Need and Advantages

Need- Life Insurance
A Human being is an income generating asset.
Loss of income
Income can be lost either due to:
 Unexpected/ pre-mature death of the bread winner
 Sickness/ critical illness
 Disability due to accident
All these (excepting death) may or may not happen. Insurance covers 2 basic certainties of Life,
namely the Risk of Dying Too Early, and the Risk of Living Too Long.
Death is certain. But we have learnt that a ‘certain event’ cannot be insured. Good logic.
The answer is, though death is certain, the timing is uncertain. In case of pre-mature death of the bread
winner in the family, the dependents shall be subjected to hardships.
Adequate life insurance cover can provide the buffer against the shock of early death and relieve the
financial stress during the period of adjustment.
Hence, life insurance is necessary to provide financial security to the dependents in case of the bread
winner dying early.
Loss of income after retirement
After retirement, the regular income is likely to be lost or reduced. Also, there is increased potential of
regular and unexpected medical expenses. Children may be living separate, or in other parts of the
world. In such cases, if there is inadequate provision for retirement needs, the person may suffer.

Life insurance is a means of independence in old age or, at least, assistance to that end. In nations
where the proportion of old people to the total population is increasing, this could well be an important
factor.
In the developed nations, the responsibility of supporting the aged has shifted from family to the State.
As the proportion of people dependent upon the State grows, the greater will be the obligation on
successive governments to provide higher old-age pension benefits with a consequent increasing
burden on younger generations. India has a relatively younger population; however the problems are
the same as in advanced nations. Old-age issues are increasing and increasing nuclear families or the
empty nest stage means more and more old people are going to be under financial insecurities.
Living too long in such a situation may be as risky as dying too early.
The Risk of Dying too early, i.e in the accumulation phase of wealth, can be covered by adequate term
insurance cover, for high sum assureds, after an effective need analysis of the client. The sum assured
should be limited to the human life value of the person insured, and not higher. An adequate risk cover
equivalent to the HLV of the person insured, would be the foundation component of the Insurance and
investment portfolio of the client.
Advantages of Life insurance:
Insurance should not be confused with only being a profitable and prudent channel of investment. It is
much more than that. It is a financial security a responsible person bestows on his or her family in the
event of him/her waiting away from the family scene before fulfilling the various responsibilities and
obligations. Life insurance addresses two important contingencies in the life of an individual:
 The financial strain on their family due to unforeseen and premature death.
 The financial strain on an individual as a consequence of retiring from an active working life
and living longer.
Unlike in other forms of savings where only the accumulations are made available, in life insurance
the entire sum assured is made available to the dependants in the event of death irrespective of the
number of premiums paid; the only condition being that the policy should have been kept in the force
by regular payment of premium.
A life insurance policy is accepted as collateral security by banks, financial institutions and housing
finance companies.
A Mortgage Redemption Policy ensures the financial security of both, the borrower and the housing
finance company. The plan covers the outstanding portion of the loan, and the borrower’s liability is
automatically extinguished on death without any hassle to the dependants.
The proceeds of the policy can be protected against the creditors through a valid assignment.
Through the purchase of immediate annuity by paying the purchase price in one lump sum, one can
buy financial security for one’s old age. And the same can be planned from a young age by
contributing to a suitable Deferred Annuity Plan.

Tax benefits are also available on the premiums paid and also on the claims proceeds according to the
tax laws in force from time to time.
Life insurance is called an immediate estate because of the death of the assured, the life insurance
proceeds are available to the legal heirs inspite of the fact that no estate was in existence up to the time
of the death of the assured. The estate itself comes into being as a result of the death of the insured,
which otherwise would not have existed to be passed on to the dependants.

Introduction to life insurance2

The floor is your 2nd level support.
What would have happened in case there was no floor support? Where would you have landed
then?
……….on the ground of the building…
..THINK…AGAIN…
“What happens if there is no 2nd level support when we fall from our comfortable lives?”
CHAIR-1st level support/broken/you fall down as a result.
FLOOR-2nd level support-makes sure you don’t fall down further.
……………………
GROUND-base level support-you cannot fall further.
What happens if there is no support for the standard of living that would fall, when suddenly the
income support on which we depend is lost.
“Have we created a 2nd level support, like the floor, to hold back the fall and maintain the
standard of living of our dependents?”
If the answer is NO, our family is insecure. We need to offer financial security to our loved ones,
and nothing better than the mechanism of life insurance to do so.
A unique feature of the life insurance contract is the immediate monetary estate created at
inception out of all proportion to the initial contribution made i.e by payment of the first premium
installment itself. This considerably reduces the mental disturbance of worry, and modern
psychology establishes beyond doubt that there is a close relationship between mental and physical
health. A mind free from worry can therefore by greater concentration, actuate the body to greater
output and production of wealth.
The ICICI-Prudential Advertisement that appears on television channels where the wife asks the
husband to sign the proposal document, and the husband asking her whether she would be able to
live without her, after his death. The wife explains that if he signs, his child’s future and his
retirement benefits will be guaranteed, and there will be peace of mind for him and the family. And
lack of tension will mean longer life. Hence “Jeetey Raho” or ‘Keep Living Longer’.
The message to the viewers is simple: Buy Life Insurance and Enjoy Living.
Many years ago, this message was outlined in a classic print hoarding released by LIC, which read:
“Insurance-A little Price-For a Priceless Security”
The world’s largest insurer, AIG (American International Group), had put up a huge Hoarding at
Times Square, New York, in the 1960’s which read…
“Smart Men Do Not Need Insurance………………
……………Their Widows DO…………”

Introduction to life insurance 1

How much insurance to buy?
Concept of Human Life Value:
Beyond all doubt, your life is invaluable. Yet, there is a certain worth that can be attributed to the
financial support you offer your parents, spouse or children. This worth is referred to as Human Life
Value (HLV). In the future, if your family does not have the protective blanket of your presence, they
will no longer be able to enjoy the benefits of the income you earned. Put simply, Human Life Value is
the present value of your future earnings.
You should calculate your Human Life Value so you can accordingly invest in insurance plans that
provide your family with adequate finances and hence security even in your absence.
Your Human Life Value is determined by 3 factors:
1. Your age
2. Current and future expenses
3. Current and future income
As a thumb rule, if you are 30 years of age, you should insure yourself for an amount approximately 8
times your annual income. At 35, your investment should be close to 6 times your income. Of course,
the exact amount of your investment should be determined by the number of people who depend on
you, your existing investments and your life stage. For example, if you are 30 years of age and have
two children and parents to provide for, the amount you invest should be reflective of your
requirements.
The Human Life Value may be defined as the capitalized value of the net future earnings of an
individual after deducting appropriate costs for self maintenance. From the point of view of
dependents, an individuals Human life value represents the measure of the value of benefits they can
rightfully expect to get from their bread-winner. Likewise, form the standpoint of an organisation, the
human life value on one of its key employees is a measure of the value of his ore her services to the
organisation.
In 1924, S.S Huebner of Wharton School of Finance and Commerce, University of Pennsylvania,
U.S.A; suggested that the human life value concept is not just a statement that a human life has an
economic value but implies that the five aspects as follows:
 Appraisal and capitalization of human life value
 Recognition of family as an economic unit organized around human life values
 Human life value and its protection as the main link between present generation and the
succeeding generation
 Recognition of human life value as creator of property values
 Application of scientific principles of business management to life values
Capitalization of economic value of a human life is possible through life and health insurance. By
guaranteeing this capitalized value in the event of death, life insurance tries to perpetuate the earning
capacity of an individual life for the benefit of its dependents. With the bread winners death, the whole
value will be swept away. Life insurance acts as a hedge against such a loss. It is the only scientific
method of capitalizing the economic value of a human life and indemnifying for its loss in case of
premature death.
Thumb rule: Without going into the mathematical aspects, if person aged 40 earning Rs 20,000 per
month, i.e; Rs 2,40,000 per annum, dies leaving behind dependents in the form of his wife and
children; the annual economic loss to the dependents is the loss of his income i.e Rs 240000. However,
that will take care of the needs of the family for a couple of years only. What about the rest? Hence,
thumb rule of maximum 10 times the annual income to maintain the existing standard of living of
dependents, or say a minimum of 5 times the annual income to meet expenses; is used. E.g; if the
deceased had a life insurance cover 10 times his income, the sum assured payable to the nominee
would have been 24 lakhs. The logic is that, this 24 lakhs if deposited in a bank, would generate
interest @10% i.e Rs 2.4 lakhs, exactly the sum the deceased earned before death. That is why life
insurance is used to maintain the same standard of living in case of unfortunate death of the life
assured.
2. Life insurance helps to maintain standard of living of dependents in case of unfortunate
death/ permanent disability of life assured.
Friends: let me ask you a simple question.
Imagine you are sitting on a chair in your home/ office located at the 3rd floor of the building. You
are sitting very comfortably (1st level support) on the chair and reading the latest bestseller book.
Suddenly, the chair breaks down. Where do you land? Of course, on the floor.

Introduction to life insurance

        In any activity of life there is a possibility that a desired event may fail to occur and that pecuniary
(financial) loss may arise. In adventures by sea the ship may fail to make the port (remember Titanic!);
or the cargo may be damaged or lost. In the adventure of life itself, the life may fail and death may
occur, causing suffering to dependants. Death comes to all sooner or later, and it is the only truth in
this world. The rest as they say is all maya (illusion). So if death is the only truth, then why do we
ignore the implications of the event? Because of the nature of its permanence, and all pervasive; death
requires understanding the financial implications on the dependents. Life insurance is therefore the
most important of all forms of insurance. It’s significance pales the other forms of not just insurance
but also all investment instruments. The theory of insurance, in general terms, may be expressed to
mean that the good fortune of the many compensates for the misfortune of the few. The consequences
of such misfortunes cannot be in many instances borne by the individual, and so the insurance
company is prepared to shoulder the burden of these consequences in exchange for an assessed
payment for the risk undertaken. Those who avail themselves of this service know that such
misfortunes will occur but do not know to whom, and when, and they are willing to make such
contributions to a common fund to buy the right to be compensated of misfortunes if they should befall
them.

The insurance company is concerned with any factor that may affect normal longevity, and once the
contract is entered into, and premiums are regularly paid by the policyholder, the company is at a risk
on a permanent contract which it cannot break.
From the collation of a vast amount of data, an assessment can be made of the rate of mortality or the
likelihood of death occurring at each age. Numbers can be quoted, but which individuals will die at
each age cannot be stated. Consequently, all who pay life insurance premiums to the common fund do
so with the same willingness that the fund shall be used to compensate the estates of those contributors
at whatever age in life they may die, within their respective contract period. This is the basic theory of
life insurance. However increasing emphasis on investment aspects has tended to overshadow the
primary purpose of protection against premature death.
Let’s discuss the following two significant statements relating to life insurance.
1. Life insurance has no competition from other financial products:
 Life insurance relates to protection of the economic values of assets. It is a mechanism
that helps to reduce the effect of any adverse situations arising out of loss of the asset. It
makes sure that the value or income is not lost.
 Life insurance helps to compensate the financial losses arising out of death/ accident/
retirement of the bread winner in the family.
 All other financial products such as bank deposits, PPF, NSC, are savings instruments,
and offer you safe returns of 8-10% p.a.
 Investment vehicles such as mutual funds, stocks; offer better return potential with
higher risk potential too.
On the loss of income due to unfortunate death of the bread winner in the family, it is only life
insurance that offers a guaranteed sum to the dependants of the deceased. That is, on payment
of first premium installment and subsequent issuance of policy, a future estate is created for
the benefit of the dependents of the life assured; which is payable to the nominee in case of
unfortunate death of the life assured.
Thus, for investment purposes, life insurance may have competition from other financial
instruments, but there is no competition as far as risk coverage/ protection of economic value
of assets is concerned.
Example:
Amount invested: Rs 10000 p.a.; age: 30 yrs
Product
name
Bank
deposits
PPF/NSC
Mutual fund
stocks
Life insurance
(pure term plan)
risk cover: 25 lakhs
Returns
p.a
8%
8%
20%*
40%*
nil
Total
value
after 1 yr.
10800
10800
12000
14000
nil
►*-returns not guaranteed, depends on share market movements
In the above case, in case of death of the life assured, the nominee would get Rs 10800 through
the bank deposit, PPF and NSC. The MF investment would give Rs 12000, and the stock
investment would provide 14000.
However, life insurance would provide the entire sum guaranteed. i.e. Rs 25 lacs.
Thus, it is only through life insurance that a future financial or monetary estate can be created
during the lifetime of the individual.
In this illustration we had assumed the risk cover was Rs 25 lakhs. How do we decide how
much risk cover to buy? Is it possible to buy any amount of cover, and how much is enough.
That question is significant since most people who bought life insurance in India, have low risk
covers. They live in an illusion that they have purchased a life insurance policy, and therefore
need not worry. However, the risk cover being grossly inadequate, their dependents would not
be getting a financial estate that compensates the human value of the bread winner, in case of
his unfortunate death.
Let’s take a case: Mr A is the policyholder and life insured. He had purchase a pure term
insurance policy for Rs 1 lakh sum assured some years back. He, being the sole bread winner
in the family and earning a gross income of Rs 30,000 per month i.e Rs 3,60,000 per annum
dies unexpectedly when still young, leaving behind dependents in the form of his wife and
children. What will the nominee (wife) get from the insurer? Yes, not greater than 1 lakh, that
being the sum assured. Will it be adequate to meet the financial obligations of the dependents
in the short term and long term, such as immediate bills that will be due, the children’s
education needs-present and future; pension needs of the widow…and so on. The picture looks
rather grim.
Therefore, merely having a life insurance cover for name sake, is not enough. It is like little
knowledge. It’s better to have no knowledge so that you are recipient to new ideas and willing
to accept and change. Likewise, we witness lots of persons who have purchased some
insurance cover, without understanding why, and even among them a significant percentage
who stop paying premiums after a period, leading to large lapsations. The agent/ advisor
should therefore, change the traditional ways of selling and adopt more scientific and
professional approaches while soliciting policies from prospective clients. A need analysis of
the client should be carried out, his Human Life Value/ HLV should be ascertained, and after
matching his requirements for various future financial obligations and aligning them with his
present risk covers purchase; the agent should recommend appropriate insurance plans to meet
the shortfalls. This approach will be useful to the proposer since he will know the real objective
of buying the risk cover. A need based analysis of the client shall determine the insurance
covers he requires and also the net cash available to the proposer to invest. Thus higher outlays
can be planned to meet greater fund requirements in the future.