It’s harmful to buy insurance for just the tax kick

Since there are no rules specifying the amount of life cover needed, we are happy with protecting our families with a fraction of what we are worth


Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

People often confuse financial planning with tax efficiency. It’s common to hear them say that they are sorted for the year, having invested the maximum permissible under the tax-exempt limit. While saving taxes is important and certainly welcome, it’s a lot more essential to ensure that each instrument actually does the job it is intended to do.

Currently, the government permits tax exemptions in certain investments up to Rs.1.5 lakh per annum under section 80C (of the Income-tax Act, 1961). Likewise, the health insurance allowance has been increased to Rs.25,000 (a higher Rs.30,000 in case of senior citizens) for the year.

Let’s take a closer look at life insurance. The basic premise of this category is to compensate the family of the insured adequately in case of an unfortunate event like death. The additional benefit is that premiums paid are deductible up to Rs.1.5 lakh per annum from one’s taxable income. Over the years, the second benefit has been given far more attention than the primary one. I’ve had several conversations with people where life insurance is discussed in terms of how many policies one has or how much premium is paid every year or even, the total of the maturity amounts (or the amount which the customer receives at the end of the term of the policy)—everything but the amount of life insurance (or the amount the family will get on the death of the person buying the policy) offered.

To get a better idea of how people look at insurance, we looked at over 8,000 users of our life insurance tool and split them into three age groups—21-30 years; 31-40 years; and 41-50 years. We then looked at how their families would do financially, if they (the person insured) were to unexpectedly pass away.

In the youngest age group, 21-30 years, a large number of people (35%) had coverage worth only three months of expenses. A few (9%) had for 3-12 months’ expenses, and a majority (56%) had for more than a year. In the 31-40 years age group, the split was similar—29%, 5% and 66%, respectively. The older age group showed more prudence—more than three-fourth (76%) had life cover of more than a year’s expenses. Still, 20% had for less than three months and 4% for 3-12 months.

While it’s nice to see that an increased proportion now has higher amounts of life insurance than about two years ago, still there were almost one-third of those who were under-40 and whose families wouldn’t have enough to last more than three months. And while it may be understandable for younger users to be less worried about morose subjects like early death, it’s difficult to understand how a fifth of those older than 40 years have less than three months of expense cover. It’s probably prudent to reiterate the customer profile being considered here.

Over 80% of those whose data was studied are:

 From the top eight cities in India

 Earn more than Rs.6 lakh per annum (the median income being over Rs.12 lakh per annum)

 Married and, therefore, have responsibility of more than just themselves

 Digitally savvy (defined as being comfortable enough with technology in general and financial services in particular; registered Internet banking customers).

So, it is not about the inability to cover one’s family adequately. In most cases, the premium amount would amount to less than 2% or 3% of the income amount.

Imagine having just three months of expense coverage. How much better is that than having none at all?

In a separate study, a surprisingly large proportion of people had lesser life insurance than their outstanding home loan amounts. This means that if such a person were to die before the home loan was paid up, either a large portion of the spouse’s income would have to be diverted to paying loan instalments or, the house would have to be sold to get rid of the outstanding mortgage.

Several countries, such as the US, make it mandatory to have at least as much life insurance as the mortgage amount so that home ownership does not suffer if the borrower(s) ceases to exist. Surely, we need this law at least as much, if not more, in India.

While there are many instruments that allow you to save for long-term goals—physical assets such as real estate and gold; and financial assets such as fixed deposits, bonds, mutual funds and stocks—there’s no substitute for insurance against events like death. Strangely, because you have no option but to insure your car (thanks to government rules and not consumer awareness), you insure it for what it’s worth and not an arbitrary amount like a tenth of it’s value. But since there are no rules specifying the amount of life cover that one needs, we are perfectly happy with protecting our families with a fraction of what we are worth.

So, doesn’t it make more sense for once to save tax on insurance products while still getting what you are paying for—the actual ‘insurance’ for when you are not there. It’s high time we ease up on our obsession with getting returns on every rupee we spend. And if you are one to squeeze every basis point on your returns, how about taking a look at your property that hasn’t returned very much for quite some time now?

Manish Shah is a co-founder and chief executive officer, BigDecisions.com

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