Personal Financial Planning (PFP)

MBA Class of 2023

Insurance

SSSIHL | Puttaparthi Campus | MBA (Final Semester) | Class of 2023 1

 What is Insurance?
Insurance = An arrangement under which the
insured or his successors receive, from the insurer a
financial compensation on the future (uncertain)
happening of a specified event

Insurance Premium = Cost of buying insurance

Insurance Premium = Cost for buying peace of

mind

Insurance is not investment. Do not look for ROI for

the insurance premium paid

SSSIHL | Puttaparthi Campus | MBA (Final Semester) | Class of 2023 2

 Insured, Insurer & Insurable Interest
Insured = The person who is covered by the
insurance policy

Insurer = The insurance company issuing the policy

Insurable Interest = The insured should have an

interest in the subject matter of insurance. Eg. A
cannot insure the home owned by B. However, if
that home is mortgaged to A, then A has an
insurable interest in that home

SSSIHL | Puttaparthi Campus | MBA (Final Semester) | Class of 2023 3

 Principles of Insurance
Protects an asset (eg. home, car) or income

earning capability (eg. life, disability)

an uncertain future event (eg. health)

Insurance should be taken when not needed;

when needed, it is not available or is very costly

It is a contract of utmost good faith

Due to information asymmetry

SSSIHL | Puttaparthi Campus | MBA (Final Semester) | Class of 2023 4
 Insurance: What is, and, What is not?
Insurance IS “only protection”

Insurance is NOT investment

Any insurance that combines protection

with investment is bad insurance

and bad investment

SSSIHL | Puttaparthi Campus | MBA (Final Semester) | Class of 2023 5

 What is impact of “only Protection”
Only protection means:

- unless the insured event takes place, no amount

is payable to the insured

- if such event never happens, as long as the

insurance policy remains valid, then the insured
will receive nothing.

SSSIHL | Puttaparthi Campus | MBA (Final Semester) | Class of 2023 6

 Types of Insurances
Non-life
Life Insurance
Insurance

Assurance Indemnity

The loss incurred

A fixed sum (i.e.
is reimbursed,
the policy value)
with the
is paid on the
maximum limit
happening of the
being the policy
insured event
value

SSSIHL | Puttaparthi Campus | MBA (Final Semester) | Class of 2023 7

 Employer Provided Insurance
Usually employers offer life and health insurances

Ignore from the point of view of PFP. Take

advantage of them (medical claims etc) but buy
own life and health insurances

Such insurance is available only until employment

continues

In the event of loss of job, the insurance shall cease

SSSIHL | Puttaparthi Campus | MBA (Final Semester) | Class of 2023 8

 What is Life Insurance?
Life Insurance = Income Replacement Mechanism

In the event of death of insured, the insurance value

will meet the needs of the dependents as well as
contribute towards the unfulfilled financial goals

Income Replacement Mechanism = Life Insurance

is required only until the age of retirement

SSSIHL | Puttaparthi Campus | MBA (Final Semester) | Class of 2023 9

 Insurance - cum - Investment
This is relevant only in life insurance

Non-life insurance will never have an investment

component

Such combination policies offer very low insurance

and very low ROI

SSSIHL | Puttaparthi Campus | MBA (Final Semester) | Class of 2023 10

 Insurance - cum - Investment: Typical Products

• Endowment

• Money back

• ULIP

• Return of premium, etc

SSSIHL | Puttaparthi Campus | MBA (Final Semester) | Class of 2023 11

 LIC Endowment Example
Assume a 25 year old salaried employee (Rs 5 L p.a.) would like to take life insurance of 20 times
his annual income valid until the age of 60 (35 year term). So policy value is Rs 1 cr.

Endowment Policy: = Premium = Rs 1 cr / 35 years = Rs 285,714 p.a. or 57% of annual salary.

At the end of 35 years, the tax-free maturity value is expected to be Rs 2.43 cr (CAGR of 4.5%).
Total premium paid = Rs 285,714 x 35 = Rs 1 Cr

In the event of death before the age of 60, the insured will receive Rs 1 cr + fund value on the
date of death (@4.5% p.a.)

Term Life Policy: Premium Rs 15,000 p.a. (approx). Life cover of 1 Cr valid until the age of 60. No
fund value at age 60. If the insured survives the policy term, nothing is payable. If the insured dies
during the policy period Rs 1 cr is paid as tax free claim, and no further premiums are payable.
Total premium paid over 35 years = 15,000 x 35 = 525,000.

Endowment policy is an investment-cum-insurance product. It gives a very low return on the

investment component. Moreover, as one cannot afford to pay 57% of their income as premium
(in the above example), he or she will forced to take a policy for a significantly lower value and
hence the life insurance will be inadequate.

The above example will be valid for several other insurance-cum-investment products.

SSSIHL | Puttaparthi Campus | MBA (Final Semester) | Class of 2023 12

 Why ULIPs Should Be Avoided
https://economictimes.indiatimes.com/wealth/insure/why-ulips-are-
useless-as-insurance-products-view/articleshow/67101746.cms?
from=mdr

This article is written by Mr. Dhirendra Kumar - CEO of

valueresearch.com, a highly respected financial professional / portal
that specialises on mutual funds.

SSSIHL | Puttaparthi Campus | MBA (Final Semester) | Class of 2023 13

 Term Life Insurance
• This is the only life insurance policy that makes
sense

• No monies are paid back except on death

• High cover at low premium

• Annual premium

• Though some policies are offered until age 100,

opt for only until retirement age (say 60, or 65)

• Riders at additional premium

• Ignore any cover from employer

• Take immediately on starting earning & review

cover every 3-5 years

• Income replacement product

SSSIHL | Puttaparthi Campus | MBA (Final Semester) | Class of 2023 14

 Term Life Insurance Value Calculation

• Insurance value = corpus needed to

generate regular income at bank FD interest
rates (post-tax, adjusted for inflation and
changes in life stages); or,

• Human life value; whichever is higher

Rule of thumb: In 20s and 30s - twenty times of

annual income; in 40s and 50s - ten times of
annual income

SSSIHL | Puttaparthi Campus | MBA (Final Semester) | Class of 2023 15

 Riders: Disability, Accident, Critical Illness

• These could be taken either as a standalone

policy or as riders in term life insurance policy

• Accident rider is usually double the value

assured in term insurance

• Never include accident cover value in calculating

the sum assured for term life

• Disability will provide a stable income when

income earning capacity is affected either
temporarily or permanently

• Critical illness pays a fixed amount on diagnosis

SSSIHL | Puttaparthi Campus | MBA (Final Semester) | Class of 2023 16

 Health Insurance
• Take health insurance when healthy

• Be aware of what cannot be claimed in the

initial periods (few months, 1 or 2 years etc)

• Disclose all pre-existing conditions

• Take cover for all family members including

elderly dependents (family floater)

• With the passage of time, keep increasing

cover with top-up policies

• If you have an employer provided health

policy, first make any claims under that policy
in event of any hospitalisation

SSSIHL | Puttaparthi Campus | MBA (Final Semester) | Class of 2023 17

 Health Insurance Value
What should be the health insurance value?

This decision is based on current cost of

treatment (consider heart bypass surgery as a
standard treatment procedure)

Assumption on inflation in health costs

Life expectancy - insurance policy value needs to

cover today’s costs as well as the costs in future
(say when the individual is 85 years old)

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 Health Insurance Inflation @ 12% p.a.

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 Health Insurance Inflation @ 5% p.a.

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 Home Insurance
• Comprehensive home insurance

• All risk including earthquake & terrorism

• Include contents in the house - burglary

• Land value component is not to be insured

SSSIHL | Puttaparthi Campus | MBA (Final Semester) | Class of 2023 21

 Motor Vehicle Insurance
• Comprehensive insurance vs Third party
Liability insurance

• Do not make minor claims - loss of no claim

bonus

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 Additional Resources
PDF FAQ on Term Life Insurance and Health
Insurance

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