Human life is subject to risks of death and disability due to natural and accidental causes. When human life is lost or a person is disabled permanently or temporarily, there is a loss of income to the household. The family is put to hardship. Sometimes, survival itself is at stake for the dependents. Risks are unpredictable. Death/disability may occur when one least expects it. An individual can protect himself or herself against such contingencies through life insurance.
Though Human life cannot be valued, a monetary sum could be determined which is based on loss of income in future years. Hence in life insurance, the Sum Assured (or the amount guaranteed to be paid in the event of a loss) is by way of a ‘benefit’ in the case of life insurance.
It is the uncertainty that is risk, which gives rise to the necessity for some form of protection against the financial loss arising from death. Insurance substitutes this uncertainty by certainty. The primary purpose of life insurance is the protection of the family. Insurance in its various forms protects against such misfortunes by having the losses of the unfortunate few paid by the contribution of the many that are exposed to the same risk. This is the essence of insurance –the sharing of losses and substitution of certainty for uncertainty.
Life insurance is a contract between two parties whereby one party agrees to pay to the other party, a certain amount of money as premium to make good the loss of life arising out of an uncertain event of death in which the insured has interest.
There are a variety of life insurance products to suit to the needs of various categories of people—children, youth, women, middle-aged persons, old people; and also rural people,etc. Life insurance products could be purchased from registered life insurers notified by the IRDA. Insurers appoint insurance agents to sell their products. Public who are interested to buy life insurance products should receive proper advice from insurance agents/insurer so that a right product could be chosen to suit particular financial needs.
Need for the Life Insurance
The original basic intention of life insurance is to provide for ones family and perhaps others in the event of death. Originally, polices were to provide for short periods of time, covering temporary risk situations, such as sea voyages. As life insurance became more established. It was realized what a useful tool it was in a number of situations, including:
- Temporary needs threats: The original purpose of Life Insurance remains an important element, namely providing for replacement of income on death etc.
- Regular saving: Providing one’s family and oneself, as a medium to long term exercise (through a series of regular payment of premiums). This has been become more relevant in recent times as people seek financial independence from their family.
- Investment: Put simply, the building up of saving while safeguarding it from ravages of inflation. Unlike regular saving products are traditionally lump is investments, where the individual makes are one time payment.
- Retirement: Provision for one’s on later years has become increasingly necessary. Especially in charging culture abs social environment, one can buy a suitable insurance policy which will provide periodical payments on one’s old age.
- Minimizing Risk: Life cannot be compensated by anything but financial help in hard time can support anyone. An earning member in family wants to secure his family who are financially dependent and need life insurance. Nevertheless, the question is “how much life insurance is required” at a time. There are many factors that are relevant in determining the amount of life cover one should buy at a time. It is essential that a particular level of income should be maintained for the family even when its breadwinner is not around.
- Social security: Insurance also provide some social security that insured expects in future such as a particular sum of money for the education and wedding of children. One may like to buy an insurance policy for a specific sum to meet such a lump sum commitment.
- Transfer of risk: Payment of insurance premium results in an outflow of disposable income. Insurance may solve future cash inflow problems that will occur during ones lifespan. Therefore, provide a cover and transfer the risk.
- Diffusion of risk: The amount and mode of payment spend on insurance is as per the option picked by one according to his own choice. Therefore one can park funds according to their choice of risk and return.
- Profitable opportunity: Our present age is a critical factor in deciding the quantum of insurance that one can afford. The rates of premium go up with the advancing age of the life assured. Hence, one can buy more insurance for the same premium at a younger age than at an older age. The final decision rests upon a careful consideration and balance of all the above factors. The need for minimum protection may be quite high, but the current need for disposable income may not immediately permit buying adequate insurance.
- Tax savings: If people have an option of risk coverage with guaranteed return and tax saving they will surely prefer it. Generally policyholders take into account the tax benefit under Section 80C.
The Five Simple Rules for Life Insurance
In the event of any misfortune, well-planned life insurance can protect loved ones from financial difficulties. However, in most cases people find it difficult to estimate the correct value of insurance they need. Partly this is because life insurance needs change through different stages of life. There are several simple methods available to broadly estimate ones life insurance needs. Five simple rules of are:
- Income rule: The most basic rule of thumb is provided by the income rule which holds that individual insurance cover should be at least around eight to ten times one’s gross annual income. For example, a person earning a gross annual income of 1 lakh should have about 8 to 10 lakh in life insurance cover.
- Income plus expenses rule: This rule suggests that an individual needs insurance equal to five times of his gross annual income, plus the total of basic expenses like housing or car loans, personal debt, childs education, etc.
- Premiums as percentage of income: By this rule, payment of insurance premium depends on disposable income. In other words, one should decide the quantum of insurance after meeting the regular outgo from salary. From the first two rules, one can make a broad estimate of the minimum insurance one should have. The premium as percentage of income rule can help one fine-tune his cash flow by committing an appropriate percentage of his income for paying life insurance premium.
- Capital fund rule: This rule suggests that if one need 1 lakh per annum for his family needs and assuming one do not have any other income-generating assets, one may like to create a capital fund of 12.5 lakh which can yield 1 lakh annual income at the rate of 8 percent per annum, one may therefore buy a life insurance policy of 12.5 lakh.
- Family needs approach: This rule holds that one purchases enough life insurance to enable his family to meet various expenses in the event of key earning person‟s death. Under the family needs approach, one has to divide his family’s needs into two main categories: immediate needs at death (cash needs) and ongoing needs (net income needs).The are various stages in life such as initial stage, married, married with children and empty nest. In every stage of life cycle the set of needs may differ individual to individual and even within a person it varies from time to time.
There is a broad relationship between needs and policyholder satisfaction over a period of time. Thus, not much life insurance is needed in the initial stage. The same is true in the empty nest stage. The maximum need for life insurance arises during the mid-phase, when one is married and has children. In other words, one may go for life insurance so long as the satisfaction level increases and once the satisfaction surpasses the need-level, the importance of life insurance declines. If one may consider inflation, there could even be a negative rate of real return at the time of maturity of his insurance policies. Therefore, while it is important to secure his familys well being through adequate insurance of the lives of the earning members, over-investing in insurance is a mistake
Benefits of Life Insurance
1. It is superior to traditional saving machine.
As well as providing a secure vehicle to build up saving etc. it provides pieced of mind to the policy holder. In the event ultimately death, of say, the main earner in the family, the policy will pay out guaranteed sum assured, which is likely to be significantly more then the total premiums paid. With more traditional, saving vehicles such as fixed deposits, the only return would be the amount invested plus any interested accrued.
2. It encourages saving and forces thrift.
Once an insurance contract has been entered into, the insured has an obligation to continue paying premiums, until the end of the term of policy, otherwise the policy will lapse. In other words, it becomes compulsory for the insure to save regularly and spend wisely. In contrast saving held in a deposit account can be accessed or stop easily.
3. It provides easy settlement and protection against creditors
Once a person appointed for receiving the benefits or a transfer of rights is made (assignments), a claim under the life insurance contracts can be settled easily. In addition, creditors have no right to any momies by the insurer, where the policy is written under trust. Under the married woman’s act the money available from the policy forms a kind of trust which creditors can not claim on.
4. It can be enchased and facilities borrowing.
Sum contracts may allow the policy can be surrendered for a cash amount, if policy holder is not in a position to pay the premium. A loan, against certain policy, can be taken for a temporary period to tide over the difficulty. Presence of life insurance policy facilitates credit for personal or commercial loans as it can be offered as collateral security.
5. Tax relief:
The policy holder obtains income tax rebates by paying the insurance premium. The specified from of saving which enjoys a tax rebate u/s 88 of the income tax act. Include Life Insurance premiums and contribution to a recognized PF etc.