One of the key aspects of your financial plan is insurance. Why is insurance so important in your overall financial plan? That is because insurance gives you protection against unforeseen circumstances and thus ensures that your financial plan does not get derailed due to some unforeseen exigencies. So, what exactly do we understand by insurance and financial planning and how does it fit into our overall financial goals. What is the role of insurance in financial planning and why it must be the pivot on which any financial plan is built. To understand the importance of insurance in financial planning it is essential to understand the types of insurance that you need to consider as part and parcel of your financial plan.
Broadly, there are 4 kinds of insurance that must be part of your financial plan and the budgets for the same must be built into your financial plan..
1. Planning your life insurance cover
A few basic debates are part of the life insurance argument. Firstly, should you opt for endowment plans or should you opt for term risk covers? The idea is to keep your insurance and investment separate. That means; instead of loading larger premiums on you through endowments, a better way will be to take a term policy with a much lower premium and use the amount saved to buy appropriate mix of mutual funds for long term wealth creation. That is a more scientific approach. The second question is what is the quantum of insurance that is required? Let us assume that your monthly expense for the family is Rs.100,000 per month. That means, your life cover must be large enough for the corpus to earn a similar amount per month. Let us assume that your family invests the corpus in very safe money market mutual funds. These funds will yield about 4% annually in post-tax terms (that is what is material). That means you will earn nearly 0.33% on a monthly basis. To earn an income of Rs.100,000 per month, your corpus must be equivalent to Rs.3 crore (100,000 / 0.0033). That means you will require a term cover of approximately Rs.3 crore to earn an equivalent income of Rs.1 lakh for your family.
2. Insuring your health for medical emergencies
Don’t get obsessed by the Section 80D benefits that the Income Tax Act offers on medical insurance. That is only incidental. The fact is that medical insurance forms the crux of your financial plan. Today, hospitalization and medical expenses have become prohibitive. A medical insurance can leave you and your family without any worry. You surely do not want your health or your family member’s health to throw your financial plan off tangent. You can also look at floaters to get a bigger cover for your premium paid. Be cautious of the add-ons that most insurance companies offer. More often than not, they do not add much value. Ensure that your medical coverage is comprehensive.
3. Insuring the assets that you own
This is something many of us tend to ignore, but it surely needs your attention. You purchase a lot of expensive gadgets like flat screen TVs, washing machines, laptops, double-door refrigerators, high-end dishwashers etc. Insuring these assets hardly costs anything. But the last thing you want is to see are any of your appliances being blown up by a fire or a short circuit. Asset insurance gives you the required peace of mind that your outlays will not be negatively impacted by losses on assets. Additionally, also get your home insured against fire, earthquake and water related depletion as these can result in huge losses for you.
4. Insuring your liabilities; but what is that?
Most of us have heard of insuring our assets and our lives. But what exactly is insuring our liabilities. Let us assume that you have purchased a home 5 years back by taking a home loan. Home loans are typically long term liabilities and will have to be repaid over a period of 15 or 20 years. But what happens in the event of sudden death of the bread winner of the family. Obviously, the family will struggle to pay the home loan EMI, which means that the bank will take possession of the home and auction. Effectively, the family loses the roof over its head. The smart way to do this would be to take a term insurance to the extent of the outstanding loan principal. This will ensure that in any eventuality the term plan will be used to close out your home loan principal and the family can keep the house. Nowadays, most banks will give loans with the insurance attached. Remember, this term insurance must be treated separate from the term plan that you take for the sake of taking care of your family’s regular needs.
Insurance forms the basis of financial planning and it is a risk management measure to ring fence your financial plan. That is the starting point and your journey towards planning your future begins with taking adequate insurance!
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