Know the Basics of Life Insurance

What is Life Insurance ?

It is a contract / an agreement between a company (insurance company) and an individual where the company provides a guarantee that it would pay a certain sum of money to the beneficiary in the event of an unfortunate scenario (death / accident) or at the end of an agreed term. In turn the individual pays a periodic amount which is called premium.

Why is Life Insurance required ?

The main purpose of life insurance to ensure the financial security of the dependents. In other words it is a financial hedge against the uncertainity of life.

What are the major types of Life Insurance ?

The major types of life Insurance policies are :

1) Term Insurance policies

As the name suggests it is a life insurance product that provides insurance only for a term. In other words it provides the benefit in the form of payment of sum assured only when the unfortunate event (death) occurs during a specified term. In case if the unfortunate event does not occur during the term of the policy(ie,if the policy holder survives) the individual does not get any benefits and all the premiums paid are kept by the insurance company. This type of policy provides complete risk cover ie, 100% risk cover. The premiums are lowest compared to other types.

2) Whole life insurance policies

This is similar to term insurance policies except that the policy holder pays periodic premiums till his death and the sum assured is given to the benefeciary in the event of the death anytime. This type of policy provides insurance cover against death. However the main disadvantage is that the sum assured usually is too low for the policy holder’s benefeciaries to really manage the finanical needs post death of the policy holder. Insurance companies have come with variants of whole life insurance products that take care of this aspect.

3) Endowment policies

The sum assured in Endowment policies is paid irrespective of the occurence of the unfortunate event. ie, The sum assured is paid to the policyholder both in the event of death or upon his survival during the policy term. This type of policy provides savings apart from the risk cover. This type of policy is the most sought after despite the fact that the premiums are relatively costly.

4) Money back policies

The main characteristic of money back policies are that a portion of the sum assured is usually paid at regular intervals during the term of the policy and the remainder is paid at the end of the term upon survival. In the event of death of the policy holder during the term, the sum assured is paid in full to the beneficiary.

5) Annuities and others

The policy holder pays a certain fixed sum of money to the insurance company which would be periodically paid at regular intervals by the insurance company in the form of annuity. There are lots of variants of annuity policies particularly with reference to the disbursement in the event of the death of the policy holder. In general this type of policy provides both risk cover and a kind of regular income something similar to pension. Apart from annuities there are other variants like children education plan, etc.

6) Unit Link Insurance plans (ULIP)

ULIPs provide both risk cover and investment characteristics. A portion of the premium paid goes for the risk cover and the remaining portion is invested in financial markets, usually a fund (debt or equity or combination of both) managed by a professional. The investment returns are in the form of bonuses.

Which is the best insurance policy ?

The best policy, however, depends on the individuals requirement and his/her current status with respect to wealth, number of dependents, lifestyle, major future expenses, etc. But in general the recommendation is to choose a policy which gives maximum coverage for risk rather than choosing the one which has a combination that is more skewed towards savings / investments and which usually demands higher premium. The point to consider is that there are other flexible products available in the market that takes care of savings (like bank recurring deposits / fixed deposits, etc) and investments (mutual funds, etc.).

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Author and Assistant Professor in Finance, Ardent fan of Arsenal FC. Always believe "The only good is knowledge and the only evil is ignorance - Socrates"
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