An eye for insurance

Striking a balance between the cover needed and the premium outgo is critical.

In India, insurance is broadly divided into life and general Insurance. Life insurance covers a family against the financial implications of the death of the insured.

In addition, it may also provide certain survival benefits, in case the policy holder survives the policy term. Life insurance policies are broadly termed as "benefit policies".

General insurance is a broad term encompassing protection in several areas such as health (For some strange reason, it is not treated as a part of the life insurance sector), property, professional liability among others. These are usually "non-benefit" covers. They will only reimburse losses suffered and not confer any additional benefits to the policy holder.

We shall discuss individual heads of insurance and the products therein in greater detail in later articles.

Before deciding whether you require insurance or not (although all of us certainly require it in some form or the other), take the following into consideration :

The probability and impact of an event:
Assess the probability of an event and its financial impact on you, before zeroing in on a policy. Of course, an element of intuitiveness, is contained in the estimation but it is preferable to a random choice.

For instance, a shopowner in Mumbai can consider an earthquake as an event which will occur infrequently but may still opt to insure against it, as the financial damage in case of an earthquake, could be significant.

Also, if the event occurs infrequently, the premium charged by an insurance company is also low. If an event occurs very frequently (like earthquakes in Japan), the premium will be high. Of course in the case of life insurance , although death is a certainty, the financial impact of death will vary with age, and the number of dependents.

Will I be adequately insured?
Merely having a cover is not enough. Take care to ensure that the cover is adequate for you. Too small a cover is virtually pointless, considering that it will not serve yours or your family's purpose.

Too much insurance will mean wastage of precious money towards payment of premiums. There are certain techniques to help you estimate the right quantum of cover. We will discuss these later.

Can I afford it?
We should take care that insurance premiums do not eat into a huge chunk of our income. This is especially important in case of long term contracts such as life insurance. This may mean working backwards, and calculating the size of the cover, based on the premium afforded by you. Beware of agents who try to hard sell you high-priced insurance covers, as they may be detrimental to your long-term finances.

Two of the most common mistakes committed by customers in the case of life insurance are:

Income tax-led decisions:
While contributions towards life insurance premium of up to Rs 1 lakh can be reduced from "gross total income" under section 80 C, there is no need to be guided solely by this consideration. Also, do not wake up to the need for insurance only in the final quarter of the year.

By doing so, you are only playing into the hands of agents who will exploit your urgent need to save tax and sell you policies that are not really suited to your needs. Let tax saving be incidental to choosing a cover, not the sole force behind it.

Bundling insurance and investments:
Unfortunately, globally, over the years insurance products has been sold more as an investment tool rather than a 'protection' vehicle. The nomenclatures change (endowment policies, money back policies, and unit-linked plans) but the underlying principle remains similar.

Agents often succeed in their efforts owing to the following factors:

Providing rosy illustrations of future investment returns, conveniently side-stepping the basic question of whether the coverage amount contained therein is adequate or not.

Stressing that an insurance-cum-investment policy compels the policy holder to be disciplined in their savings program and this aids in long-term wealth creation.

Several studies have proved that unbundling of the insurance and investment aspects lead to better overall results. Of course this will call for investing discipline on the part of the policyholder, but that is another story altogether.

I feel that apart from insurance agents, consumers too are responsible for the so-called mis-selling. Against this backdrop, we will look into specifics of different policies from the next article onwards.

The writer is vice-president at Parag Parikh Financial Advisory Services