Are you ‘minding’ your ‘gap’?

Buying life insurance young always makes sense. They not only get it at a cheaper premium but will also imbibe the habit of thrift or regular forced saving, which is so essential for building a good financial plan, Vijay Sinha highlights

The phrase ‘Mind the Gap’ was first introduced in late sixties on London Underground to warn train passengers to exercise caution while crossing the gap between the train door and the station platform. Having originated as a utilitarian safety warning, over the years ‘Mind the Gap’ has turned into a stock phrase and today used in many other contexts having nothing to do with transport safety. Here, we are discussing it in the context of one’s family’s financial protection against the ‘IF’s’ of life.

A report published in September 2011 by the leading global reinsurer Swiss Re, highlighted the huge     ‘mortality protection gap’ in the Asia Pacific. The ‘mortality protection gap’ here refers to the difference between the life insurance cover people have and what they should have. The report revealed a startling protection gap of US$ 41 trillion for the Asia Pacific Region and India surfaced on the third spot in the list with a staggering protection gap of over USS 6.67 trillion, which when translated in Indian rupee is well over Rs. 374 trillion ($1 = Rs. 55). This implies that for every Rs. 100 that needs to be spent on life insurance cover in India, only Rs. 7.4 is actually spent on life insurance and savings put together— leading to a GAP of 92.6% in our family’s financial protection against the IF’s of life. To make things worse, this gap is growing at a CAGR (compound annual growth rate) of 13%.

Most of us are oblivious of this huge GAP. It’s time that each one of us dwelled into our personal ‘protection gap’ at the earliest and do something about it.

The primary objective of life insurance is to enable one to protect his/her family’s standard of living (SOL). If asked, none of us under any circumstance is ready to compromise on one’s family’s SOL. But this huge protection gap highlights the fact that what we may not want to compromise, is actually being compromised, because we hardly buy adequate life insurance. Adequate life insurance cover is that which ensures that in case of an unfortunate event, the life insurance proceeds provide the dependant family with sufficient financial income that will enable them to maintain the same standard of living, as before the unfortunate event. It is thus essential that one appreciates the importance and need of adequate life insurance and plan for it accordingly.

To understand how much life insurance is enough to maintain one’s family’s SOL, let’s look at an example. A Rs. 50 lakh cover will provide a monthly income of Rs. 25,000 at an assumed long term rate of interest of 6% (Assuming that the family would put the life insurance money in a safe instrument like a fixed deposit which over the long term generates an average interest of 6% per annum). Now let us ask ourselves a question—Is Rs. 25,000 per month enough in today’s time to maintain the standard of living or SOL of an urban middle-class family? The fact remains that despite this, many of us in India may not even have a life insurance cover of Rs. 50 lakh. According to the data of in-force individual business (policies and sum assured) published in the Insurance Regulatory and Development Authority (IRDA) Annual Report for 31 March 2011, in India the average sum assured per in-force life insurance policy is only Rs. 1,17,144. This shows how grossly underinsured we are as a nation.

While many people understand the importance of life insurance, often are not sure how much life insurance protection they need to have to be financially protected. We can find that ourselves by following a simple four-step process:

Step 1:           From your total monthly household expense (including EMI) deduct total monthly loan EMI’s. This gives the net monthly household expense that needs to be financially protected. By multiplying this net monthly household expense with 12, you will find out net annual household expense.

Step 2:           Decide what long term fixed deposit rate you expect on your corpus. Divide the net annual household expense by this long term fixed deposit rate. This is the amount of life insurance cover you require to protect your income.

Step 3:           Always remember, your life insurance protection is never complete till you have covered your debts. To the amount arrived after Step 2, add the total outstanding principle of all your loans. This is the gross life insurance cover required by you.

Step 4:         You may have some existing life insurance cover. Deduct the total life insurance cover you currently have from gross life insurance cover and you will find out the amount of net life insurance cover you need to protect your family’s SOL. 

The above process only ensures that the GAP with regard to protection of your family’s SOL is taken care off. There may be other GAPS in your financial plan as well that require life insurance protection such as child’s education, marriage, etc. Let’s say that you need Rs. 10 lakh in today’s value for your child’s future education. As of date, you have saved Rs. 2 lakh for the goal. There is a GAP of Rs. 8 lakh in terms of your child’s education goal. You need to add this GAP and other GAPs, if any, in your financial goals as on date, to the net life insurance cover arrived at above in Step 4.

The basic premise of life insurance is that—if there is an income, it needs to be protected. And in addition, never ever forget to cover your debts. People often ask me: “What is the right time to start buying life insurance”? The answer is, whenever you start earning, buy life insurance and protect that income, even if you are just 21 years of age.

Always remember, the younger you buy, lesser are the rates. So why wait? Cover your GAP now. As you grow, your income will grow, your responsibilities will grow and the need for more life insurance cover will also arise. If you have bought your first life cover early in life—it will not only be cheap but will also ensure that the protection gap, due to increase in your income, is not very big and can be easily covered. Buying life insurance young always makes sense. They not only get it at a cheaper premium but will also imbibe the habit of thrift or regular forced saving, which is so essential for building a good financial plan.

The question is: Are you mindful of your gap? If “yes” please “mind the gap” now. Don’t wait as the GAP will only increase.

The writer is the senior vice president, marketing, product development & agency training at Tata AIA Life Insurance.

Read more:

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Asymmetry in life insurance selling

Life insurance during retirement

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