Life insurance
Also written Life cover · Life insurance products · Life assurance
The product family that covers loss of income: temporary loss from disability and permanent loss from death — the first of the three covers in a household insurance plan.
In plain language
A household runs on somebody's income. Insurance planning starts by asking what happens to that income if something goes wrong.
Two things can stop it. A disability can stop it for a while. Death stops it for good.
Life insurance is the product family that covers both. The workbook puts it in one line: the temporary loss of income from disabilities, and the permanent loss of income from death, can be covered with life insurance products.
Notice what is being insured. Not the person, and not an asset. The income. That is why the amount of cover is worked out from what the family would have to replace, rather than from what the premium happens to buy.
Health and accident insurance covers a different problem — the cost of treatment and lost earnings during recovery. General insurance covers loss or damage to property. Life insurance covers the earner.
How it works
Section 1.3.3 places life insurance inside insurance planning, which is one of the components of a financial plan.
The mechanism first. Insurance is a risk transfer mechanism where a small premium payment can result in payments from the insurance company to tide over risks from unexpected events. Several unexpected expenses that can unbalance a household's income and expenses can be managed this way.
The three product families the workbook names, and what each one carries:
| Cover | What it protects against |
|---|---|
| Life insurance | Temporary loss of income from disabilities and permanent loss of income from death |
| Health and accident insurance | Unexpected events that impair the income of a household while increasing its expenses on health care and recuperation |
| General insurance | Loss and damage to property and other valuables from fire, theft and such events |
What insurance planning actually is: estimating the losses to the household from unexpected events and choosing the right products and amounts to cover such losses. Both halves matter — the product and the amount.
A life policy can also be collateral. Section 17.6.4 notes that a loan can be taken against a life insurance policy by assigning the policy to the lender, or to the insurance company itself if the loan is taken from the company. Once assigned, any payouts by the insurance company on that policy go to the assignee until the loan is repaid and the insurance company is so intimated.
And it is where an adviser's conflict bites hardest. Chapter 19, on ethical issues, uses life insurance as its example of a commission-driven recommendation: Unit Linked Insurance Plans or whole life policies have a higher premium, which leads to a higher commission for the entity selling this, and the adviser has to tackle that as an ethical dilemma. Relationship managers pushing unit linked insurance plans at older clients for whom they are unsuitable is the workbook's own instance of the problem.
This paper gives no premium rates, sums assured or product figures for life insurance. Section 1.3.3 is three sentences of classification; the mechanics of a term plan, a whole life policy or an endowment sit in the papers that teach insurance products. What X-A owns is where life insurance fits in a financial plan, how it is used as collateral, and the conflict of interest it creates.
A worked example
The workbook's own case study opens with Vinod, aged 40, earning Rs 2,00,000 a month and saving about Rs 40,000. He is the sole earning member of his family, and he already pays premiums on life insurance for himself and his wife.
The question the workbook then asks of his plan is the right one: does he have adequate insurance cover which will take care of his family's requirements in the event of his untimely demise?
The figures below are illustrative, added to Vinod's case, to show what adequate has to answer:
| What stops or falls due on his death | Amount |
|---|---|
| Annual income to be replaced | Rs 24,00,000 |
| Years to his children's independence | 15 |
| Home loan outstanding | Rs 35,00,000 |
| Children's education corpus | Rs 60,00,000 |
| Existing life cover | Rs 50,00,000 |
On those figures the family's needs run well past Rs 1 crore, against Rs 50,00,000 of cover — and the shortfall is invisible until someone does the arithmetic. A policy existing is not the same as a policy being adequate. That is exactly the gap insurance planning is meant to find, and the method for sizing it is the needs analysis.
The second thing his adviser owes him is the product choice, made for his family rather than for the commission. A Rs 1,00,00,000 cover bought as term insurance costs a fraction of the same cover bought inside a whole life or unit linked policy — and it is the more expensive one that pays the seller more. Chapter 19 says plainly that the adviser has to evaluate the product and avoid it when it is not suitable for the client.
Why NISM asks about it
Chapter 1 (Introduction to Personal Financial Planning), section 1.3.3 (Insurance Planning), which names life insurance as the cover for temporary loss of income from disability and permanent loss from death; Chapter 17, section 17.6.4, for assignment of a policy as loan collateral; Chapter 19, section 19.4, for the commission conflict. Expect a question matching a described loss to the right insurance family, or one asking what life insurance actually covers.
Common exam traps
- Life insurance covers two events, not one. Temporary loss of income from disability as well as permanent loss from death.
- It insures the income, not the person or the asset. The medical bill belongs to health insurance; the burnt house belongs to general insurance.
- Insurance planning is products and amounts. Holding a policy says nothing about whether the cover is adequate.
- Assignment, not lien. A loan against a life policy is taken by assigning the policy; payouts then go to the assignee until the loan is repaid and the insurer is informed.
- The costlier policy pays the seller more. ULIPs and whole life policies carry higher premiums and higher commissions — the workbook's own ethical example.
- This paper gives no figures for life insurance. Premium tables, sums assured and product mechanics come from the insurance papers, not from X-A.
Check yourself
1.Loss and damage to property and other valuables from fire and theft is covered by:
- a)Life insurance
- b)Health and accident insurance
- c)General insurance
- d)Term insurance
Show the answer
Answer: (c) General insurance
"General insurance can provide covers for loss and damage to PROPERTY AND OTHER VALUABLES FROM FIRE, THEFT and such events." Life insurance covers temporary loss of income from disabilities and permanent loss from death; health and accident insurance deals with events that impair income while increasing health care and recuperation expenses.
Where this is taught
Free preparation for NISM Series X-ARelated terms
- Needs analysis for life insuranceA worked application of the needs-based approach: adding up income replacement, debts and goal corpora, then subtracting existing cover, to find how much more life insurance a client needs.
- Non-life insuranceInsurance covering the loss or destruction of assets and unexpected large expenses, health, motor, home and travel cover, as distinct from life insurance, which covers the loss of a life.
- Term insuranceLife cover for a fixed period: if you die during the term your nominee receives the sum assured, and if you survive it nothing is paid back. It is the cheapest way to buy protection.
- Whole life insuranceA type of life insurance policy that stays active for as long as you keep paying the premiums, rather than for a fixed term like term insurance.
- Health insuranceInsurance that covers an insured person's medical and surgical expenses, regulated in India by the Insurance Regulatory and Development Authority of India (IRDAI).
- Insurance as risk transferThe mechanism by which a household hands its risk of an unexpected loss to an insurance company, in return for a small, certain premium — the basic idea underlying every insurance product.
- Embedded valueFor a life insurer, the present value of the expected net future cash flow — adjusted for probability — from the policies currently in force, used as the base of a Price/Embedded value multiple.
- Pre-nuptial agreementAn agreement entered into before marriage setting out how finances and other matters will be dealt with if the couple separates — a device whose legality in India the workbook says is not established.
- Insurable interestThe requirement that the person seeking insurance would suffer a monetary loss if the subject matter were lost or destroyed — the test that separates insurance from a wager.
- Human Life ValueThe present value of the income a person is expected to earn over their remaining working life that is available for dependents — the upper bound on how much life cover is justified.
- Beneficial nomineeA life insurance nominee who is a parent, spouse or child of the policyholder — entitled to keep the claim money in their own right instead of holding it in trust for the legal heirs.
- Keyman insuranceA life insurance policy a company buys on the life of a key executive, paying the premiums and taking the benefit itself — and the one life policy whose proceeds are not exempt under section 10(10D).
- Income replacement needThe insurance need that arises from a risk to the earning ability of an asset, including a person and their life, met by life, critical illness, accidental disability and annuity products.
- General insuranceNon-life insurance — cover for property, motor, health, travel and personal accident risks — as against life insurance, which covers loss of life or income.