Investments & Financial Planning

Insurance – Cover Your Risk

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Ramesh aged 35 Years, an IT professional, has an annual income of around Rs.15 lakhs. He lives with his spouse, a homemaker, and a daughter of 4 years age. One of his close friends, Suresh, met with an accident. The hospital bill came to Rs. 3 lakhs and unfortunately Suresh did not have any insurance. To foot the bill, he had to close his bank FD. This FD was earmarked to fund his child’s educational needs, which is not a possibility now. His child’s educational needs remain underfunded.

Suresh was the sole bread winner of his family and was asked to take complete rest for four months. This is a double whammy for people like Suresh – one being uncovered medical expense and another being loss of income. Suresh was rightfully worried as to how he would manage his family expenses for the next four months without any income. Looking at the situation of Suresh, Ramesh felt its high time, he takes up insurance cover. But he was not sure what kind of risk he is exposed to and how does he go about estimating and managing his risk?

So, let us analyse the above situation and understand how to “Cover Your Risk

Step 1 – Cover Your Risk – Life Insurance

Ramesh is a very energetic and positive person; he takes good care of his health and strongly believes he will live longer. But let’s be realistic, death is certain and only the timing is uncertain. Ramesh has another 25 years of work life. Assuming he will earn the current income for the next 25 years (without taking any growth), he has the potential to earn Rs 3.75 Crore (Rs 15 lakhs/year X 25 years). Ramesh should take coverage of Rs 3.75 Crore to protect the income loss for the family in case of his demise either natural or accident. So, let’s see the different kinds of products available in life insurance for Ramesh to safeguard his family’s financial position in case of his demise.

  • Term Insurance — Term insurance is a pure risk cover and a very good product. The premium would depend on age, health condition, and other factors. This product gives very good coverage for a very small premium amount, for example, it would cost approximately Rs 35,000 per annum for Rs 1 crore coverage, and if he pays a premium of around Rs 1.30 lakhs he will get a coverage of Rs 3.75 crores.
  • Insurance cover + Savings (Conventional product/Non-market linked) — These products specify the returns for the investors which can be either fixed or variable. The coverage varies between 10 to 15 times the premium. Here Ramesh shall pay a premium of Rs 1 lakh per year, to get a coverage of Rs 10 to 15 lakhs. In the case of his demise, the family will get an amount between Rs 10 to 15 lakhs. It is equivalent to Ramesh’s one-year earnings. How can his family survive on this amount for the rest of their life? It is not possible. So always treat this product more like a savings product and less as an insurance product.
  • Insurance + Investment (Market Linked or ULIP) – ULIP products are the flavour of the day, it is an investment product that invests in Equity & Bond market. The investment return depends on the market performance and the re-balancing strategy you deploy to move funds between bond and equity markets. In terms of coverage, it’s like a savings product where the coverage varies between 10 to 15 times the premium. If Ramesh pays Rs. 1 lakh premium, the coverage would be between Rs. 10 to 15 lakhs. So, again this is more of an investment product and less of an insurance product.

Step 2 – Cover Your Risk – Health Insurance (Disability Cover) – Income loss due to sickness or accident

Ramesh, realized life insurance will only cover for death; but what if Ramesh falls sick or meets with an accident which might reduce his earning ability?

Accidents could be the reason for loss of income
  • Critical Illness Cover—Health Insurance companies offer critical illness cover policy. Critical illness products cover pre-specified critical illnesses. In case the policyholder is diagnosed with any pre-specified critical illness under the policy, then the policyholder will get the sum assured or pre-specified amount. This can be used towards the hospitalization expenses or can be invested to create a regular source of income.
  • Personal Accident Cover (PAC)—Personal Accident Cover can offer financial support in case of loss of income due to accident. Ramesh can get a PAC for Rs 1 crore at an approximate annual premium of Rs 8,000. In case Ramesh meets with an accident and it leads to either disability or death, based on the extent of disability he will get compensation. This can be invested and that can offset the income loss due to disability either fully or partially.

Step 3 – Cover Your Risk – Health Insurance – Hospitalization Expenses due to sickness and accident

Health cost in India is on the rise. A report by Mercer Marsh Benefits said the forecasted Medical trend rate will be 10% in India, higher than the general inflation. Ramesh, when he heard Suresh had to close his bank FD to make the payment towards hospital expenses – he could see that happening to him too if he fails to take adequate cover. If he opts for a family cover (himself, spouse & child) of Rs. 10 lakhs for hospitalization expenses, it would cost him close to Rs 20,000-25,000 per annum. But he can have peace of mind, that in case of medical emergency he does not have to sell his investments, assets or borrow money.

Conclusion

Insurance is one of the most important financial products which mostly gets lower priority compared to other products. Buy an insurance product with the primary objective of covering risk and not for returns or tax benefits. If you can pen down five friends or relatives, who will financially support you and your family for the rest of the life, in case of your income loss due to disability or death, then you don’t have to consider insurance. If you cannot pen down the names, then insurance is a product you should look at seriously and Cover Your Risk.

Aiyappan V R CFA

Aiyappan is a CFA Charter-holder and a certified Financial Risk Manager. He specializes in personal finance and founder of www.merafunds.com. He strongly believes in the concept of financial freedom and loves to spread and help people achieve financial freedom. For any queries related to personal finance, you can reach him on aiyappan.vr@gmail.com.

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