Publication : DNA, Mumbai; Date: Aug. 14, 2006; Section: Financial Planning Page: 24
Ajay Mehra, an acquaintance, sought my advice on his insurance needs six months back. He asked me: “Do I need an insurance of Rs 90 lakh?”
I shared my thoughts with him on why insurance is important and how he should go ahead with it. He told me he would take an insurance cover but he did not take any action on it.
Then, one day Ajay called me and said, “I am opting for a unit linked insurance plan (ULIP) which a friend has recommended.” He added that the plan has generated 30% per annum returns in the last three years.”
After getting to know the details of his policy, I told Ajay that he would be underinsured by a huge margin and that he should go for a much cheaper term plan. A term plan is a pure risk cover. In such plans, in case of death of the policy holder during the period of the policy, his nominee gets the sum assured.
And if the policy holder survives the period of the policy, he does not get anything. Term plans have the lowest premium among all the different insurance plans.
“You do not need insurance to generate 30% returns per annum. You need insurance to ensure that your family maintains its lifestyle and does not have to suffer financial hardships if something happens to you,” I told him.
“You do not take a car insurance policy on hopes of getting good returns if nothing happens to your car. Also, you do not insure your Rs 10 lakh car for Rs 3 lakh. You insure it for its actual value at any point of time. Then, why are you underinsuring yourself,” I added.
After that I did not hear from him. I figured out that he might have opted for the ULIP. This happens in most cases where people confuse insurance with investment.
The insurance industry is primarily to be blamed for this as I see no effort on their part to promote term plans.
In fact, a majority of the policies sold by life insurance companies are ULIPs, endowment, money back, whole-life plans etc. All of these have an investment angle to it. So, even if a client wants to buy a term plan, the chances are that he will hear answers like “Dont buy this, you wont get anything back or ULIPs are hot cakes”.
If we all knew that nothing would happen to us, why then go to insurance companies at all. Wont we be better off putting money in just PPF, EPF, mutual funds, stocks and real estate.
Ajay, a senior level corporate executive in his early 40s, was drawing a salary of Rs 25 lakh per annum. He was well settled with his wife Reema and two lovely kids.
All was well for the family until the terrible July 11 bomb blasts. Ajay was travelling in one of the affected trains. His untimely death came as a shock to his family, friends and people who knew him.
After a few days, I was reflecting on Ajays situation and how his wife Reema would cope up with this situation. Besides, the huge emotional damage this event has caused the family, there are some serious financial implications for the Mehras.
Having read a lot of stories on how families had suffered due to the blasts, I thought it would be important to stress on the importance of making the right choices when it comes to insurance.
Financial goals of Ajay were:
– To have a post-tax retirement income of Rs 75,000 per month in current terms starting in 2020.
– To secure a corpus of Rs 25 lakh each for his sons and daughters education in the US. (His reasoning was some provision could be made through scholarships and education loans) by 2016.
– Have a corpus of Rs 10 lakh for daughter Juhis marriage in 2021.
– Donate Rs 50 lakh to start a school in his native village.
Current situation
– Ajay had a majority of his investment in RBI relief bonds, real estate, life insurance policies and EPF. He also had around Rs 2 lakh of cash holdings.
– The monthly expenses for the family were around Rs 1,25,000. Excluding Ajays expenses, monthly mandatory expenses for the family were around Rs 95,000.
– The current life insurance cover stood around Rs 30 lakh. He had been paying a premium of Rs 2.2 lakh per year. He also had reasonable cash reserves.
– Most of his investments were illiquid. Some of them could be liquidated in times of need but there is a cost attached to liquidating them.
– He had an outstanding home loan of around Rs 35 lakh and a car loan of around Rs 3 lakh.
– Reemas insurance premium payments were around Rs 80,000 per annum.
– They had to support Reemas ailing mother as well.
On a detailed analysis of the situation, the following observations were made:
-Though Ajay was paying a very high premium, the cover he received was very low and barely sufficient to cover his home loan.
-They had no critical illness cover.
-Medical cover was around Rs 1 lakh for all family members.
Ajays employer was kind enough to pay around Rs 25 lakh to his family and offered a job to Reema at a salary of Rs 35,000 per month. This eased some of the problems for the family.
Risk management
-Scale up your medical insurance cover to at least Rs 3 lakh.
-Surrender Reemas endowment plan and money back plans.
-Buy a term plan of Rs 50 lakh for Reema covering childrens education and other goals.
-The premium for this will be around Rs 12,000 per annum.
-Take a homeowners all-risk policy for your current home.
-Keep an additional Rs 3 lakh in one-year fixed deposits (FDs) that can be encashed in case of any medical emergencies for Reemas mother.
Investment strategy
-After taking stock of Reemas new modified goals, tolerance to risk, time horizon and current asset allocation, we recommended the above asset allocation to her.
-Reema understood that equity is a long-term investment and any money that she did not need in the next 10 years should be invested in equity. Short-term investments could be in floating rate funds, fixed maturity plans, savings accounts & FDs. Mid-term money was invested in balanced funds.
-Incremental debt out of her monthly income was added through PPF, EPF and voluntary contributions to EPF for Section 80 C investments. Childrens education fees could also be utilised towards Section 80 C contributions.
-Besides, one-time investments in stocks and diversified equity MFs, we started systematic investment plans (SIPs) in funds from reputed fund managers with lower costs and, lower volatility etc. We created a large-cap portfolio with one mid-cap oriented fund to act as a topping on the equity portfolio.
-We kept around 20% in cash to take advantage of further volatility and other investment options such as real estate MFs & gold exchange traded funds.
One must remember that insurance is about providing for your family, protecting their lifestyle if you are not around and ensuring that the goals for which you have worked so far are achievable even in your absence. It is a risk cover, not an investment option.
(The author is a full member of the Financial Planning Standards Board India. Feedback on this Case Study may be mailed to myplan@fpsbindia.org. The Case Study is only a model for educational purposes and for customisedFinancial Plan, kindly consult afinancial planner.)
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