Choose a life insurance policy…

Financial needs of a family

1. Protecting future earnings from life and health events (what happens to a family if the bread-winner cannot work for a few months or forever?)

2. Preparing for when you retire and stop earning (who will support the family when the bread-winner retires?)

3. Protecting the household from large medical costs (where will money come from if a child needs major surgery after an accident?)

4. Setting aside money for a known future expense (where will money come from to finance a child’s education at a top university,or for the dream-marriage of a daughter?)

5. Protecting existing capital against erosion due to inflation (where can the family put accumulated savings to get inflation beating returns,without risking the capital?)

Case study

A good insurance adviser will help you to establish and prioritise your needs. However,you can do it yourself. Let’s create a hypothetical family to illustrate how:

Sandeep and Sheetal Gupta are in their early thirties,and have just had their first child,Jai. Sheetal is a qualified high-school teacher,but is staying at home to look after Jai. Sandeep has a good job in a bank,with total annual earnings of Rs 9 lakh. He has life cover of Rs 12 lakh through his employer,as well as medi-claim cover. They want to buy a place of their own,but are currently paying rent of Rs 20,000 per month. They have a savings account,but aren’t making much progress. They own a two-wheeler,and have an outstanding loan of Rs 50,000.

How could the Guptas prioritise their needs?

1. Prioritise based on how soon the event may happen. Unfortunately,accidents can happen at any time. So for Sandeep,providing some protection for his family if he is disabled or worse,is a high priority. Similarly,medical costs can arise without warning — but for now,the family should find the medi-claim cover from the employer will suffice. Saving up for the deposit on their own home is a short term priority. Providing for Jai’s education is important,but it is a lower priority given that it is almost 20 years away. Providing for retirement is also very important,but it is even further away,so can be ignored for now.

2. Prioritise based on how big the impact of the event is likely to be. If Sandeep loses his life-time earnings,the family will need an income of at least Rs 4 lakh per annum to replace the lost earnings,even if Sheetal returns to work. This income will need to increase with inflation,so a simple rule for the cover required is: Remaining working life multiplied with annual income gap minus existing cover.

In this case: 30 years*Rs 4 lakh – Rs 12 lakh (from employer) = Rs 1.08 crore

The other needs are small in comparison.

3. Prioritise based on “need” as opposed to “want”. The Guptas “want” to buy an apartment — but they can continue renting if necessary. However,the Guptas “need” to protect Sandeep’s income stream.

4. Now determine how much you can afford to pay each year to meet your current needs. In the Guptas case,they budget for expenses and know that they have at most Rs 1 lakh a year to spend on meeting future financial needs (including saving for their home). This does not mean that the entire Rs 1 lakh should be spent on insurance. Having done an exercise of this kind,it may be clear what your priorities are. When you meet an insurance adviser,don’t allow him to sell you a product that does not meet your primary need. After that is met,look for products to meet your other needs,but keep your priorities in mind.

Which insurance policy is best?

Remember that it depends on your needs. If you are sold a “state of the art” investment plan with all the features a smart investor could ever need,it will not satisfy the need to give maximum protection to your family.

On the other hand,if you buy term insurance to meet this need,and find out later that another insurance company would have been 15 per cent cheaper (if you got through the medicals),you still have a good policy for your circumstances.

Every insurance company has a range of exciting sounding products,and it is not easy to give you an analysis of all of them in one place. Here is an insight that will help you understand most insurance products a little bit better.

* The savings and protection elements of an insurance product compete with each other.

If the death and disability cover are high (greater than 100 times the annual premium),there won’t be much money available at the end of the term. If the death and disability cover are low (less than 20 times the annual premium),there should be a significant maturity benefit (which may be paid over several years).

Returning to the Guptas,a term insurance policy with accidental disability cover is probably the best match for their primary need. A cover of Rs 1.08 crore on death and Rs 10 lakh on accidental disability for 25 years will cost just under Rs 20,000 per annum (cover of about 600 times the annual premium).

The remaining Rs 80,000 of annual surplus can be saved to buy their home,and/or invested in a policy to provide for Jai’s education. Sandeep will sleep well at night,knowing that his family is protected.

Always remember

If you plan to use your money in less than five years,you should not consider an insurance product to meet your need.

To recap,your needs should help you chose which insurance product to buy; prioritize your needs,and then ensure that the product meets the most important need.

The writer is chief actuary,Kotak Mahindra Old Mutual Life Insurance