A standard query in any question and answer section is always to do with the selection of stocks or mutual funds and whether they should hold on or let go. But I have not heard any query related to an insurance portfolio. Sometime people ask about one or two policies which they have already invested or are planning to invest in but no one is concerned about their complete insurance portfolio.
Just like your investments portfolio, your insurance portfolio too should be properly designed and reviewed from time to time. When I talk of an insurance portfolio it is with reference to the sum assured and not the number of policies. As in every financial plan, insurance is a risk management tool which provides a back-up security to your goals and savings. Any wrong move can prove to be costly. Just as in investments, asset allocation plays a crucial part, in the composition of insurance policies.
Points to ponder while analysing your insurance portfolio:
1.) The kind of insurance policy
2.) The sum assured (SA)
3.) Timely review
4.) Avoiding common mistakes
Let’s discuss them one by one:
1.) Kind of insurance policy
Generally there are four kinds of insurance policies which should be a part of your portfolio – life, health, personal accident and critical illness.
Now the question arises as to who should take what and when?
The purchasing of any policy should be guided by your life cycle stage and goals.
Life Insurance: It is very clear that when there is anyone financially dependent on you, you should definitely buy life insurance policy with adequate sum assured.
Health Insurance: This is a very important cover which must be taken even if there are no dependents. Looking at the rising health care costs one must buy this policy the moment they become financially independent. Sometimes people avoid taking health insurance since they are already covered by their employer. But to cover up the uncertainties in the job market this insurance is must. Moreover one should understand that it would be very difficult to get a health cover once you get diagnosed with some illness or when you retire. The earlier, the better.
Critical Illness (CI) policy: One can buy a separate policy or can take it as rider with the life insurance policy. This insurance covers major illnesses related to the heart, brain, kidney etc. and provides a one-time lump sum amount for treatment. ( also read: All about critical illness policy)
Personal accident (PA) policy: This is the most ignored amongst the lot as it does not have any tax benefit. On the other side it is the cheapest, so sometimes you find its benefit attached with your credit card, bank accounts etc. But like other policies this policy has its own impact on your financial well-being and insurance portfolio. This policy covers you in the case of accidental death, permanent total disability, permanent partial disability and temporary total disability. You can purchase this policy separately or can take it as a rider with any life insurance policy. But it is advisable to take it separately as you can manage it better. Also, the stand alone policies are generally more comprehensive than riders. (Read: don’t ignore personal accident policy)
2.) Sum assured
This is a very crucial question and answer varies according to the person’s profile. In life insurance the sum assured required is calculated by computing the Human Life Value but in Health/Critical Illness and personal accident policies, there are no such formula available. In general, you should have a cover of at least 7 – 10 times your annual salary for life insurance and the same should be for personal accident policy as it covers disablement and if you were to be disabled you would become a dependent thereby increasing the pressure on the family expenses. But there’s a limit to the sum assured in the PA policy. If you are employed then you the SA cannot be more than 10 times your annual salary and if you are self-employed then the limit is 20 times of annual income.
In case of health insurance and critical illness policy one should go with the maximum cover which one can afford. So sit with your financial planner and get advice on a suitable coverage. Rather than going with floater policy, you should buy separate policies for each family member, as it has its own inherent advantages.
3.) Timely review
Just like your investment portfolio, your insurance portfolio also requires constant review. With the change in family composition, income or expenses profile, increase or decrease in assets or liabilities, your insurance portfolio needs to be modified accordingly. Some common milestones where your insurance portfolio needs to be reviewed are:
1.) When you get married
2.) When you have kids
3.) When you take loan
4.) When your job profile demands more traveling
5.) When there’s Increase in income or expenses
Besides the above, it is always better to get your insurance portfolio reviewed by a Certified Financial Planner every three years. ( also Read: Financial Planning Review is important)
4.) Avoiding common mistakes
Even after an effort in building and managing your insurance portfolio there are some common mistakes which one makes which one can avoid:
a) Treating insurance as investment
Every advertisement by insurance companies has the same pitch “covering of risk and uncertainties” which attracts one towards the plan. Sometimes they want you to start saving for your long term requirements like children’s’ education, own retirement etc. And you end up purchasing an investment plan rather than insurance. Who’s at fault? You cannot blame the company as you yourself are responsible for that .You think of Insurance policies as an investment tool, rather than as a security net. Insurance is shown as a freebie by product sellers. But there’s nothing free in this world. You always pay for the insurance costs, distribution and fund management expenses. So do not mixup investment & insurance. First build a proper insurance portfolio and then design your investment portfolio depending on your risk profile and goals.
b) Buying insurance for tax benefit only
This is the most common mistake which people make and then blame the advisor for the same. You don’t do any tax planning and when in March your chartered accountant or human resource manager asks for the tax saving proof you end up purchasing those insurance policies which are of no benefit to you. One should not buy any insurance just for the tax benefits, but after looking at the self and family requirements.
c) Purchasing too many insurance policies
“My banker gave me this policy and said this would be best for me. My cousin has joined an insurance company so I have to purchase one policy from him. My friend’s wife has become an agent so I have to help her ….” and so on. All the above reasons for purchasing insurance without proper planning will do you more financial harm than good. Go with few policies and get yourself an adequate sum assured.
d) Continuing with bad policies at the cost of your overall portfolio
This is also a very common mistake. While designing financial plans I have found many people who are paying 70% of their premiums towards investment linked policies, which provide for negligible insurance. People are reluctant to accept the advice of canceling some policies and purchasing insurance while investing the surplus in other good investment options. They are ready to compromise on their family’s security at the cost of the mistakes they have made in past. Take the help of experts if required.
Insurance is a major part of any financial plan and has a very big impact on your finances. So look at it wisely and manage it better. Your insurance portfolio should prove to be a backup of overall financial Plan.
Written for Financial Planners’ Guild India and published on www.fpgindia.org.
Hindi version of the same has been published in Business Bhaskar dt 08/03/2011