future in his absence? For argument's sake let's take 8x his annual household expenses i.e. Rs 4 m.

How much would it cost to take a life cover of Rs 4 m? Well, that would depend on the type of policy you choose.

Annual Premium (Rs)
Term 13,270
Endowment 118,830
Age: 30 yrs; Sum Assured: Rs 4 m; Tenure: 30 years
For HDFC Standard Life Policies

From the premium numbers it is apparent that the individual will find it very difficult to cover himself adequately by opting for an Endowment Policy (an insurance come savings product). He will have to resort to a Term Plan, where there are no maturity benefits i.e. a pure risk product (and that is why the plan is so affordable).

But, term plans are not very popular, as individuals 'want their premiums back on maturity' (if they survive the policy period). And since Endowment Plans are more expensive, individuals forgo taking adequate cover. Again, they are not being driven by the need for life cover (when the need is for Rs 4 m, what will Rs 0.4 m do!).

One point to note is that the attractiveness of Endowment Plans from the perspective of savings cum insurance product is misplaced. This is mainly due to the fact that returns from such products do not compare well with alternative investment opportunities. Despite this, individuals prefer such plans.

An interesting thing to note is that individuals willingly pay insurance premiums for their vehicles. Here too premiums are not reimbursed in case no accident/theft occurs. For some people then it would not be wrong to say that they value their vehicles more than they value their own lives!

One of the arguments against Term Policies is that if the individual survives it amounts to a loss - to the extent the premiums have been paid. And then they go on to calculate this cost. In our case 13,270 * 30 yrs = Rs 398,100. But is the right way to look at it?

The cost actually is much lower than the calculated amount. The reason is that with time the value of the Rupee erodes with inflation and therefore, Rs 13,270 paid 30 years from now is not equal in value to Rs 13,270 paid today. So what is the present value of the premium we pay in the 30th year? Assuming an inflation rate of 5%, it would be about Rs 3,070!

Now the next logical step is to calculate the present value of all the premiums the individual will pay. Without getting into the mathematical calculations, it amounts to about Rs 214,000.

Is Rs 214,000 too expensive to cover your life for Rs 4 m over 30 years?

You may think it is. But factor in benefits of this Rs 4 m that will accrue to your family in your absence and the scenario changes completely.

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