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NTRODUCTION TO

NSURANCE


By M.Vedavalli
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WHAT IS
INSURANCE?
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WHAT IS INSURANCE?
Insurance from economic
perspective is a financial
intermediation function by
which individuals exposed to a
specific financial contingency
contribute to a pool from
which covered events suffered
by participating individuals are
paid .
Insurance in legal sense is a
contract by which one party in
consideration of the price paid
to him agrees to pay an agreed
amount of money to other
party to make good for the
loss, damage or injury to
something of value, in which
the other part has a pecuniary
interest, by the happening of
certain specified events.
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WHAT IS INSURANCE?
Insurance is an arrangement
between one entity (Insured) and
another (insurance company,
insurer ) to protect the insured
against risk to something of
value in which the insured has a
pecuniary interest . The
consideration paid by the insured
is called premium.
Insurance is a form of risk
management which is used
primarily to hedge against the
risk of a contingent, uncertain
loss.

Risk is the uncertainty
about a situations
outcome- may be an
unpredictable event
which leads to loss or
damage
Risk is a potential
problem it might
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EQUITABLE TRANSFER
Insurance is an equitable
transfer of risk of a
potential loss from one
entity to another in
exchange for a premium.
No Protection of Assets
Only Compensation


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INSURANCE: A SOCIAL DEVICE
Main Function of
Insurance is to spread the
loss over a large number
of persons who are
exposed to a particular
risk.
Co-operative mechanism
Risk not averted
Loss minimised
Transfer of Risk
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NATURE OF INSURABLE RISKS
Large Number of Similar exposure units to be present for spreading the loss as
insurance is subject to the Law of large Numbers. Greater the number of exposures the
actual results will approach more closely the probable results.
Loss caused by the risk must be definite. The peril must produce the loss that is
definite in time or place. Since cost of insurance depends on the extent of hazard.
Occurrence of Loss must be accidental or Fortuitous
Potential of loss must be large enough to cause hardships but not catastrophic.
Cost of insuring must be economically feasible.
Must be possible to calculate the chance of the loss
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ESSENTIALS OF INSURANCE CONTRACT
Essentials
Lawful Offer
and
Acceptance
Legal
Relationship
Lawful
Consideration
Capacity of
Parties
Free and
Genuine
Consent
Others
Legal
Formalities
Lawful
Objectives
Certainty and
possibility of
performance
Requirements of Section 10 of Indian Contract Act 1872.
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FUNDAMENTAL LEGAL PRINCIPLES
OF INSURANCE CONTRACTS
Principle of Utmost Good Faith
Principle of insurable interest
Principle of Indemnity
Principle of Subrogation
Principle of Contribution
Principle of Causa Proxima
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PRINCIPLE OF UTMOST GOOD FAITH -
UBERRIMAE FIDEI
A higher degree of honesty is imposed on an insurance
contract than imposed on other contracts to fully
disclose all material facts.
A material fact is a fact that influence the mind of the
prudent underwriter in assessing a risk.
Honesty is mainly imposed on the insurance applicants.
It is supported by three legal doctrines:
Representation Concealment
Warranty
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PRINCIPLE OF UTMOST GOOD FAITH
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Statements made
by an applicant
Insurance is
voidable at the
insurers option.
Material
False
Reliance
cf: Innocent
misrepresentation
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Intentional failure
to disclose a
material fact
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A statement of fact
or a promise made
by the insured,
which is part of the
insurance contract
and must be true if
the insurer is to be
liable under the
contract.
In exchange for
a reduced
premium, a store
owner warrants
that a burglar
alarm will be
always on.
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PRINCIPLE OF INSURABLE INTEREST
Pecuniary Interest of a person in the subject
matter of insurance. The insured must be in a
position to financially suffer if a loss occurs.
Why?
1) To prevent gambling.
> Insurance on a property and wait for a loss
to occur.
2) To reduce moral hazard.
> Life insurance on a person and pray for
his/her death for insurance proceeds.
3) In order not to indemnify more than an
insureds financial interest.
> It supports the principle of indemnity.
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PRINCIPLE OF INSURABLE INTEREST
Property-Casualty insurance
At the time of a loss, an insured must have insurable interest.

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Life Insurance
Insurable interest must exist at the time of a policy inception,
but not at the time of a loss (death)
No
insurable
interest
no financial
loss
no
indemnity
Support
Principle of
Indemnity
Marine Insurance: Insurable interest either at the time of making the contract
or at the time of making the claim.
Fire Insurance: It should be present at both ends
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PRINCIPLE OF INDEMNITY
The insurer agrees to pay no more than the actual amount
of the loss suffered by the insured.
Why?
The purpose of the insurance contract is to restore the insured
to the same economic position as before the loss.
The insured should not profit from a loss.
It reduces the moral hazard by eliminating the profit
incentive.
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PRINCIPLE OF INDEMNITY
To support the principle of indemnity an
insurance contract uses Actual Cash Value
(ACV) method.
Broad evidence rule
The determination of ACV should include all relevant factors
an expert would use to determine the value of the property
Replacement cost (RC) less depreciation
RC current cost of restoring the damaged property with new
materials of like kind and quality.
Fair market value
The price, a wiling buyer would pay a willing seller in a free
market.
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Repair to the satisfaction of the Insured.
Reinstatement: Restoration or rebuilding to the original
condition in fire insurance cases


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PRINCIPLE OF INDEMNITY
To support the principle of indemnity insurance
contract includes Other Insurance Provisions.
Escape clause
The policy (or insurance) would not apply if the insured was
covered by another policy.
Primary-Excess
It (or This insurance) is excess insurance over any other valid
and collectible insurance.
Pro-rata provision
Proration by face amounts
Proration by amounts otherwise payable
Contribution by equal shares
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PRINCIPLE OF INDEMNITY
Pro-ration by Face Amounts
It limits an insurers maximum obligation to the
proportion of the loss that the insurers policy limit bears
to the sum of all applicable policy limits.
Assume that there are three polices covering the same loss
and the loss amount is Rs.150,000.
Insurer A Insurer B Insurer C
Policy Limit Rs.100,000 Rs.200,000 Rs.300,000
Share 1/6 2/6 3/6
Payment Rs.25,000 Rs.50,000 Rs.75,000
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PRINCIPLE OF INDEMNITY
Pro-ration by Amounts Otherwise Payable
The amount what would be payable under each policy in
the absence of other insurance
Assume that there are three polices covering the same loss
and the loss amount is Rs.150,000.
Insurer A Insurer B Insurer C
Policy Limit Rs.100,000 Rs.200,000 Rs.300,000
Payable Rs.100,000 Rs.150,000 Rs.150,000
Share 1/4 1.5/4 1.5/4
Payment Rs.37,500 Rs.56,250 Rs.56,250
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PRINCIPLE OF INDEMNITY
Pro-ration by Amounts Otherwise Payable
What if the loss amount is Rs.60,000?
Insurer A Insurer B Insurer C
Policy Limit Rs.100,000 Rs.200,000 Rs.300,000
Payable Rs.60,000 Rs.60,000 Rs.60,000
Share 1/3 1/3 1/3
Payment Rs.20,000 Rs.20,000 Rs.20,000
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PRINCIPLE OF INDEMNITY
Contribution by Equal Shares
Each insurer contributes equal amount until it has paid its
applicable limit of insurance or none of the loss remains,
whichever comes first.
Assume that there are three polices covering the same loss
and the loss amount is Rs.150,000
Insurer A Insurer B Insurer C
Policy Limit Rs.100,000 Rs.200,000 Rs.300,000
Equal Share Rs.50,000 Rs.50,000 Rs.50,000
Payment Rs.50,000 Rs.50,000 Rs.50,000
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PRINCIPLE OF INDEMNITY
Contribution by Equal Shares
What if the loss amount is Rs.400,000?
Insurer A Insurer B Insurer C
Policy Limit Rs.100,000 Rs.200,000 Rs.300,000
Equal Share 1 Rs.100,000 Rs.100,000 Rs.100,000
Equal Share 2 N/A Rs.50,000 Rs.50,000
Payment Rs.100,000 Rs.150,000 Rs.150,000
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PRINCIPLE OF INDEMNITY
Valued policy (or
agreed value)
Pays face value
of insurance if a
total loss occurs
Life insurance,
disability
insurance, fine
arts, antiques
eg. Value of a
fine art is
agreed at
Rs.250,000.
Valued policy
law
A law that
requires
payment of the
face amount of
insurance to the
insured if a total
loss to real
property occurs
from a covered
peril, regardless
of the propertys
ACV.
Replacement cost
No deduction
for depreciation
in determining
the amount paid
for a loss.
Exceptions to the Principle of Indemnity
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DOCTRINE OF SUBROGATION
Substitution of the insurer in place of the insured for the
purpose of claiming indemnity from a third party wrongdoer
for a loss paid by the insurer.

Why?

To prevent collecting twice
To hold the negligent party responsible
To hold down insurance rates
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PRINCIPLE OF SUBROGATION
The insurer is entitled only to the amount it has paid
under the policy.
What if the insurer collects more, from the negligent party,
than the amount the insurer paid to its insured?
The insured cannot impair the insurers subrogation rights.
Subrogation does not apply to life insurance and to
individual health insurance contracts.
The insurer cannot subrogate against its own insured.
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PRINCIPLE OF CONTRIBUTION
According to this principle, the insured can claim the compensation
only to the extent of actual loss either from all insurers or from any
one insurer. If one insurer pays full compensation then that insurer
can claim proportionate claim from the other insurers who have
covered the same loss.
4 essential conditions for the application of this doctrine are:
The insured must be the same person.
The policies concerned must all cover the same risk which
has caused the loss.
The policies must protect the same interest.
The policies must be in force at the time of loss
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The principle states that the active and most efficient cause that sets in motion
a chain of events which brings about a result, without the intervention of any
force started and working actively from a new independent source.
The Principle of Proximate (i.e Nearest) Cause, means when a loss is caused
by more than one cause, the proximate or the nearest or the closest cause
should be taken into consideration to decide the liability of the insurer.
To find out whether the insurer is liable for the loss or not, the proximate
(closest) and not the remote (farthest) must be looked into.
To entitle an insured to recover, the chain of events from an insured event
leading from the insured peril to actual financial losses suffered by the insured
must be unbroken.

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PRINCIPLE OF CAUSA PROXIMA - APPLICABILITY
Suicide within one year of
policy: Payment restricted
only upto the interest of 3
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party, provided interest of 3
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party expressed atleast one
month prior to the suicide.
Accident Benefit : when
an insured under
accident policy is killed
or suffered an injury
which has an immediate
cause and also a remote
cause. Double the policy
amount paid.
War Risk: Where policy
is issued on exclusion of
war risk, the proximate
cause of death is
important.
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Financial support sufficient to
replace loss, not to create gain
Loss is limited to the amount
of premium for the limit upto
which the carriers would
accept to insure.
Existing risk transferred
Insured are risk avoiders
Risk mitigation practices to be
put in place in some cases.
Greater predictability
Possibility of either loss or
gain
Gamblers may buy more risk
than they can afford to pay for.
Gamblers create new risk
transfer.
Risk seekers.
No risk mitigation
Cant be predicted.
Insurance Wagering/Gambling
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IMPORTANCE OF INSURANCE TO BUSINESS
Instrument of Employees Welfare Attracting and retaining
employees- Injury, Disability, old age Group Insurance
Loss of key person
Credit Enhancer
Security,stability and Peace of Mind
Economic risks
Consumer spending
Supplier risks
Protecting intellectual property
Credit risks
Operational risks
Catastrophic risks
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INSURANCE AND SOCIETY
Equitable Spreading of Risk
Accelerates the Process of
Economic Growth
Encourages Foreign Trade
Enhances Invisible Exports
Solving Complex Social
Problems
Spreading Education
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WHY IS IT IMPORTANT TO HAVE INSURANCE?
Helps limit financial losses
when a loss/damage/injury
occurs
Helps an individual/family be
prepared for the unexpected
Plays a large role in most financial
management plans-
Profitable investment and
Good tax planning
Insurance is a
source of
Peace of Mind
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GENERAL USES OF LIFE INSURANCE
1.
Create an estate
2.
Pay taxes at death
3.
Income replacement
4.
Capital loss due to death
5.
Fairness at inheritance time
6.
Provide for retirement funds
7.
Excellent for business transfers
8.
Gifts to charities
9.
Payoff mortgages, guarantees, loans
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CLASSIFICATION OF INSURANCE
LIFE Non_Life Social
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TYPES OF INSURANCE
Types of
Insurance
Automobile
Health
Life
Disability
Homeowners/
Renters
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LIFE INSURANCE
Life insurance is a contract
between an insurer and
policyholder specifying a sum
to be paid to a beneficiary
upon the insureds death or
excessive longevity.
A beneficiary is the recipient
of any policy proceeds if the
insured person dies.
Provides money for family
members or dependents when a
wage earner dies.
A dependent is a person who
relies on someone else
financially.
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WHAT IS AN INSURANCE POLICY?
A policy is a contract between
the individual and the insurer
specifying the terms of the
insurance arrangements
A policyholder is a consumer
who purchases the policy
A premium is a fee paid to the
insurer to be covered under
specified terms outlined in the
policy
A deductible is the amount
paid out of pocket by the
policyholder for the initial
portion of a loss before the
insurance coverage begins- the
deductible is stated in the
policy
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AUTOMOBILE INSURANCE
Automobile
Insurance
Liability
insurance
Medical payment
insurance
Uninsured or
underinsured
motorists
insurance
Physical damage
insurance
Collision Comprehensive
arrangement between an individual
(consumer) and insurer (insurance
company) to protect the individual
against risk from automobile accidents
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HEALTH INSURANCE
Health insurance provides
protection against financial
losses resulting from injury,
illness, and disability.
May cover hospital,
surgical, dental, vision,
long-term care, prescription,
or other major expenditures.
Specific coverage depends
upon the individual policy

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Why is it important to have Health Insurance?
Health care costs are extremely high
Large medical expenses could deplete an individuals savings
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HEALTH INSURANCE
May be purchased by the
individual or through their
employer
Individuals often seek
coverage for dependents
(spouses and children)
Many health insurance
policies offer dependent
coverage but there is no
requirement to do so

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DISABILITY INSURANCE
Disability Insurance
replaces a portion of
ones income if they
become unable to work
due to illness or injury
Insurance typically pays
between 60-70% of ones
full-time wage
Factors such as the length
or severity of a disability
influence the percentage
of income a person will
receive
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HOMEOWNERS INSURANCE
Homeowners
Insurance -combines
property and liability
insurance into one
policy to protect a home
from damage costs due
to perils
Peril -an event which may
cause a financial loss like fire,
falling trees, lightning and
others
Property Insurance -protects
the insured from financial
losses due to destruction or
damage to property or
possessions
Liability Insurance- protects
the insured party from being
held liable for others financial
losses
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RENTERS INSURANCE
Renters Insurance protects
the insured from loss of the
contents of the dwelling rather
than the dwelling itself.
Necessary because a landlords
insurance policy on the
dwelling does not cover the
renters personal possessions.
Covers major perils, provides
liability protection and
provides for additional living
expenses if the dwelling is
rendered uninhabitable.

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FIDELITY INSURANCE
A contract of Guarantee
to which insurance
principles apply
Guarantees the employer
for any damages or loss
resulting from the
employees dishonesty or
disloyalty.
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INSURANCE NEED ANALYSIS
By M.Vedavalli
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LIFE STAGE ANALYSIS
It is important to
understand that according
to the typical life cycle
stage one currently is in ,
insurance needs change .
So it is vital that one
knows the financial
commitments and long
term financial needs
before choosing a
product.
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MOST COMMON LIFE CYCLE STAGES
Ages 18 to 26 years ( unmarried ,
young professionals )
Still be in higher education
First job
May or may not have spouse
May or may not own home
May or may not have dependents
Financial needs
May still have support from parents
May be saving towards future
Family needs eg. Buying home
May be paying off education loan
Likes to spend money

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YOUNG PROFESSIONAL
Life insurance needs are probably
zero as no dependents
There is possibly a need for
saving .
can take Equity Linked Insurance
Scheme ( Insurance + Investment)
Short Term Endowment
Assurance Policy
Insurance Needs:-
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POST MARRIAGE
Ages 26 to 35 ( married , with or without kids )
Probably in debt ( ex. Home loan )
Earn moderate income
high expenditure
Not much accumulated wealth
financial status
Worried about protecting dependents in case of
prolonged illness or disability
Need to save for children
Need to support elderly parents
Need for planning a comfortable retirement phase
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This stage needs
maximum insurance
protection because of
:
High debt , high
expenditure phase
Familys dependency
Low accumulated
wealth
Need for planning
retirement phase
Insurance needs are due to:
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POST MARRIAGE
Ages above 35-60 ( pre-
retirement )
Older , financially independent
children
Reduced debt or repaid loans
Decreased expenditure
financial needs
save for retirement
Enjoy a life time holiday on
retirement
Save for children
Protect dependents financially
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POST MARRIAGE AND PRE RETIREMENT
Insurance needs
Retirement planning
Wealth transfer or other saving vehicles could be used .
Emphasis should be on returns on investment
Fixed Term Insurance, Money Back Policies, Children
Policies ULIP
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POST RETIREMENT
Ages over 60 (post retirement)
Move from employment to
retirement.
Debts either paid off or
minimal.
Reduced income
More accumulated wealth,
savings
Risk of running out of money
in case of long life span.
Need for long term care
Financial needs-
Need to save for spouse , for
medical expenditure of both ,also
save for children
Need to save if you live longer
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POST RETIREMENT
Insurance needs
Protection in case you
live long
Protection for spouse in
case of death
Wealth accumulation for
children
Single Premium
immediate annuities,
retirement plans which
protect capital and give
steady income.
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DETERMINING THE AMT. OF LIFE INSURANCE
Simple rules of thumb
/Income replacement Value
Human Life Value
Approach
Need Replacement concept
Methods of Insurance Need
Analysis
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INCOME REPLACEMENT VALUE
Simple guidelines that can be
easily applied to a situation
Easy to use and provide a
starting point for insurance
need evaluation .
Income Rule
Annual Income X Number of
years left for Retirement
Another rule is the insurance
requirement is10 times of gross
annual income (10 is called
Income Replacement
Multiplier)
Income replacement
Multiplier changes with
age:

AGE INCOME MULTIPLIER
25-30 5-10
30-40 15-20
40-50 10-15
50-60 5-10
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METHODS OF INSURANCE NEED ANALYSIS
Income plus expenses-
This rule considers gross annual income along with cash
needs at death and any special funding needs such as
private school or tuition fees.
Under this rule the insurance requirement is 5 times the
gross annual income plus the total of any mortgage ,
personal debt , final expenses etc.

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METHODS OF INSURANCE NEED ANALYSIS
Premium as a % of income-
Under this rule , 6 % of the earning members gross
income plus an additional 1 % for each dependent should
be spent on life insurance .
Ex. For an earning member with a non-earning spouse
and 2 dependents , the insurance premium would be ???
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METHODS OF INSURANCE NEED ANALYSIS
Disadvantages of rule of thumb
They fail to consider the need and
circumstances of the individual .
No considerations of age of the insured or
the dependents
No adjustment is made for special
circumstances .
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HUMAN LIFE VALUE APPROACH
Also called Income Replacement approach.
Every individual has a human life value and insuring
human life value is primary purpose of insurance.
an individuals net worth is the PV of that persons
future income stream that will be allocated to fulfill the
lifestyle needs of people dependent on them .
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HUMAN LIFE VALUE APPROACH
1. Estimate the individuals average annual income from
the persons present age to retirement.
2. Deduct the amt. that is not allocated to others eg.
Income tax self life and medical insurance premiums ,
self maintenance expenses.
3. Using reasonable rate of interest determine the PV of
the amounts allocated to others for the working period
used in step 1 .
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HUMAN LIFE VALUE APPROACH
Mr. A aged 35 , earning gross income of Rs.2 lac today
will retire at the age of 65 . His personal expenses are Rs.
56000 . Current interest rate in the economy is 8 %.
Calculate HLV of Mr. A.
PV is Rs. 16.21 lacs .
Thus if MR. A doesnt return home today , his family
will lose earning , whereas they have Rs.16.21 lac
deposited earning 8 % interest , then the family will be
able to withdraw Rs. 1,44,000 every year for 30 years , at
the end the amt. will be nil.
Thus , HLV is Rs.16.21 lac
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HLV APPROACH -CONCERNS
It does not take
into account actual
needs in future .
It does not
integrate with
pension plans or
other sources of
income .
Considers only
replacement of
income and net the
lumpsum needs in
case of death.
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FAMILY NEEDS APPROACH
It assumes that the goal of life insurance is to cover the
surviving family members immediate expenses after the
death of the insured as well as the ongoing expenses of
the family members in future .
It focuses on surviving members financial needs rather
than the expected earnings of the insured .
Familys needs are divided in 2 categories
1. Immediate needs
2. Ongoing needs
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FAMILY NEEDS APPROACH
immediate
needs at
death
pv of ongoing
family needs
expected
available
assets
Life
insurance to
meet family
needs
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NEED ANALYSIS WORKSHEET
Tool to facilitate making of Need Analysis
Provides an opportunity to refine the assessment of life
insurance needs and arrive at a Profile after assessing
various parameters and grading them
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UNDERSTANDING KEY CONCEPTS
Risk cover v/s investment
returns
Insurance options range
from low premium policies
with that offer almost no
returns, to high premium
ones that offer returns
depending on the fund option
you choose. Buy policies
skewed towards investment
returns only if you are in the
high-tax bracket, prefer to
invest in low-risk, fixed-
income options
Whole life v/s limited period
As you grow older, the
number of dependants may
decrease (since children
would be independent). Also,
your wealth may reach a
level where it can support
your dependents financial
needs in the event of your
death. You should therefore
consider whether if you need
to insure yourself for whole
life or for a limited term.
Obviously, the cost of
insurance for the latter is
lower.
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UNDERSTANDING KEY CONCEPTS
The premium paid for an insurance policy also qualifies
for tax deduction under Section 80C of the Income Tax
Act. But don't buy insurance only to save tax. Read why
insurance + investment + tax = a bad combo!
How long do you want to pay your insurance premium
for? This decision depend on the following factors:
1) How many years of regular income you expect.
2) Level of your regular savings.
3) How much insurance premium you can firmly commit
to.
4) How long you want to be insured versus how long you
expect to pay a premium for.
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UNDERSTANDING KEY CONCEPTS
Other important questions:
1) Do you want to participate in bonus/ profit share?
2) What is the primary objective - risk cover or
investment returns?
3) Do you want accident cover?


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THANK YOU!!!
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