Types of Policies

There are two broad types of life insurance: protection-only and investment-type. If your main need is for protection, there are two schools of thought:

• The first recommends that you choose protection-only insurance, which is called 'term insurance'. In its simplest form, it pays out a specified amount if you die within a selected period of years. If you survive, it pays out nothing. It is the cheapest way overall of buying the cover you need. The numerous variations on this basic theme are described below.


• The second recommends that you choose a whole-of-life policy that is one form of investment-type policy. As the name suggests, this provides cover for as long as you live. Since the policy must eventually pay out, it builds up an investment value that you can cash in by surrendering the policy. However, it takes many years for a surrender value to build up and, in general; whole-of-life policies are an expensive buy if your main need is protection. A variation called a 'maximum protection policy' lets you buy a high level of cover at a premium that is initially very low. You should always avoid taking out an endowment policy if your primary need is protection.

Endowment policies are investment-type life insurance, which pay out if you die within a specified period (the endowment period) and also pay out if you survive. On the face of it this may seem appealing - something to gain whether you die or not - but such policies are an expensive way of buying life cover. Endowment policies can have a role to play in your financial planning, and this, but they are not ideal for protection of your dependants.

Roles of Insurance

Risks and uncertainties are part of life's great adventure -- accident, illness, theft, natural disaster - they're all built into the working of the Universe, waiting to happen.


Role 1: Life insurance as "Investment"

Insurance is an attractive option for investment. While most people recognize the risk hedging and tax saving potential of insurance, many are not aware of its advantages as an investment option as well. Insurance products yield more compared to regular investment options, and this is besides the added incentives (bonuses) offered by insurers.
You cannot compare an insurance product with other investment schemes for the simple reason that it offers financial protection from risks, something that is missing in non-insurance products.

In fact, the premium you pay for an insurance policy is an investment against risk. Thus, before comparing with other schemes, you must accept that a part of the total amount invested in life insurance goes towards providing for the risk cover, while the rest is used for savings.

In life insurance except for term insurance, unlike non-life products, you get maturity benefits on survival at the end of the term. In other words, if you take a life insurance policy for 20 years and survive the term, the amount invested as premium in the policy will come back to you with added returns. In the unfortunate event of death within the tenure of the policy, the family of the deceased will receive the sum assured.

Now, let us compare insurance as an investment options. If you invest INR 10,000 in PPF, your money grows to INR 10,950 at 9.5 per cent interest over a year. But in this case, the access to your funds will be limited. One can withdraw 50 per cent of the initial deposit only after 4 years.

The same amount of Rs 10,000 can give you an insurance cover of up to approximately INR5-12 lakh (depending upon the plan, age and medical condition of the life insured, etc) and this amount can become immediately available to the nominee of the policyholder on death.

Thus insurance is a unique investment avenue that delivers sound returns in addition to protection.

Role 2: Life insurance as "Risk cover"

First and foremost, insurance is about risk cover and protection - financial protection, to be more precise - to help outlast life's unpredictable losses. Designed to safeguard against losses suffered on account of any unforeseen event, insurance provides you with that unique sense of security that no other form of investment provides. By buying life insurance, you buy peace of mind and are prepared to face any financial demand that would hit the family in case of an untimely demise.

To provide such protection, insurance firms collect contributions from many people who face the same risk. A loss claim is paid out of the total premium collected by the insurance companies, who act as trustees to the monies.
Insurance also provides a safeguard in the case of accidents or a drop in income after retirement. An accident or disability can be devastating, and an insurance policy can lend timely support to the family in such times. It also comes as a great help when you retire, in case no untoward incident happens during the term of the policy.


Role 3: Life insurance as "Tax planning"

Insurance serves as an excellent tax saving mechanism too. The Government of India has offered tax incentives to life insurance products in order to facilitate the flow of funds into productive assets.

How Much Life Insurance Do I Really Need?

Life insurance is a topic that concerns many people, yet very few actually take steps to make sure they are properly covered. According to a 2003 MetLife study, 49% of the respondents are concerned about their family's financial security in the event of their death or their spouse's death. However, nearly the same percentage of participants, 45%, had done no specific planning for premature death.
 
When it comes to life insurance, there are two mistakes you can make - not having enough, and having too much. How do you determine how much life insurance you need?

One basic approach for estimating the need is based on your annual salary. Simply multiply your annual salary by five to 10 and you have a potential value. While this method is easy, it fails to take into account your unique circumstances such as a mortgage, marriage, and the number of children. In addition, the range of insurance solutions can be quite broad depending on whether you use the number five or 10.

Another method for determining your life insurance need is to identify the specific expenses that will need to be covered when you are gone. Typically, six factors are part of this calculation - child care expenses, debt retirement, education funding (for kids or surviving spouse), income replacement, burial expenses and your current amount of life insurance.
 
If you should pass away, your spouse will most likely return to work to support the family and child care could be a necessity. This expense can be crippling to any family's budget. To gauge this amount, multiply the annual child care expense by the number of years that care will have to be provided.

To retire some debt, you can add in an additional amount to the policy's death benefit to alleviate part of the financial burden should a premature death occur. Some of these debts could be mortgages, college loans, and auto loans to name a few. If you choose, you can also add in an amount to provide for your children's education. Depending on your situation, an amount may be included for the surviving spouse's education in order to support the family.
 
When considering income replacement, the amount will probably be less than your current salary on an annual basis because your personal expenses will no longer be an issue. Multiply the amount of annual income that needs to be replaced by the number of years you would like it provided.

Add up these expenses and subtract the amount of your current policy. Will your family have enough to cover these expenses with your current insurance coverage?

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