Last week, we saw how cognitive biases lead to the wrong purchase and buying of financial products, particularly life insurance policies. If misselling is construed as selling a wrong product, offering a policy that doesn’t fully cover the insurance needs of the policyholder also qualifies as misselling.
The extent of underinsurance in the country can be understood from the following data published by the insurance regulator in its latest annual report for 2010-11. The total number of life insurance policies in-force at the end of March 2011 stood at a little over 23.32 crore. Consider this against the country’s population of more than 121 crore estimated in Census 2011. You will see that only 19.28 per cent of our population have any life insurance cover.
This, however, still doesn’t give the true picture if one takes into account the fact that most policyholders in our country own multiple policies. The percentage of population having life insurance cover will then look much lower than 19 per cent.
According to the Insurance Regulatory and Development Authority figures, the outstanding sum assured on the policies in force at the end of March 2011 was Rs 27,79,667 crore. In other words, the average sum assured per policy is only Rs 1,19,197. This shows the phenomenon of gross underinsurance in the country.
The IRDA data further reveal that policyholders had paid an average annual premium of Rs 12,504 — the total premium earned by life insurance companies in the financial year 2010-11 was Rs 2,91,605 crore. The average sum assured, thus, works out to be less than 10 times the average annual premium.
Why do then people pay so much premium for so little insurance cover? Policyholders buy life insurance for reasons other than the insurance benefit.
Even today, tax savings, investment and tax-free returns are the prime drivers for buying a life insurance policy. This explains the extent of underinsurance in the country.
Insurance companies know this. So does the insurance regulator.
Beyond tax incentives
Insurance companies do not complain because they make more profit by selling a lower risk cover at a given premium. This is the main reason why they made such a furore against the proposal in the new direct tax code draft that suggests the sum assured should be 20 times the annual premium for a life insurance policy to get income tax benefit.
With DTC pending for implementation from April 2013, the finance minister has changed the eligibility criteria for tax benefits pertaining to life insurance products. The sum assured has now been increased to 10 times the annual premium for life insurance policies sold after April 1, 2012, in order to get income tax exemption.
Now, DTC has also proposed that an assessee can claim tax deduction up to Rs 50,000 towards payment of premium for life insurance and medical insurance together. This provision will reduce the tax incentive for life insurance policies to a great extent and force people to buy more insurance.
Suppose, you pay an annual premium of Rs 50,000 for a life insurance plan and claim the tax benefit to the fullest extent. Depending on whether DTC retains the clause that the sum assured has to be 20 times the annual premium or 10 times as proposed in the budget for 2012-13, you can have a maximum life cover of Rs 10 lakh or Rs 5 lakh, accordingly, by buying any savings-cum-insurance plan.
If you instead buy a pure risk cover, commonly known as a term insurance plan, you can buy more insurance and still enjoy the tax benefits.
Term insurance plans have become significantly cheaper than before as more and more insurers are selling these plans online without the mediation of agents.
Let us explain this with the example of Reliance Life Insurance Company, the latest insurer to offer an online term insurance plan.
Reliance Life has a traditional term insurance plan, regular endowment plan and the new eTerm plan.
A 30-year-old man will have to pay an annual premium of Rs 14,260 if he buys Reliance Life’s endowment plan with a life cover of Rs 5 lakh and a policy term of 30 years. If he opts to buy the insurer’s traditional term insurance plan, he can buy a Rs 10-lakh cover for an annual premium of only Rs 3,640. In case of the eTerm plan, the annual premium goes down further — Rs 4,281 for a life cover of Rs 30 lakh.
The obvious benefits of purchasing an online term insurance plan are the low premium cost and a much higher life cover.
However, you can utilise the excess premium, which you would have otherwise paid for an endowment plan, for buying a medical insurance for yourself and your family or can invest it in a Public Provident Fund account and get tax exemptions there as well.