By definition, Insurance is an agreement between a company and a party where the company takes the guarantee to pay the compensation for loss or damage to assured in return of a payment, in the form of premium, from the party. The assured can be an individual, his/her health, a vehicle or anything like that.
The purpose of writing this definition here is not to teach you if what is an insurance. Everyone may be knowing that. But the problem is that only few of us actually understand the real meaning of Insurance, the logic behind Insurance. We buy Insurance for compensation as per the above definition.
But when it comes to buying Life Insurance, that very meaning of Insurance is ignored. Most of us just fail to recognize the difference between an Insurance and an Investment. This is never a good thing for you and your personal finance.
Why Life Insurance ?
The purpose of a Life Insurance is to financially secure the lives of your loved ones, your dependent family in the event of your unfortunate and unexpected demise. The sum you assured in your Life Insurance is all what they shall be getting after you.
Even without getting a life insurance calculator, you can roughly guess, looking at your current expenses, the amount they would require living a comfortable life in coming years without you. Being a responsible person in your family, it is up to you to decide how much they get in case you don’t survive.
While planning to go for a Life Insurance Policy, most people end up buying an Endowment Insurance which is more like an investment product. This happens due to lack of knowledge. This Insurance has meagre sum assured on the name of Life Insurance. It makes no sense in buying such Life Insurance which can’t cater financial needs of your family in your absence. At that very time, the actual purpose of having a Life Insurance gets diluted.
Types of Life Insurance
Life Insurance is available in two forms –
1. Term Plans
2. Endowment Plans
What is Endowment Plan?
Endowment Plans are the ones that most of us prefer to buy, unfortunately! Endowment Plans are those where you keep paying your premiums regularly for fixed time, say 10,15 or 20 years. At maturity of the policy, you get your entire paid premiums back along with some fixed Interest, bonuses, dividends and Income Tax benefits during the policy tenure. Insurance cover offered is marginally higher than the total premium you’ll be paying in total policy tenure.
What is Term Insurance?
Term Insurance is the simplest Life Insurance. Term Life Insurance is the one where you keep paying certain fixed premiums for certain fixed tenure for fixed sum assured. At the maturity of the Term Plan, you get back Nothing. Shocked? Don’t be!
The reason is that in return you get huge sum insured for the period you buy Term Plan. The figure reaches almost closer to the amount you’d be earning in your working years till your retirement. You always have the flexibility to increase or decrease the sum insured. At maturity, you may renew or surrender your policy.
Which is Better Insurance?
Usually, to have a good Life Insurance cover, you need to have an Insurance Plan which offers you the risk cover to the tune of 15-20 times of your annual income. You can take it as this is the amount you will accumulate in your working years till retirement after excluding your expenses if you survive these years.
Term Plans are all about covering the risk, the risk of your life. We never know what is going to happen in next moment. Risk cover is the biggest benefit of Term Plans. Looking at the risk covered and their capability to pay huge compensation for reasonable premium makes them a cheap life insurance product to buy. Income Tax benefit are of course there like Endowment Plans. Some Term Plans also offer accidental covers or any critical illness by paying additional premium.
Suppose you are 30 years old now and want Life insurance for next 30 years (till retirement). If you check life insurance quotes, most life insurance companies may offer good Endowment Plan for around ₹ 12000 per annum premium which you would be paying for next 25 years to keep your policy live for 30 years. For this you get sum assured between ₹ 2 – 3 lac (0.2-0.3 million). Do you consider this figure sufficient to cover your risk?
With same above figures, Term Life Insurance quotes suggest a cover of around 1 crore (10 million) with regular premium payment of nearly ₹ 12000 per annum for 30 years. Roughly you would be paying total 30 X 12000 = ₹ 3,60,000 as premium in 30 years.
In Term Insurance, we have sum assured which is around 50 times that of in Endowment Plan. Figure of 3.6 lac is not such a big number you can’t spend in next 30 years without expecting to get it back when it comes to cover your life risk.
Why People Prefer Endowment Plans?
The reasons for preference to Endowment plans are that we want our premiums back at the time of maturity of the policy. We are interested in rate of return yielded. Income Tax saving on the premiums paid is additional benefit. Instead of Insurance, we are making it our investment. The actual purpose of having Life Insurance is the least bothered aspect.
Actually, we live in delusions that I am not going to die very soon, or if I die what the money is use of after me. So, I shall buy where I am going to be paid at policy maturity. These all are wrong notions from Life Insurance prospective.
The maturity amount we expect at maturity in Endowment Plans is never going to be substantial. As mentioned above the average return offered by these Plans ranges around 7-8% annually. The current Inflation Rate is hovering around 5.7%. The actual returns you’d be getting 8-5.7=2.3%. Risk of ignoring the big advantage of Term Plan for a return of 2% is not worth taking, especially when the interests of your family are concerned.
Keep things simple. Buy Life Insurance only for risk cover, not for the sake of savings, investment or income tax benefits. It is really important to keep our Savings, Investments and Insurances separate. Never mix them. Never look for growth or return on your Insurance Plans. For growth, there are stocks, mutual funds, real estate etc. where you can make your capital grow.