Why Term Plan? & Basics of Insurance

Recently, one of my friends died due to accident. Hemant was just 33 and was heading family owned business in Mumbai. He is survived by his home maker wife Rohini aged 30 and 1 kid aged 7.

He used to contribute 1 Lakh per month for the family. His monthly cash flow was as follows.

EMI for the Business Loan – 30,000
House hold expenses – 28,000
Parents’ Support – 20,000
Life Insurance premium – 5000
Mutual Funds Investments – 17,000

He was staying in own house which was a ancestral property and were leading a quality life. Kid is studying in good school.

He was paying an insurance premium of 5000 per month for a life insurance policy of 12 Lakhs. The insurance company settled the claim of 12 Lakhs.

Rohini has deposited this amount of 12 Lakhs in a bank. She is getting around 6,000 per month as interest on it. Now the family is living on this. But she finds it difficult to manage the schooling of the kid with this income. She is planning to shift the kid to another school from next academic year.

If they want to maintain the same standard of living, there should be an inflow of 28,000 per month. Instead of 12 Lakhs, if there were 44 Lakhs in bank, she will be getting 28,000 as monthly interest.

In simple words, Hemant should have insured his life for 44 Lakhs.

Is it sufficient? In the above calculation, I have not considered the effect of inflation, possibility of reduction in interest rates etc. Assuming these 2 factors into consideration, the amount required to ensure an inflation adjusted withdrawal of 28,000 per month for the next 50 years (till she is 80) is around 1.3 Crore. Here I have assumed that the amount of 1.3 Crore will generate a return of 1% above the inflation.

So, this is the amount Hemant would have looked at instead of 44 Lakhs. He was planning to provide for 10 Lakhs in today’s cost for the higher education of his kid when she reaches age 17. For that he was investing in mutual funds. If you consider this goal also into account Hemant would have insured his life for 1.5 Crores.

Had he insured his life for 1.5 Crore, now his family will be getting 1.5 Crore as death claim. Rohini can invest 20 Lakhs for the children higher education needs and use the balance 1.3 Crore to ensure same standard of living till she is 80.

Now, let us check the premium for a 1.5 Crore policy. He was paying a premium of 5000 for a 12 Lakhs policy. Going by that rate, the premium for a 1.5 Crore policy will be around 62500 per month, which is not affordable to him.

Is there any alternate to insure life at a lesser premium? Yes. He could have opted for a term insurance policy.

What is Term Insurance?
In this policy, there are no maturity benefits. In simple words, you will not get anything at the end of the policy. But if you die during the term of the policy, your nominee will get the policy amount immediately.

If you are 35, the annual premium for a 1.5 Crore policy will be around 18,000. If you pay this premium every year from 35 to age 60, your family is sure about the payment of 1.5 Crore in case of your death. But if you live upto age 60, nothing is payable from this policy. You will be losing the premium of 4.5 Lakhs paid during these 25 years.

This is the only way to ensure adequate life insurance for a person. The amount of 18,000 per year (1500 per month) is to be considered as the price you are paying for the peace of mind you are getting in ensuring a decent living for your spouse and kids in your absence. After all, this 1500 per month is just the cost of a weekly outing.

Precautions while purchasing term policy

Insurance is based on the concept of ‘Utmost Good faith’. You are supposed to disclose your health/habits etc correctly while applying for an insurance policy. For example, if you are diabetic, or having hypertension don’t forget to mention these in the proposal form. Similarly if you are a smoker or consume alcohol, mention these in the proposal. The insurance company may charge a higher premium depending on your health/habits. It is called loading. This prompt disclosure is important to avoid confusion later. If you are hiding these details at the proposal stage, there is a possibility of claim rejection in future. Be 100% honest while purchasing the policy.

Claim Settlement Ratio

This is the ratio of clams settled out of claims reported. The higher the ratio, the better it is.

Some companies are claiming that their claim settlement ratio is highest in the industry. Suppose the claim settlement ratio of company A is 98% and for company B it is 90%. As a heart patient, if you purchase a policy from company A without mentioning this issue and die after 2 years the claim will be rejected. So, you will be within that 2% rejection of company A.

But if you are purchasing the policy from company B with prompt disclosure, your claim will be settled. This is because you will fall under the 90% of company B.

More than claim settlement ratio, prompt disclosure from your side is more important in insurance. You may purchase the policy from the company of your choice with prompt disclosure.

If the claim is rejected, there are many options for the claimants to represent the case. They can approach the grievance cell of the insurance company, insurance ombudsman or consumer forum with appeal. Normally all genuine claims will be settled.

Ensure Prompt Nomination

While purchasing the policy, ensure that you are nominating your legal heir as the nominee. If you are purchasing the policy before marriage and nominate parents as nominee, it is better to change the nomination in favour of your spouse after marriage. Remember, you can change nomination anytime and the nominee has a role to play only in case of your death.

Inform the nominee the following

I have purchased a policy for Rs. X from company ABC and as a nominee you are eligible to get Rs. X after my death.
The policy number, premium amount and the due dates of premium.
Where you are keeping the policy document
The contact details of company ABC to be contacted in case of your death.

Why term policies are not popular in India?

We feel that we are losing the premium in term policy because there is no maturity benefit. But see the large benefit in case of death of the bread winner! This is the only way to ensure a decent life insurance cover for a person at an affordable premium. If you really love your family, purchase a term policy of decent value when you are alive and healthy.

The main reasons for the low popularity of term policies are

1) Agents are not interested in selling this policy because of the low premium and the small commission involved.
2) Low awareness about the real benefit of term policy.
3) Feeling that you are not getting anything on maturity and losing the premium paid.
4) Emotional issues like wife saying – I don’t want any amount because of the death of my husband.
5) If every wife knows what a widow feels, no husband will remain uninsured.

It is high time that you should purchase a term policy and ensure all earning members in the extended family and friends circle are insured for a decent amount. Infact government can think of making it mandatory as a social security measure so that no family will suffer in case of death of the breadwinner.

Savings linked life insurance policies

The aversion to term policies by Indians motivated life insurance companies to innovate and come out with policies with maturity benefits along with death benefit.

Let’s understand this with an example:

If you are aged 35 and purchasing a 20 year endowment policy of 10 Lakhs, the annual premium will be around 50,000 per year. You have to pay 50,000 for the next 20 years and you will be getting the following at age 55.

Sum assured – 10 Lakhs
Bonus – 8.4 Lakhs
Total – 18.4 Lakhs

Bonus is declared by the insurance company every year based on its profitability and claim experience. In the above calculation, I have assumed a bonus rate of Rs. 42 per thousand sum assured. Since it is a 10 Lakhs policy, the bonus for a year will be 42,000. If you are getting the same bonus for the next 20 years, you will get 42,000 x 20 = 8,40,000 as bonus.

Let’s calculate the rate of return on this policy. It is around 5.5%. This is a pathetic return for a long term investment.

Please note that the bonus is not guaranteed and it can change every year. Since the interest rates are coming down in India, there is all possibility of a reduction in bonus rates in the near future.

Now, let us understand the benefits from this policy in case of your death. Your nominee will get the sum assured of 10 Lakhs and bonus accrued till date of death. Suppose the death happens at age 40, your nominee will get the following

Sum assured – 10 Lakhs
Bonus for 5 years – 2.10 Lakhs (42,000 x 5 = 2.10 Lakhs)
Total – 12.10 Lakhs

Will this 12 Lakhs is sufficient for the family in your absence? No.

This policy is not good as investments due to poor returns and not good for risk cover due to the low insurance cover it offers.

Who benefit from this policy?

When you are paying 50,000 as the first year, premium, your agent is getting around 25-30% of it. 12,500-15,000/- is going to his pocket. From second year, the commission is around 5%. The agent is getting 2500/- every year as long as you pay the premium. In the 20 year policy, the agent is getting 65,000/- in total!

This is the reason why agents and banks are trying to sell insurance policies.

What you can do?

Instead of paying 50,000 premiums under such policy, you can purchase a 1.5 Crore term policy by paying 18,000 per year. The balance amount of 32,000 can be invested in a mix of equity & debt as per your risk taking capacity. If you are investing 32,000 per year in an equity mutual fund, you can expect around 23 Lakhs assuming 12% returns. Please note that many good mutual funds have given 20% returns in the past 20 years.

In case of unfortunate death, your family will get 1.5 Crore immediately. This amount can really help your family in maintaining the standard of living in your absence.

This combination of term policy & mutual fund is beneficial both in case of death and maturity.

Different types of savings linked policies

To make it attractive, insurance companies are offering many types under this category. The most popular ones are the following:

Endowment Policy

In this policy, the sum assured and the bonus is payable at the end of the policy term. In a 20 year policy, you will get this at the end of 20 years as explained above.

Money back policy

In this policy, you will be getting certain percentage of the sum assured at different intervals. A typical 20 year money back policy will give you 20% after 5 years, 20% after 10 years, 20% after 15 years and 40% along with bonus at the end of 20 years. In case of death in between, the nominee will get the full sum assured irrespective of the payments made already. The premium under money back policy is high compared to endowment policy.

Children policies

This is sold in bulk on emotional appeal. The benefits under this policy are paid in instalments during the higher education of the child. In some cases, there is an option to waive the premium in case of unfortunate death of the parent proposer.

Pension policies

In this policy, the benefits are paid out as pension during your retired life.

Unit Linked Policies (ULIP)

In this policy, the insurance company is investing your premium in a mix of equity & debt instruments as per your mandate. ULIP policy can give better returns compared to other types of policies discussed above.

But there are many charges which are deducted from your policy, which will reduce your effective return.

Draw backs of savings linked policies

The main draw backs of savings linked policies are:

Lack of flexibility

Once you join for a 20 year policy and later, if you are not happy with the policy, exit options are limited. If you stop paying the premium in the first 3 years, you will not get anything back under most of the traditional policies. If you surrender the policy after paying premium for 3 years, then you will get only 30% of the premiums paid. After paying 50,000 for 3 years (1.5 Lakhs), you can exit the policy with just 45,000 as surrender value.

In ULIPs, you will not lose the premium paid, if you stop paying the premium within 3 years. The fund value will be moved to discontinuance fund and it will be payable to you on completion of 5 years from the start of the policy. During this period, you will get around 4% returns on the fund value.

If you want to surrender the policy after 5 years, you will get the fund value immediately.

If your fund is not performing the only option for you is to surrender and take the money out.

In both these cases, you can understand that there is no flexibility. But if you opt for a combination of term policy & mutual funds, you have 100% control on your money. If a new insurance company is offering a term policy with lesser premium, you can opt for that and just drop the existing policy (subject to your good health at that time). If your mutual fund is not performing, you can just sell it and reinvest in better funds without any difficulty.

Lower returns

In traditional policies, the returns will be in the range of 4-5% only. This is because the investment is happening mainly in debt products and a good amount is going towards commission and other expenses of the insurance company.

In ULIPs, there are many charges. When you pay Rs. 100/-, full amount is not invested in your account. The company deduct premium allocation charges from your premium and only the balance is invested. If the allocation charge is 10% only Rs. 90/- is invested in your account. There are other charges like policy administration charge, fund management charge and mortality charge etc. These charges are deducted by way of cancellation of units from your account. You will not understand it unless you verify the fund value statement carefully.

If you just check the percentage return on your Net Asset Value, it will not reflect the reduction in number of units due to various charges. Even if the fund is performing well, your actual return will be much less due to the cancellation of units.

Conclusion

The only policy you require from a life insurance company is a basic term policy. Buy it online to get the advantage of lower premium. All other policies are not beneficial to you. It will help only the insurance company and the agent.

#Weekend Reading Behavioral Biases

Creating and managing a portfolio by the investor requires investment decisions to be made on which asset classes to invest in, how to invest, timing of entry & exits and review & rebalancing the portfolio. These decisions have to be based on the analysis of available information so that they reflect the expected performance and risks associated with the investment. Very often the decisions are influenced by behavioral biases, which lead to less than optimal choices being made. Some of the well documented biases that are observed in decision making are;

Greed and Fear

These are the most common biases impacting the retail investors. Investors enter the market when prices are already high and sell when the market bottoms out; thereby losing in both the scenarios and finally concluding “equity is the worst investment class”. Few who exercise patience overcomes these biases and emerges as winners.

Loss Aversion: The fear of losses leads to inaction. Studies show that the pain of loss is twice as strong as the pleasure they felt at a gain of a similar magnitude. Investors prefer to do nothing despite information which may lead to a loss. Holding on to losing stocks are manifestations of this bias.

Over confidence Bias: Investors cultivate a belief that they have the ability to outperform the market based on few investing successes. Such winners may be the outcome of chance rather than skill. If investors do not recognize the bias, they will continue to make their decisions based on what they feel is right rather than on objective information and lose out in the long run.

Familiarity Bias: This bias leads investors to choose what they are comfortable with. This may be a familiar asset class, stocks or sectors that they have greater information about. Investors holding only real estate or a stock portfolio concentrated in shares of a particular company or sector are demonstrating this bias. Since other opportunities are not explored , the portfolio is not diversified enough to mitigate the risks of a concentrated portfolio.

Herd Mentality: This bias is an outcome of uncertainty and a belief that others may have better information, which leads investors to follow the investment choices that others make. Small investors keep watching other participants for confirmation and then end up entering when the markets are over heated and poised for correction. Investing by taking tips comes under this bias.

Choice Paralysis: The availability of too many options for investment can lead to a situation of not wanting to make the decision. Too much of information also leads to a similar outcome on not taking action.

Sunk Cost:These are observed more in buying Insurance for investment. After paying premium for a long period, there is reluctance to discontinue the policy despite knowing that the return is very low. The selling agents exploit this bias by telling that the money already paid will be lost and advise not to discontinue the policy.

Individual investors can also reduce the effect of such biases by adopting a few techniques. As far as possible the focus should be on data and analysis. Adopting process-oriented investing and reviewing methods can help biases. Facility such as systematic investing (SIPs) will help. It is always good to have an adviser whom the investor can trust.

The Bucket List

Imagine you were told you had 6–12 months left to live.

What would you do with your time left?

Today i watched the movie again.

It’s about Billionaire Edward Cole (Jack Nicholson) and car mechanic Carter Chambers (Morgan Freeman) who meet in the hospital and learn that their respective illnesses will kill them in less than a year’s time. Instead of letting the news bring them down, they decide to create a bucket list together, which is basically things each of them want to do in life before they die. The rest of the movie explores the relationship between the two men as they go out and try to live their bucket list.

It’s a beautiful movie that I’d definitely recommend.

Lessons I learnt from The Bucket List, thought it might be useful to you:

  • Death often comes Unexpected: Edward and Carter were in their old age when they found out they were going to die. But it still crept up on them. They were living normal lives, and then suddenly their time was going to be up.

    Whether old or young, death often comes when you least expect it. You really never know what can happen. That’s why you need to grateful for every day you wake up and make sure you’re living the life you want.

    In financial context, make sure you have adequate Term Cover & Health Cover for your family to support their lives.

  • Make your Bucket List Now:Seriously. Don’t wait until life passes you by and it’s too late. Start today!

    Write down all the things you want to do in life. Dream big.

    List all your objectives, goals, aspirations to achieve. You get life only once.

 

  • Actively plan to execute the objectives mentioned in the list:Making the bucket list is the easy part and only Step 1. It’s worthless unless you start planning out how you’re going to accomplish the things on it.

    Edward and Carter couldn’t really plan since their time was limited. They just took action, which is a major part of the equation too.

    While you likely have a lot of time to accomplish the items on your bucket list, don’t wait for “some day” to come. Again, you never know when your time is up here, so there needs to be a little sense of urgency and desire to take action. Squeeze everything out of life while you can. Start by picking an item that is attainable and take the first step to figuring out how and when you can do it.

    Planning & Execution is the Key to achieve the goal. Planning your finances, spending, investing, formulating a financial plan & executing it makes sense.

 

  • Bring joy to other people’s lives:In the same story about the deceased waiting to get into heaven, Carter tells Edward that the question god ask them is “Has your life brought joy to others?”

    Life isn’t meant to be all about you. Yes, your dreams and goals matter, but it’s really about impact and legacy. How many people’s lives can you touch while you’re here? How can you be a role model for others?

    As Carter said in the movie, “You measure yourself by the people who measure themselves by you.”

    I try to educate & empower all through right financial planning, financial awareness, personal finance & investing principles for wealth creation.

 

  • Be adventurous:When Edward and Carter saw the world, they did it in style. Their journey was all about having fun and doing things they had always wanted to do. They pushed the boundaries of what they thought they were capable of and grew in the process.

    We should all try new things more often. There’s so much out there to be experienced. If there’s something that’s been on your mind a lot that you’ve wanted to do, just go do it. Take someone with you. Create memories you can hold onto. Have the most fun possible. Do it all.

Continue reading The Bucket List

How to be Happy & Successful in Life?

munger

By Charlie Munger

If all you succeed in doing in life is getting rich by buying little pieces of paper, it’s a failed life. Life is more than being shrewd in wealth accumulation.

A lot of success in life & business comes from knowing what you want to avoid.

Develop good mental habits. Avoid evil, particularly if they’re attractive members of the opposite sex.

If your new behaviour earns you a little temporary unpopularity with your peer group, then the hell with them.

Beware of Envy

The idea of caring that someone is making money faster (than you are) is one of the deadly sin. Envy is a really stupid sin because it’s the only one you could never possibly have any fun at. There’s a lot of pain & no fun.  Why would you want to get on that trolley?

How to Get Rich

Spend each day trying to be little wiser than you were when you woke up. Discharge your duties faithfully. Step by step you get ahead, but not necessarily in fast spurts. But you build discipline by preparing for fast spurts.

The Importance of Reading

In my whole life, I have known no wise people who didn’t read all the time. You’d be amazed at how much Warren reads.

I think when you’re trying to teach the great concepts that work; it helps to tie them into the lives & personalities of the people who developed them. I think you learn economics better if you make Adam Smith your friend. That sounds funny, making friends among the eminent dead, but if you go through life making friends with the eminent dead who had right ideas, I think it will work better in life & work better in education. It’s way better than just being given the basic concepts.

Reduce Material Needs

Most people will see declining returns (due to inflation). One of the great defences if you’re worried about inflation is not to have a lot of silly needs in your life. You don’t need a lot of material goods.

Avoid Debt

Once you get into debt, it’s hell to get out. Don’t let credit card debt carry over. You can’t get ahead paying 18%.

The Decline of Public Schools

You could argue that (the decline of public schools) is one of the major disasters in our lifetime. We took one of the greatest successes in the history of earth & turned it into one of the greatest disasters in the history of the earth.

Weekend Reading

Are you misbehaving with your money?

If you are of the opinion that you are behaving cordially and appropriately with your money, you are probably wrong. Given the way our brains are wired, it is impossible to not let our emotions overpower logical reasons. In the academic arena this is known as behavioural economics or behavioural finance. We can look at some routine day to day examples to prove this fallacy.

1. Neha had parked 5 lakhs Rs. in a fixed deposit at 8℅ p.a. and she is also serving a 3 year personal loan of Rs. 4 lakhs at 15℅ p.a.
Now logically it makes so much sense to close the personal loan as Neha has adequate surplus available with her. But by behaving irrationally she stands to lose. Having her money parked in fixed deposit gives Neha tremendous sense of comfort.
Wrong comfort zone, wrong investment decision.

2. Mr. Aggarwal is a so called intelligent investor. He follows Warren Buffett’s maxim, “Buy low and sell high.” He always buys stocks which have hit their 52 week lows and sells the ones that have hit 52 week highs.
However, Mr. Aggarwal has not made money. What is an issue? Choice of an arbitrary reference point. The company which has hit 52 week low may be in the downtrend due to some big problem and may go down further. Likewise, 52 week high does not stop the stock to go up as the company may have produced outstanding results and holds terrific potential due to some discovery.
Wrong reference point, wrong investment decision.

3. Wasim started Investing in ABC mutual fund via SIP 10 years ago. The fund performs exceptionally well and gives Wasim 20℅ compounded returns over 10 years. Wasim is happy as he is able to meet his goal of making down-payment for buying a house and is also able to prepay his car loan.
However, Wasim gets disappointed when he comes to know that his friend William has got 23℅ return during the same period.
Well, fund manager does not ideally aim to generate best returns but the returns should ideally be enough to meet investor’s goals. But Wasim started comparing his returns with William’s fund. However, what was the risk taken by William’s fund manager to generate extra 3℅ returns???
Wrong comparison, wrong investment decision.

4. If you analyse the stock portfolio of a large number of investors, you will notice the following.
a. There are few multibaggers.
b. There are quite a few failed stocks.
This happens because people hate losing money. They are affected by loss aversion. Similarly when the stock appreciates they are eager to book profits. Selling early denies investors huge amount of potential profits. Peter Lynch rightly said, “If you cannot imagine to see your investments going down 50℅ you should not be in the market. You are not yet ready.”
Wrong timing, wrong investment decision.

These stories amply prove that humans are emotional fools. Remember how companies shape our behaviour to make more profits.

#learningneverstops

Kaustubh Deole

Weekend Reading

The Porcupine Story

The story goes that it was a particularly harrowing time in porcupine land. The winter was severe and the porcupines were finding survival difficult. They were freezing to death.

That’s when they held a meeting to decide on a course of action. As they got together to discuss their survival strategy, they discovered that just by being in close proximity with each other they were able to feel warmer and protect each other.

Being closeted together meant that their bodies generated heat which helped keep everybody warm. So they found they could survive the cold by just staying together!

But there was a problem.

As they moved closer, they found each other’s quills to be a bother—they poked and hurt.

Feeling the discomfort, some porcupines decided to avoid the pain from the quill pokes and moved away.

And as they ventured out on their own, the cold got them and they died.

Soon better sense prevailed and the porcupines realized it was better to stay together and survive rather than go out on their own and die.

Getting poked by the quills of porcupines that were close to them seemed like a small price to pay for survival.

This story has a great lesson for investors.

1) Investors afraid of market volatility redeem their investment because volatility seems to hurt them. Only if they could tolerate a little volatility their lives would be much better off in due course but their fear gets the better of them and they hurl themselves into a bigger crisis.

2) Another lesson investors can draw from this story is of leaving their Advisors and practicing self advisory or self medication whatever one may like to call it because the small fee that they have dispense seems to hurt them. They eventually venture out on their own and with no Advisor to manage their irrational and emotional behaviour, they too fall prey to greed and fear and lose their way.

#learningneverstops

Kaustubh Deole

Weekend Reading

Have a Proper Investment Plan

Boris Becker had it all — six grand-slam tennis titles, models hanging off his arm and luxury houses all over the world.

At the height of his career, the German ace had amassed a reported $63 million in prize money and sponsorships, but now the man once known as “Boom Boom” for his ferocious serve has gone from boom boom to bust.

Now 49, Becker was declared bankrupt by a British court, capping a fall-from-grace story that saw the one-time wild child go from Wimbledon champ to walking headline by blowing through money, women and business ventures in retirement.

His lawyer pleaded for more time and “one more chance” to make good on debts he has racked up in retirement.

But the judge said, regretfully, the man she had once watched dominating center court has already had plenty of chances.

“One has the impression of a man with his head in the sand,” Registrar Christine Derrett said.

The above news of Boris Becker, Six times grand slam winner and one of the most successful tennis player, becoming bankrupt sends one of the most powerful message to all the youngsters of today.

“Success is never permanent . Plan well when the sun is shining coz failing to plan is planning to fail. “

Financial management is most crucial lesson one should learn in these uncertain times.

Have a great weekend.

Kaustubh Deole