19 May, 2015

Insurance needs & portfolio assessment

need are dynamic. You can't adopt a "fill it, shut it, forget it" attitude. Instead, reassess your insurance requirements once in three years at least. Look into your insurance needs post major events like marriage, birth of a child, buying a home with a loan, and so on. When responsibilities or liabilities increase there is a need for higher insurance.

Life insurance should ideally replace income that may be lost when the income earner is no more. Income replacement is ideal; but may not be practical, for the amount of insurance required may be too high. A more practical approach would be to take insurance that can take care of regular expenses now, and in the future, and also cover important goals.

Keep a manageable portfolio of policies that are simple, with features and benefits that are easy to understand. Ideally, it would be good to have simple term policies to get the required protection for the family.

Besides term plans, you have endowment, money back, wholelife, and to choose from. Most of the policies, with the exception of term insurance, have an component. In case of traditional policies, the insurance company is bound by rules of how they can invest the policyholder's money. They can mostly invest in specified government and corporate securities. Hence, after accounting for the charges, returns tend to be very low in case of traditional policies like endowment or moneyback policies. The returns for moneyback policies can be between 3.5 and 4.5 per cent and that for endowment policies between 5 and 6 per cent. It may be somewhat more for longer tenures. These returns are tax free.

Unit-linked products can offer much higher returns but the corpus is subject to market vagaries. However, equity markets tend to offer double digit returns over a long period. There is a distorted notion that Ulips are costly. At no point were Ulips costlier than traditional products. Only that they were transparent and the costs that were imposed on a client became apparent. Traditional products have been opaque and their cost structures are not known.

The fact that traditional products offer up to 40 per cent as commission in the first year to their agents point to their high costs. Also, while surrendering a traditional policy, the first year premium is not taken into account at all, which means that the cost imposed on a policyholder in a traditional policy is almost the entire first year premium. In contrast, the costs in Ulips have significantly come down over the years and many of them can effectively even compete with mutual funds on costs. This aspect is not well understood by investors.

If you have an unwieldy insurance portfolio, you need to do something about it. If too much money is going into traditional insurance policies, it could depress your returns potential. Hence, meeting life goals becomes that much more difficult. If traditional insurance products are choking the cash flows, it is time to make some of them paid up or take the hit and surrender some of them. A proper cost benefit analysis is in order before taking the decision. Also, if there are too many policies in the portfolio, manageability would be a problem. That is another reason to apply the broom.

Insurance premium is low at a younger age. However, it does not mean that it comes cheap. Insurance policies normally collect level premiums throughout the term. They collect more premium in the earlier years - more than the mortality charges that would apply at a young age - to compensate for lower charges they would collect later. Hence, taking insurance at any age is the same, as they would collect the applicable premiums one way or the other, in any case. So, taking insurance at a young age does not give any special benefit monetarily.

However, there are two reasons for taking insurance early. One, you may not have any adverse medical condition and would be able to get insurance easily. Two, when one is young, savings and assets would be low and liabilities could be high.

  • Look into your insurance needs post events like marriage, child's birth or home purchase with loan
  • Traditional policies like endowment or money-back policies tend to give low returns
  • Traditional products are opaque and their cost structures unknown
  • Returns for moneyback policies vary between 3.5 and 4.5 per cent
  • Returns for endowment policies vary between 5 and 6 per cent
  • Unit-linked products offer higher returns than traditional policies but are subject to market volatility
  • If traditional insurance products are choking cash flows, it may be better to surrender some of them
  • Take insurance early as savings and assets are low and liabilities high when young
Author : Suresh Sadagopan   |   Article published in Business Standard on 10/01/2014


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