Personal accident insurance

Life insurance replaces an income that has stopped because the earner died. Personal accident insurance answers the other case: the earner is alive and can no longer earn.

The workbook's definition is the policy wording itself. The policy provides that if the insured sustains any bodily injury resulting solely and directly from accident caused by external violent and visible means, the company shall pay to the insured — or to his legal personal representative, as the case may be — the sum defined in the policy.

The phrase "the sum defined in the policy" places it firmly among the defined benefit policies. There is no assessment of actual loss. The sum is pre-fixed.

Three grades of disablement are covered, and the workbook lists them in this order:

• Permanent total disablement
• Permanent partial disablement
• Temporary total disablement

How much cover is right — and why nobody has enough. The workbook makes a pointed observation. The need for calculating permanent total disability due to accident should be worked out just like calculating a life insurance need — that is, through the Human Life Value or needs-based method. Because that calculation is often overlooked, permanent disability cover due to accident is often inadequate.

The logic is unarguable once stated. A 38-year-old who is permanently and totally disabled has lost the same future income stream as a 38-year-old who died — and, unlike the deceased, he continues to consume, and now needs care. The economic loss is larger, not smaller. Yet the cover bought against it is routinely a small rider on a health policy.

Where it sits among the products. The workbook groups it with critical illness and life insurance as an income replacement need — the category of insurance that answers a risk to the earning ability of an asset. Health insurance and motor insurance, by contrast, are income protection needs: they defend existing income against an unexpected charge.

The workbook's own illustrative case: Arushi, a computer-aided design professional, met with an accident in which she lost her eyes and can no longer continue with her profession. Its comment is that a personal accident disability insurance would have provided a corpus that could generate the income Arushi lost.

Mr Sengupta is 38, earns Rs 18,00,000 a year, and expects to work to 60 — 22 years. He holds:

The mismatch. If he dies tomorrow, his family receives Rs 2.5 crore. If instead he suffers permanent total disablement tomorrow, his family receives Rs 10,00,000 — and now has a permanently dependent adult to support as well.

What the workbook says the calculation should have been. The same one used for life cover. Assume income growth of 6% and a post-tax return of 8% on the sum assured, giving an adjusted discounting rate of about 1.89%, over 22 remaining working years. The present value of Rs 18,00,000 a year on those assumptions is roughly Rs 3.2 crore — the same order as his life cover, not a thirtieth of it.

The shortfall is about Rs 3.1 crore. At a 6% withdrawal rate, Rs 10,00,000 generates Rs 60,000 a year. The income it was supposed to replace was Rs 18,00,000.

The remedy the workbook points at. Because the large sums are generally not available as a rider, adequate disability cover has to be bought as a standalone personal accident policy — and for critical illness, either a standalone policy or an accelerated sum insured rider on a life insurance policy.

Chapter 3 (Features of non-Life Insurance Products), section 3.1.2(d), gives the definition and the three disablement types; Chapter 1, sections 1.4(b) and 1.5, place it among defined benefit policies and among income replacement needs, with the Arushi illustration. Expect a "which of these is a defined benefit policy" question, a listing question on the three types of disablement, and a reasoning question on why disability cover is typically inadequate.

• Three disablements: permanent total, permanent partial, temporary total. There is no "temporary partial" in the workbook's list.
• "External, violent and visible means" is the trigger. An illness, however sudden, is not an accident.
• It is a defined benefit policy, not an indemnity policy. No assessment of actual loss, and the contribution clause does not apply — the workbook notes that where there are multiple defined benefit policies, all of them will pay.
• Disability cover should be sized like life cover, by HLV or needs analysis. Treating it as a token rider is the error the workbook names.
• It is an income replacement need, not an income protection need. Health and motor insurance are the protection products.
• Personal accident is not critical illness. Critical illness pays a lump sum on diagnosis of a specified disease, usually after a 30-day survival period, and pays nothing on death.
• A rider generally cannot carry a large enough sum — a standalone policy is what an adequate calculation points to.