The Dangers of Being Underinsured (Inadequate Insurance)

Written by : Knowledge Centre Team

2020-10-27

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Shubham is one of the cautious and frugal investors and manages his money penny for penny. He is very particular about meeting his tax-saving limits and keeping the tax outflow as low as possible. So, when his tax-saving investments fell short by some Rs. 9000, he searched frantically for a tax-saving investment to cover the gap.

He figured he had no choice but to go for a term insurance cover, for the low premium cost and as he had heard, ‘it’s a need.’ He selected the cover amount and benefits keeping in mind his tax-saving budget.

So, at the age of 32, he finally secured online life insurance of Rs. 1 crore with a lump sum pay-out option and accidental death and disability cover. His annual take-home income is Rs 15 lakhs and he is currently responsible for his wife and a three-year-old child.

He bought a house using Rs. 30 lakhs as a home loan a few months ago. Other than that, he does not have any liabilities.

The Risks Shubham’s Family Carries

Now let us look at the vulnerabilities Shubham has adopted by simply buying a term cover without looking at the benefits:

His term cover may be inadequate for the family as 30 lakhs will go towards the home loan repayment
His homemaker spouse will have to make major investment decisions to:
- Generate a regular monthly income out of the remaining term insurance proceeds

- Save enough money for the child’s future goals
He has no insurance for any critical illnesses. So, in case of contracting one of the terminal diseases, he will need to use his savings for the treatments.

What Is Underinsurance?

Underinsurance doesn’t just mean low sum assured for your term cover it also means that you are not covering all the risks. In other words, you may have an umbrella for the rainy days, but one, it’s too small to cover your entire family and two, it protects from only rain and not the sunlight or snowfall.

Underinsurance by amount is the truth for the Indian market as a whole, with the largest gap or protection margin of 92.2%. Protection margin refers to the gap between required and availed life cover protection by the policyholder.

Couple this with a lack of an adequate number of covers, many of these families suffers the financial consequences of uninsured risks.

Potential Dangers of Inadequate Insurance Cover

Even minor events like long hospitalisation can affect your income and long-term savings
In case of death, the family’s lifestyle will decline in the absence of adequate regular income
The family may have to compromise on children’s important life goals such as higher education pushing the next generation few steps back financially.

Inadequate insurance cover, in reality, will fail to serve its core purpose that is ‘to help your family maintain their lifestyle and financial status.’

How to Cover the Gap or Get Adequate Life Insurance?

First thing is to figure out how much life cover you will need. Although this can be a simple equation given that there are other risks to your family’s financial wellbeing, you also need to plan for contingency.

For example, in case of accidental disability, your capacity to earn money would be affected, and your income may change. In case of critical illnesses, you may need huge financial support for the treatments and to run your household effectively.

So, in case of any contingency your insurance plan should provide you for:

1. The Household Expenses

One thing which is common for any risk cover is your household expenses. This is a regular need and is best covered by a regular income. Since household budget also defines the family’s lifestyle you need the regular income to at least grow to cover inflation.

2. Treatment & Other Costs

Critical illnesses, accidents may involve long-term care and treatment costs. You may need a large pool of funds to take care of these expenses. So, your long-term investments can continue towards their goals.

3. Future Financial Goals of the Family

Most long-term financial goals like a child’s higher education and marriage goals take consistent regular investments. In the event of your early death, these investments will stop midway. Thus, the term insurance cover should provide for these goals as well.

How Much Insurance is Sufficient?

Ideally, your financial advisor will estimate the cost of all your goals and the amount needed to run your household expenses to give you an adequate life cover. The amount is typically 15 to 20 times your annual income if you are in your 30s.

So, for a faster estimate, we can use this rule to get close to the adequate life cover amount. But, getting term insurance 15 times your annual income is not enough. How?

Remember that your family needs a regular income to look after the household and lifestyle expenses. Therefore, you need to ensure they can receive regular income after your demise.

Fortunately, with term plans from Canara HSBC Life, you can divide your total sum assured into two parts:

Paid as a lump sum to the family
Converted to safe regular income and paid monthly

With the regular income option, you can also opt for a growing income to account for the inflation in lifestyle, and you should. A fixed regular income for a long time would cause a decline in the family’s lifestyle over time due to inflation.

What about the Other Insurance Covers?

You can add the other insurance covers like the critical illness and accidental death and disability as addon covers to your base term insurance. You can also select a separate sum assured for each.

The sum assured for these benefits, however, depends on the prevailing healthcare costs instead of your lifestyle. So, you can choose the maximum eligible amount as per the insurer limits, which will be based on your annual income.

Hopefully, this will help you and your family avoid the dangers of being underinsured.

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