Insurance has always been an indispensable instrument in the financial planning arsenal, providing financial security to individuals as well as businesses that face a constant threat from the uncertainties of the world. This is especially true in the current times when the world is facing an insurmountable health crisis that threatens to undo the remarkable progress made on the economic front in the last couple of decades.
According to the data from the United Nations (UN), India lifted a stonking 271 million people out of poverty between the years 2005-06 and 2015-16. Unless apt measures are put in place, the pandemic will certainly bend the poverty figures in the wrong direction. However, individuals of all the socio-economic categories will feel the repercussions of COVID-19, more so by the poor and lower-middle-class.
Furthermore, this pandemic highlights just one of the multitude of risks that individuals and businesses face on a daily basis. Other risks could emanate from such unfortunate events as accidents, fires, burglary, etc. The potential financial damages from such events could force individuals into poverty and businesses on the brink of bankruptcy. These risks, therefore, necessitates the inclusion of insurance within a financial portfolio.
What is Insurance and how does it work?
Insurance Meaning & Definition
In simple terms, insurance is a mechanism
through which individuals can transfer their financial risks to insurance
companies, for a premium. It is a risk transfer mechanism. In legal terms,
insurance is a legal contract between two parties, the insurance company
(insurer) and the individual or a firm (insured), where the insurance company
promises to compensate the insured for any financial loss arising from a
contingency covered by the insurance policy.
Such a remarkable risk transfer process is made possible by the basic concept of risk pooling. Insurance companies collect premiums from all the policies that it has written. The insurance company, then, pools the money it has collected to pay for the losses arising from the insured event. In case the company receives a claim request, it draws on the resources it has built by collecting those premiums.
What are the 4 types of Insurance?
As mentioned above, knowing the importance
of insurance has never been so necessary. Following insurance products are a
must-have for any individual in these challenging times:
Health Insurance: Our health is constantly under threat. Given that we are living in a world that increasingly under pressure from rising health care costs and there are increasing incidents of new diseases, protection against such contingencies would provide a financial cushion and help in maintaining a living standard. There are several types of health care plans such as individual health insurance, critical illness health insurance, family floater health insurance, etc. It is essential to have adequate health insurance coverage.
Life Insurance: This kind of insurance protects the dependents of the insured in case of an untimely, unfortunate death. In such a situation, you don’t want your dependents to be financially shattered. The insurance company in such a situation would provide the sum assured to the nominee of the insured. It’s probably the most crucial insurance. There are various types of life insurance policy, but it’s important to first avail term insurance with sufficient coverage.
Motor Insurance: This type of insurance is mandatory for every vehicle owner under the Motor Vehicle Act, in India. Be it a commercial vehicle or a private one, it is compulsory to insure against the third liability that arises in case of an accident. The rising incidents of road accidents, given a phenomenal rise in the number of vehicles on road, protecting against such liability should be a necessity.
Home Insurance: Home is probably the most valuable possession in a financial portfolio for individuals. There are various risks that your property is exposed to, even after doing your best to safeguard it in the best possible manner. Risks such as damage from natural disaster etc., which might not be mitigated completely. Therefore, financial protection against such damages and losses might be the best possible solution.
What does term insurance mean?
Term insurance meaning
Term insurance is a life insurance product,
which offers financial protection to the policyholders and their dependents for
a specified period of time. In case an insured dies within the term of the
policy, a death benefit, equal to the sum assured, is paid by the company to
the beneficiary. This is the simplest and the purest form of life insurance
policy that is available.
How does term insurance work?
Once a customer decides the coverage
amount, the policy terms, and the insurance company, a premium is calculated
based on several factors such as age, health, term, etc. Those premiums can be
paid in one go or policyholders can choose to pay at regular intervals.
Once the policy is purchased, the policy pays the coverage amount to the beneficiary on the death of the policyholder. At the end of the coverage, if the policyholder is alive, he/she is not entitled to receive anything from the insurance company. However, if the policy includes any survival benefits, the policyholder is entitled to a lump sum at the end of the coverage period.
Term Insurance v/s Life Insurance
Source: Tavaga Research
Term insurance benefits
Safety and Protection: Life, in general, is very uncertain and can throw unpleasant surprises at you when you least expect them. Therefore, to effectively deal with any such contingency, it is essential to take out a term insurance policy. For instance, in case of your unfortunate and untimely demise, term insurance plans safeguard your family and their financial needs. Whether it’s paying for your child’s education or replacing lost income, your surviving dependents get the much-needed financial security.
Peace of Mind: Death is not something that can be avoided. In the face of tragedy, securing the financial future of your family is the least that you can do. Even if the sum assured is small, you’ll at least have the satisfaction of doing your part to help them tide over difficult times.
Very simple to understand: Simplicity is one of the factors that make term plans so popular among people. As mentioned above, term insurance is a pure life plan that provides your dependents with the same assurance in case of your death. All that is needed is for you to pay the premiums on time.
Premiums are locked in for the duration of the plan: When you buy a term plan, you’re effectively locking in the premium that you will pay to the insurance company this year, next year, and every other year till the plan ends. Since younger aged people have a lower probability of dying, it, therefore, helps to start the term insurance plan as early as possible.
For instance, if you buy a term insurance plan with a coverage of INR 1 crore till the age of 80, at the age of 25, you would be paying a premium of INR 10000 every year. That is, you would pay INR 5.5 lakhs in total. But, if you buy the same plan at the age of 40, you would be paying a yearly premium of around INR 25000. In this case, you would pay a total of INR 10 lakh.
Tax-free death benefits: These plans like most other life insurance plans, mentioned above, offer the nominee tax-free death benefits, under section 10 (10D) of the Income Tax (IT) Act. Additionally, under Section 80C, individuals can claim a deduction of up to INR 1.5 lakhs for a certain kind of investments and purchases. This also includes the premium amount that you pay towards the term life plan.
Supremely Affordable: The premiums on these insurance plans are as low as 0.1 percent of the total sum assured. This is always expected to fit well within your affordable budget.
Factors to consider when buying life insurance policies
While buying an insurance policy it is
essential you understand its basics, as different kinds of policies offer
different kinds of benefits. Therefore, the choice of an insurance policy
depends on other things, in addition to just the premium of the policy.
Consider the following factors while buying a term insurance policy:
Tenure of the plan: Ideally, a term insurance plan should cover you till your retirement. The tenure should not be too short, since the policy might lapse before the time you need it the most. However, it should not be too long as well, since you’ll not need them after you free yourself of all the financial obligations. Additionally, the premium would be higher for higher tenure policies.
Coverage Requirement: The importance of an adequate coverage amount cannot be overstated and it is essential to avoid being over-insured or underinsured. Term insurance provides the dependents of the insured when you are not around. Ideally, the insurance plan must cover the basic expenditure of your family. If an inadequate sum assured is purchased, then the entire purpose of protecting your family’s expenditure is defeated.
Inflation factor: If you bought a term plan of INR 1 crore and you think your family is well secured, think again. In a matter of 10 years, the real purchasing power of this amount would have reduced drastically. So, it is imperative to consider the inflation factor while buying a term insurance plan.
Claim-settlement ratio: Claim settlement ratio (CSR) measures the proportion of claims paid by an insurance company, during a financial year, vis-à-vis the total claims made upon it. Hence, an insurance company having a CSR of 95 percent means that the insurance company will settle 95 out of the 100 claims reported. However, this indicator should only be an indicator and helps you filter out insurance companies with a poor claim settlement track record.
Features of the plan: It is essential that the features of the plan should match your requirements. The pan should be flexible enough to allow you to choose the sum assured, the tenure, and the means by which you want to pay your premium. Additionally, check if the plan provides any additional benefits related to death benefits in the policy.
Best term insurance plan
Among the dozens of term plans available in the market, these are currently some of the best:
Source: Tavaga Research
An important thing that should be pointed out is that insurance policies should only be considered as a protection against the risks that individuals and businesses face on a day-to-day basis, they should not consider these as investment vehicles.
Tavaga is everything you need to start saving for your goals, stay on track, and achieve them in time.