November 2012

Understand : What are Annuities & Various Types of Annuities

Understand , What are Annuities , Various Types of Annuities, Deferred Annuity, Immediate Annuity, Pension Plans, Insurance

 

“Life is Uncertain. Only Death is Certain.”

The risk of death is covered using a life insurance. Whereas the risk of living longer is covered by Annuity 

 

In a life insurance contract the insurers pay on the death of the insured, but under an annuity contract the insurer usually stops paying upon the death of the annuitant.

Hence Annuities are often described as the `reverse’ of life insurance.

Annuities may be purchased from life insurance companies by a single lump sum payment or by a series of regular contributions spread over many years. Payment may be made by the annuitant or a pension scheme or by annuitant’s employer, or any other personal benefactor. 

An annuity is a series of regular payments from an annuity to an individual, referred to as the annuitant. 

Annuities can be either immediate or deferred annuities. 

Immediate annuities 

Annuity become payable immediately after they have been purchased on a lump sum payment. The annuity payments commence at the end of the month, quarter, half-year or year as per the features of the policy/option exercised by the policyholder. The commencement is called `vesting’. 

Deferred annuities 

Under deferred annuities purchase price may be paid as lump sum in advance or paid in installments over a series of years before vesting date.

Mr X at 40 years purchases a retirement plan by paying a lump sum amount of Rs.10 Lakhs and prefers receiving annuity payments after his 60th year (Called Vesting) 
The insurance company will invest the lump sum amount for 20 years and earn interest.

When Mr X is 60, the accumulated money will be used to pay a regular annuity to him. 
Age 60 years is the vesting date as the annuity payments will start from that date. 

At the time of vesting Mr. X can decide whether to buy the pension plan from the same insurance company or some other life insurer of his choice. This option to choose the pension provider is known as the open market option. 

At the time of vesting Mr X will have the choice of selecting the type of annuity plan that he would like from the annuity 
The annuity amount will depend on the type of annuity chosen and the rates prevailing at the time of vesting.

Life annuity Annuity payments are made during the life time of the annuitant and ceases on his death 

Guaranteed period annuity 

In this method annuity is payable for a guaranteed period of 5, 10, 15, and 20 or 25 years and thereafter until death of the annuitant. The amount during the selected period will be paid whether the annuitant is alive or not. During the selected period, if the annuitant dies, the annuity will be paid to his survivors & stops at the end of the selected period. If the annuitant is alive after the selected period, the annuity will be paid till his death. 

Joint life, last survivor annuity 

Annuity is purchased on life of two annuitants, usually husband and wife. The fixed pension would be paid to them. Either of them dying regardless of who dies first, the surviving spouse continues to receive the same amount of annuity payment throughout the survivors lifetime. 

Alternately, the annuitant gets annuity payments during their lifetime, and after the death of their spouse the surviving of spouse gets annuity payments at a reduced percentage during the lifetime of survivor, say 25%, 50% or 75% of the original amount of annuity.

Under this annuity the payments are made at the 100% level as long as the first named annuitant is still alive. If on the death of the first named annuitant, the spouse is still alive, the surviving spouse will receive the reduced percentage, throughout the life time as mentioned in the policy.

Mr & Mrs X, have taken a Joint life, last survivor deferred annuity policy. The annuity is to commence after 10 years. After 10 years, they start getting a monthly annuity of Rs. 25000/-. Three years later, Mr. X dies in an accident. Mrs. X will continue to get the annuity of Rs. 25000/- throughout her life time.

Life annuity with return of purchase price 

In this plan of annuity the annuitant receives regular annuity payments during his lifetime. On his death, the original purchase price is returned to the nominee/beneficiary. The purchase price in case of deferred annuity is the value of the amount of accumulation / investment at the time annuity has vested or in case of immediate annuity, the lump sum amount paid at the time of purchasing the annuity. 

Increasing annuity 

In this type of annuity the terms can be similar to any of the above, but the annuity increases every year by a fixed percentage or in line with an agreed inflation index. 

Understanding the various insurance options is the first step towards insuring the safety of family and self. 

Understand : What is Paid Up Value in your Insurance Policy

What is Paid Up Value , Insurance Policy, Surrender Value, Life Insurance Concepts, Policy Lapse, Assignment, Nomination, .

Awareness precedes success

Most of the Insurance Policy Holders are unaware of the concept of Surrender Value and Paid  Up Value in case of lapse of a policy for any reason. This note with an example will help understand the concept. 

Guaranteed Surrender Value 

Under Sec 113 of Insurance Act 1938 if a person discontinues a policy, the insurer will not be allowed to forfeit all premiums paid. In every premium there will be an element of savings element accruing in a reserve fund. Insurance Act 1938 stipulates that the insurer should pay a guaranteed surrender value, if the premiums are paid for a minimum period of 3 years. Some Insurers pay more than the amount stipulated by the Act and this is called Special Surrender values. 

Paid Up Value 

When policy lapses after 3 years the Insurer will reduce the sum assured to a sum in the same ratio as the number of years premiums paid, bearers to total number of years in term of the policy. 

If Mr X. had taken a policy for 32 years for 10 Lakhs and he has paid the premium for 8 years only, then he would have paid for the term only. The Insurer offers to pay the Sum Assured, due payable on the maturity date or death if earlier as Paid up value that is Rs. 2,50,000. 

Reduced Sum Assured (RSA is the Reduced Sum Assured or the Paid up value) =
(Total number of years premium paid X sum assured) / (Total term of the policy)

Policies are with Profits or Participating polices wherein the policy holder will be eligible to get share of surplus of insurer called the bonus. 

No bonuses will be added to the sum assured of policies without profits or non – participating policies. 

 In case of policies wherein bonus eligibility is available, the sum total of Reduced Sum Assured + bonus allocated, shall be the Paid up Value. 

Where there is no bonus eligibility for the policy, the Reduced Sum Assured shall be the paid up value. 

Premiums are paid in advance in Insurance transaction. So the policy will be in force for the term depending on the mode of payment. Obviously, a monthly mode will keep the policy alive for 1 month, in quarterly it will be for 3 months, Half yearly for 6 months and yearly for 1 year.

Mr. X had taken a Half yearly mode of payment for 10 Lakhs with profits for 32 years term. The policy had commenced on 28th March 2002. He paid the premiums due on 28th September 2009. Due to certain financial constraints he could not pay further. Upon lapse of his policy due to non payment of premiums, not all of the money paid is lost.

What is Paid Up Value , Insurance Policy, Surrender Value, Life Insurance Concepts, Policy Lapse, Assignment, Nomination,

 

 

 

 

Reduced Sum Assured = Rs 2,50,000
Add Bonus Accrued = say 1,60,000
Total Paid Up = Rs 4,10,000

How much Life insurance is another article which you will find useful….

The Business of Insurance and it’s Benefits to Economy…

The Business of Insurance in India,  IRDA, FDI regulations,  Benefits to Economy, General Insurance, Life Insurance,

.

Insurance, as a vibrant Financial Industry, has an enormous potential with abundant scope to source out premium collections as well provide multi facet security to people. India being a country with large rural population has potential untapped for want of more organized activity.

History of Insurance :

Existence of the concept of Insurance can be traced back to the phrase “Yogakshemem Vahamyaham” from the Bhagavad Gita and thereafter in the joint family systems.

Further, Insurance in its present profiles takes us back to the Great fire of London in 1966, trade agreements in Lloyd’s coffee house in London etc. In India, the English Company started operating in 1818. 

How has the Insurance sector Grown in India ~ 

  • 1818 First insurance company to start life insurance business in India in 1818 was the Oriental Life Insurance Company in Kolkata. The company failed in 1834.
  • 1829 The Madras Equitable started transacting life insurance business in the Madras Presidency.
  • 1870 British Insurance Act 1870 was enacted and Bombay Mutual (1871), Oriental (1874) and Empire of India (1897) in the Bombay Residency started its activities.
  • 1912 It was breakthrough in Indian Insurance history as a first Statutory measure “Indian Life Assurance Companies Act 1912” was passed to regulate Life Insurance Business.
  • 1928 The Indian Insurance Companies Act 1928 was enacted to enable the Government to collect statistical information about both life and non-life business transacted in India by Indian and foreign insurers, including provident insurance societies.
  • 1938 To provide the Government effective control over the activities of insurers, the earlier legislation was consolidated and amended with a view to protect the interest of the insuring public
  • 1950s Move by the Government of India to nationalize insurance business as the level of competition in the insurance business was very high and there were allegations of unfair trade practices.
  • 1956 Formation of LIC: on 19 January 1956 an Ordinance was issued nationalising the life insurance sector and the Life Insurance Corporation (LIC) of India came into existence.
  • 1999 Formation of IRDA
    Insurance Regulatory and Development Authority (IRDA). The IRDA was incorporated as a statutory body in April 2000 to regulate and develop the insurance industry The key objectives of the IRDA include the promotion of competition with a view to increase customer satisfaction through more consumer choice and lower premiums, while ensuring the financial security of the insurance market. 
  • Under current regulations the foreign partner can hold 26% stake of Foreign Direct Investment (FDI) in the joint venture. Now there is a proposal to increase the FDI from 26% to 49%, which is awaiting approval in Parliament. At present there are 23 Life Insurance companies conducting Life Insurance business in India.
India emerged as the fifth largest insurance market in the world and is still growing rapidly.

The Insurance sector is poised for significant growth in the coming decade and is widely considered a sunrise sector. The contributions can help our country in various developmental activities. 

Channeling premiums into Investment projects: 
The premiums collected can be used for funding infrastructure projects and progressive activities will blossom 

Employment: 
These activities in turn will open new vistas of Employment opportunities and thus helps to improve living standards of people. 

Investments: 
The funds so channeled will ensure optimum safety and bring orderly growth of returns. Then people will have better faith in Insurance and accept insurance as a sound saving system. 

Increases the Risk taking abilities of business:
When people are assured of safety against personal risks, they tend to concentrate more on their business which in turn brings growth in business and increase in income. 

Increases Tax Revenue for the Government:
Growth in Insurance Industry indirectly promote better education to children, lucrative job opportunities, larger collections of service tax, education cess, Income Tax etc. 

Improves overall Growth of Economy:
When an individual grows, business flourishes, higher investment potential happens, brings more revenue to Government, and tension free life to business man and all industries flourish.

The Business of Insurance is a long term investment for companies. The insurance companies in India have begun to break even after almost a decade of gestation and some companies have reported profits as well. The Insurance sector is poised for significant growth in the coming decade and is widely considered a sunrise sector in India, for now. 

July 2012

IRDA Consumer Education website ~ Insurance ~ Educating Customers

insurance, IRDA, consumer education, life insurance, health insurance, car insurance, plans, Insurance is a sophisticated financial instrument which requires a fairly high level of involvement on the part of the consumer to make it effective. Yet insurance is also a basic requirement that every person should have. This universal need coupled with its complexity makes for a difficult combination since there is a mismatch between the perceptions of the customer and the reality of the product. It is this perception-reality gap that consumer education bridges.

The best protection for a consumer is education.

The IRDA website appears to be a sincere effort in this direction. Make use of the resources given in the website. It is useful.

You can access the site here : IRDA Consumer Education website

June 2012

Pension Policies and Differences between conventional life insurance plans and pension plans

 
retirement planning,life  insurance, pension policies, bonus,  life, maturity, tax benefits, nominee, beneficiary, business, What are pension schemes?
—Policies that offer money to the insured at the retirement age.
—If death occurs during the policy term, his nominee gets the amount – lump sum or as annuity.
—Pension plans (also referred to as retirement plans) are offered by insurance companies to help individuals build a retirement corpus. On maturity this corpus is invested for generating a regular income stream, which is referred to as pension or annuity.
—Pension plans are distinct from life insurance plans, which are taken to cover risk in case of an unfortunate event.
Classified as immediate or deferred pension plans.
 
Here are some of the differences between a traditional insurance policy and pension plans.
 Parameter Conventional insurance plans Pension Plans
Maturity payouts Full maturity amount received by the individual Only up to one-third of the maturity amt can be withdrawn. Remaining 2/3rd amt has to be compulsorily invested in an annuity
Death benefits Full maturity amount received by the nominees/ beneficiaries Nominees/ beneficiaries have the option of receiving either the entire maturity amt or investing up to 2/3rd of the amt in an annuity
Tax benefits Deduction up to Rs 100,000 available under Section 80C Deduction up to Rs 10,000 available under Section 80CCC
Taxation of maturity payouts Entire maturity amt treated as tax free in the hands of the receiver Up to 1/3rd of the maturity amt, if withdrawn, is treated as tax-free. Pension received on the remaining 2/3rd amt is taxed as per the individual’s tax slab
Stream of income Entire maturity amt/ death benefit received in one go. No provision for a stream of income by way of pension On maturity, provides for a regular stream of income. In case of an eventuality, option of pension benefits available

Components of Life Insurance Premium for Endowment Plan

In many parts of the world, Insurance policies get sold. They do not get bought.

Almost 70-80% of the Insurance Policies which get sold in India comprise of the Non-Term Life Variety (means that approx 80% policies are not pure risk cover).

Do you know the components of the premium which gets paid periodically. Many agents miss-sell and never disclose the breakup of the premium components.

It makes a lot of sense to be aware of the breakup and make a wise decision when buying a life insurance policy (whole/endowment etc)

Components ,Life Insurance ,Premium , Endowment Plan, Insurance, Tutorials, Understand Concepts

 

Next time be sure to ask your agent. Here is an example.

e.g. Annual Premium = Rs.100000, Sum Assured = 25,00,000, 15 yr Endowment policy for a 35 year old
Then (these are approximate figures, meant only for illustration purposes)
Mortality Premium = Rs. 10000
Agent Commission Expense = Rs. 25000
Operational Expense = Rs. 10000
Profit/ Loss = Rs. 5000
Policy Holder Fund ( Investible Surplus) = 100000 – 10000-25000  – 5000         = Rs. 50000
 
Mortality premium is the pure risk premium in case of a fatal event on the life of the insured. This is same premium which will be paid when one insures using a pure term policy for a sum assured of 25,00,000. 
 
Agent Commission/Operational Expense … self explanatory
 
The Investible surplus is the amount which can be invested by the insurance company in G-secs (Government securities)/ Bonds. 90% of the interest generated is distributed in the forms of bonuses. 
 
More on Insurance Primer…

July 2010

The Simple rules to Successful Investing – Part 1

The Simple rules to Successful Investing , Understanding Investing, Stocks, Mutual Funds, Tax, Insurance, Estate, Wills.

“No amount of talking or reading can teach you swimming. You will have to get in the water.”

There are these little general rules which are applicable and useful for decision making and taking actions. And these simple rules are applicable in so many aspects of life, they are just some small reminders, some common-sense stuff which are really useful.

And yes most of them are applicable in investment planning as well.

a. Perfect Plan – Forget it.There is no such thing as a perfect investment plan and no such thing as a perfect time. The right time is now. Tomorrow is and always will be uncertain. Perfectionism is the enemy of action. Do not let perfect investment plan or a perfect time to invest stop you from starting.

b. Analysis Paralysis – Too much thinking will often result in getting stuck.Some thinking is good — it’s good to have a clear picture of where you’re going or why you’re doing this — but don’t get stuck thinking. Just do.

c. Get the Broad Picture and Start. You need to get the broad picture in your mind. You need to understand your future requirements or what do you want to achieve (goals). You need to know the time you have to meet those requirements. And, then you should have the broad plan to meet the goals. Once you have the broad picture. Get going.
All the planning will take you nowhere unless you take that first step, no matter how small it is.

d. Keep things Simple and take Small Steps. Small steps always work. Little tiny blows can break down that mountain. And then each step counts. Keep the big picture in mind, but start by taking small steps.

Understand the advantage of Investing Early here.

The Little Rules to successful action To be contd … Part 2.

“Free Lunch” Seminars—Avoiding the Heartburn of a Hard Sell

"Free Lunch" Seminars,Avoiding the Heartburn of a Hard Sell , Retirement Planning, Investment Planning, Tax Planning, Life insurance selling malpractices.

BEWARE —-Investors frequently get invited to free seminars. These seminars make tall promises. To educate  about investing, or profit from home trading strategies or about managing money in retirement. They also provide VIP treatment , sometimes provide an expensive meal at no cost.

Please remember that , just because someone buys you breakfast, lunch or dinner does not mean you that you have to buy into whatever these guys they are saying. And definitely you need not buy into all what they are selling. Believe me , you will avoid some serious heartburns……… Use your judgment to arrive at a decision later point in time.

The same holds true when specially you go to buy a car. Most people spend a good time looking at the car and take a test drive. Now just because the salesman spent his 30mins — does not mean that you need to buy the car.

The same holds for when you are being sold — Life Insurance, General Insurance, Boutique stores, Electronics etc.

Be careful – If you do not wish to purchase and are being forced into a deal , Use your judgement and Learn to say No – firmly. We live in an age where it is still a buyer’s market – do not forget this.

March 2010

How much Life Insurance do I Need?

How much Life Insurance do I Need, Human Life Value, Need Based Insurance, Term insurance, Dependents, Future requirement, Current assets,You never know what is enough, until you know what is more than enough.  ~William Blake

There are so many people, who ask me the big question: how much life insurance do I need? I have heard it from 21 yr old working in BPO’s, 35 yr old married person with wife and children,from super rich HNI’s and so on.

Many life insurance sales agents who are out selling life insurance start out by asking the following question : ‘How much insurance premium do you want to pay in a year”. Unfortunately many people take up wrong life insurance product on the basis of thier premium paying capacity.

My advise to you is that if you come across such life insurance agent, simply get up and walk away. Insurance is a need and should not be reverse engineered. The sum assured has to be decided first. And then the appropriate life insurance product has to be chosen. So, this leads us to the question – How much life insurance do I need?

If at all you are looking for insurance coverage, and truly there is a need, then the term life insurance is the way to go. All Other types of policies have some kind investment built into the insurance policy and may turn out to be inadequate. Term policies are simple to understand. They offer a certain amount of coverage over a certain period of time. If you die within that time period, your beneficiary will receive the value of the insurance. Period. As simple as that. Pure insurance.

Point number 1Not everyone needs life insurance. The Super Rich HNI’s or People who have accumulated enough wealth throughout their lives often might have no need for life insurance as they’ve accumulated enough wealth on their own to sustain their family. Also, people with no dependents often have little need for life insurance.

The important question – how much insurance do I need? The following pointers should help in answering this all important question:

(A) Income shortfall for the dependents – How much money each year would your survivors need to maintain their current standard of living? Take into consideration the annual expenses like home loans , auto loans, Rent, Debt repayment, education expenses, household running expenses, entertainment expenses, home maintainance, general insurance, and various other expenses (which are recurring in nature) and add them up.

(B) Time for which they need this income – If children are young, it will be quite a while (say 20 yrs or so). If you just have a spouse, the need might not need it for as long. For parents, get a term which is long enough so that the children become independent before the term expires. Shorter terms tend to have cheaper monthly premiums, but you may find yourself buying a new, more expensive policy in 10 or 20 years time frame. Remember the younger you are the cheaper are the insurance premiums. Of course, one can plan to increase the policy in a staggered manner in 5-10 years depending on the major changes in life)

(C) Future Lump Sum requirements: Things which should be considered : child education cost in future (Graduation/ Post Graduation), child marriage cost in future,  any special care needs (for example, taking care of elderly parents after you’re gone?).

(D) Current Assets – how much do you have now? What’s in your savings? Your investments (FD’s, Provident Fund, Mutual Funds, Stocks, Real Estate)? What other insurance policies do you have? Will the dependents be willing to sell off the house and downgrade or would you like them to maintain the current lifestyle?

The above pointers are essentially doing a Gap Analysis and Identifying the Gap. A*B + C – D That’s how much life insurance you should have, Roughly speaking, which will be required to plug the Gap. Please read the time value of money in my previous post (What is Time Value of Money) , to better understand future value requirements and converting them to present value. This will help you to arrive at proper numbers.

In case of unsure of certain numbers, you can make a rough estimate. It is always better to make the estimates on the upper side rather than letting your loved one’s down in case if ever the unfortunate event were to happen.

Finally , be aware that life insurance is bought for the benefit of loved ones. Having sufficient cover provides you with a peace of mind.
Do the calculations, ask pertinent questions to the people selling insurance. Asking the right questions will help in procuring optimal policies. And of course the knowledge will give a good night sleep.

Good luck!
Pls note that the above method is to quickly and roughly estimate the insurance need. Inflation etc, needs to be considered in doing a detailed analysis. In future post, I will cover some quantitative methods  (Human Life Value, Need Based Analysis, Income replacement method etc.) and probably present a spreadsheet with case study which will help you in actually understanding the doing the calculation.

You will find this post on (What is adequate life insurance coverage) interesting.

February 2010

What is adequate life insurance coverage?

What is adequate life insurance coverage,foundation of financial planning, current liabilities, financially secure the foreseeable future, .

“Death is certain and Life is uncertain.”

You work hard, You earn , You save. You plan and have dreams. You do this to secure your future and the future your loved ones.

However, your untimely demise, can jeopardize the future of your loved ones. Emotional needs, of your loved ones and your dependents cannot be replaced or compensated.
However in case of financial needs, you can always plan ahead, so that your loved ones are left behind with adequate financial resources to take care of their future needs. This is all the more important in case you have dependents who are financially dependent on you (like your non-working spouse, children , old parents etc.).

This is where “adequate”  insurance of  “life” assumes such a significance.
Life Insurance is the foundation of financial planning and you should ensure that it is properly planned, first.

Many a times , I am truly surprised when I ask clients and people about their insurance coverage. I get responses like the following :
“I believe I am adequately covered” (– Salary 20Lacs/yr, Home Loan 40K / month, Car Loan 3Lacs, 2 young school kids, Insurance coverage – sum assured around 40Lacs ONLY – 2 policies, annual premium around 2Lacs) And he believes he is adequately covered. Badly mistaken……………

“I have one investment flat, and one flat in which I currently live – In case something happens to me , my wife can sell that flat and that can easily service the needs of the future”. I told him, why does he need to wait for his death, in order to sell the flat. Why is he not doing it now.? An hence why should his spouse sell the property to finance family needs ……………? This person understood the crux and went ahead to increase his insurance………….

“My father tells me about the futility of insurance – See, he is 65 yrs of age and he is still going hale and hearty” – This is such a stupid response. It is really difficult to believe seemingly intelligent people making such comments………….

“I will get 20Lacs at the end of the policy” Upon asking , how much money his wife will get in case he were to die today  – His reply was ” I do not know, I will have to check my policy”. He does plans his weekend outing to Lonavla and Khandala or other places near Mumbai along with friends meticuluosly. But hey , no plans for life………

” I have a child insurance policy which will give me 15 Lacs in due course apart from my endowment life policy of 20Lacs” Again , this fellow has been sold into these policies is paying roof high premiums for paltry insurance. And by the way, why insure your child , when you yourself are inadequately covered. Also does one really need child’s life to be insured to cover financial needs. No……….

” I have a ULIP (Unit Linked) policy and the agent has promised me guaranteed (LOL……..) returns in next 15 years” ……… I am sure the agent also must be laughing his way to the bank ………..

” I had bought policy from LIC to to save taxes. And I am happy to save on taxes”Now buying insurance just to save taxes is one of the worst mistakes one can make. Buying Life insurance to save taxes or to invest is just not right………

These are responses of intelligent,hardworking , well educated people. However, they fail to get the financial planning act together. I am sure that they can also put in little extra effort to get this part right as well.

As you can see, all the responses above have one underlying theme – all of the different sets of people have inadequate Life Insurance coverage. In some  cases unplanned, some have planned but due to thier ignorance have been sold products which will truly not help in case of insurance.

Let us face it , no one likes to really think about his own death. However, the truth also cannot be denied that death is indeed certain.It can happen in (a) normal course of time (let us say avg 70yrs)  (b) earlier in an untimely fashion (let  us 30 -45yrs) — this is prime time when dependents really need you (c) or later than normal. (>85+ yrs)

All the three cases can be properly planned for.

So, that brings us to the question — What is adequate life insurance coverage?

Simply put, an adequate life insurance coverage should cover the current liabilities of the descedent and should financially secure the foreseeable future needs of the dependents in such a way that the lifestyle of the dependents remains unaffected going forward and life goes on normally as if nothing truly happened……………..

Later we will see , how much insurance do you need. Or How to arrive at the magic figure of sum assured. You can read the post here at How much life insurance do I need?