Borrow or Invest: You Can’t Do without Life Insurance

There are two schools of thought on borrowing. Both are right in their own way.

  1. Don’t borrow. Don’t waste your money on EMIs. Debt is evil. Invest for your financial goals, grow your money, and enjoy only when you have enough money. OR
  2. Money can be earned later too, but the time won’t come back. Debt is NOT objectively evil. So, while you must invest regularly, it is OK to borrow within limits and pay EMIs.

The first approach is safer. Prevents you from living beyond your means. You can adjust your wish list based on how much you earn and save.

The second approach is riskier. What if you spend too much and become overburdened with debt? However, if you are responsible with debt, you can own assets (house/car etc.) and spend on experiences/memories at the right time. What would you prefer? A foreign vacation with your family when your daughter is 10 years old and you are her world OR when she is 20 and wants to spend more time with her friends?

While I prefer the first approach, I see a lot of merit in the second approach too.

In any case, no matter which approach you subscribe to, there is still a common thread. Without which, you are putting the financial lives of your family at risk.

Life Insurance Is That Common Thread

It is important that you invest regularly. But your investments for financial goals can continue only as long as you are alive. In your absence, those monthly investments will stop. Where will the family get the money to fulfill all the financial goals?

Answer: Life Insurance

You want to accumulate say Rs 25 lacs for your daughter’s education in the next 10 years. You have been able to accumulate only Rs 3 lacs. In your absence, where will this remaining Rs 22 lacs come from?

Answer: Life Insurance

You have taken a home loan of Rs 50 lacs to purchase your dream purchase. You and your family love the house. You are the sole breadwinner and pay the EMIs diligently. What happens if you were not around? Who will pay the EMIs? Yes, it is possible that the family has assets to sell and close the loan. What if the family doesn’t? And even if the family has the assets, what if those assets were earmarked for other financial goals? What happens to those financial goals? How can you ensure that the bank does not take away your dream house from your family?

Answer: Life Insurance

What Are the Different Types of Life Insurance Products?

There are two broad types of life insurance covers.

  1. Term Life Insurance: Products that offer only life insurance and nothing else
  2. Unit Linked Insurance plans and Traditional Life Insurance plans: Products that offer the dual benefit of life insurance and investments

On the face, the second set of products looks better. With a single product, you get both things done. Insurance and Investment. And that’s why these products are immensely popular too. However, as they say, there is no free lunch. The dual nature of products comes at a cost. In terms of higher charges, inferior returns, lower flexibility, and high premature exit costs. By the way, that is just my opinion. You may think differently.

What if I were to tell you that these are not my biggest problem with these combo products? Yes, you heard this right. There is an even bigger problem.

The Risk of Staying Underinsured

The biggest problem with ULIPs and Traditional Plans is that you may stay underinsured.

You have calculated that you need a life cover of Rs 1 crore. You reach out to an insurance company or an insurance agent about the annual premium. The annual premium for a ULIP or a traditional life insurance plan would range between Rs 5 lacs and Rs 10 lacs. You can’t pay that much. You can spend only Rs 1 lac per annum towards insurance products. So, you buy what comes for Rs 1 lac annual premium. Deal closed and you come back happy.

While you have bought insurance, the problem here is that, for an annual premium of Rs 1 lac, you get a cover of only 10-20 lacs. Hence, while you have spent Rs 1 lac, your life cover is only a fraction of your estimated requirement. You remain underinsured. And that’s the biggest risk. Your life cover requirement does not go down with your premium payment ability.

With a term insurance plan, you can buy cover of Rs 1 crore for about 10,000-20,000 per annum. The remaining Rs 80,0000-90,000 can be invested in a pure investment product. Term Life Insurance is the best and the cheapest way to buy life insurance. Even if you see merit in ULIPs and traditional life insurance plans, you must first ensure that you have adequate life coverage through a term life insurance plan.

How Do You Figure out What You Are Buying?

There is a very simple way.

  • In ULIPs and traditional plans, the life cover (usually referred to as Sum Assured on Death) will be 10-20 times of your annual premium.
  • In a term plan, the life cover will be a much bigger multiple of the annual premium. Typically, 200-1000 x annual premium.

Hence, if you are keen to buy just a term plan, this is the easiest way to determine that you are buying a term plan and not something else.

What Is Adequate Term Life Coverage?

There are thumb rules to calculate this: 10-20 x your annual income.

Another simple way to solve for the following equation.

(Your Life Insurance cover + Your Existing assets) should be sufficient to:

  1. Square off your loans
  2. Fund all the financial goals
  3. Provide for regular expenses of the family for life

You may tweak the above equation for your case and family structure.

Now, have you bought adequate life insurance cover?

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