Published in Mint on Dec 05 2016, Written by Kapil Mehta
Insurances can become irrelevant because of product improvements, lower current cost, change in laws or even lack of expected change in laws.
Friends often send me their insurance portfolios to review. As I browse through the dusty files there are many insurances that are no longer relevant. Insurances do not last forever. Much like the lives and assets they insure, insurances grow old and are made redundant by circumstances. You must occasionally review and clean up your insurances, sometimes just letting them go.
Insurances can become irrelevant because of product improvements. Our insurance history has a few such examples. Lakhs of people continue to hold unit-linked insurance plans (Ulips) that were issued before October 2010. These plans are characterised by high administrative and fund management charges, both upfront and ongoing. It was not unusual for over half the premium, in those early Ulips, to be deducted in the first year itself. As I review those insurances today, many of which have been in force for over 10 years, the accumulated fund is often just slightly higher than the premium paid. This suggests that significant value has been destroyed. Had the premiums been invested in fixed deposits, the accumulated fund would have been 1.5 times the premium.
In October 2010, the Insurance Regulatory and Development Authority of India (Irdai) stipulated a limit on the charges in Ulips. Overnight, the product improved dramatically. But what of the purchases made before October 2010? Those have continued and, in many cases, the surrender charge is now minimal. If you have insurances like that it may make sense to replace those with the newer products or invest elsewhere.
Term plans were introduced in India around 2001. Initially, these were not popular because agents, the primary distribution mode, earned little when they sold term insurance. But many early adopters did buy these plans. Now it’s time for those pioneers to replace their old term covers with new term plans. In the previous 5 years, term insurance rates have fallen significantly because the online channel has made price comparisons easier and the industry now has better mortality data.
So, if you had bought a term plan over 5 years ago, it is likely you will save money by buying new plans today, even after adjusting for the fact that you will pay rates for an older age. You could choose not to save money but increase your sum assured within the same budget. Either way, let go of the old plan.
An early innovation, around 2003, in life insurance was to sell riders attached to base plans. The critical illness rider, in particular, was valuable because health insurance options were limited then. The rider paid a fixed benefit if the insured person developed pre-specified critical illnesses, typically 4-8 diseases. A decade later those old critical illness riders are less relevant. General and health insurers have adopted the critical illness innovation and launched stand-alone critical illness plans that are better than the riders. These stand-alone insurances cost-effectively cover more diseases, often over 20, with higher sums assured and lifelong renewability.
Perfectly good insurances get destroyed by inflation. Mediclaim insurances bought before 2010 were of small sums assured, less than Rs5 lakh; did not have a provision to increase the sum assured; and had several restrictions. Today, these insurances are inadequate for even basic hospitalization or room rent costs. Consider buying new health insurance with higher sums assured and fewer restrictions. Port the old insurances to get the benefit of lower waiting periods. Early adopters of home insurance bought a certain sum assured that was adequate, a decade ago, to cover construction cost. Today those sums assured are much less than the construction costs. The extent of underinsurance over a 10-year period can be as high as 50%. In home insurance claims, payments are reduced by the extent of under-insurance. This means that only half a claim amount will be paid if you suffer a loss today. Replace this insurance with a new home insurance that has the correct sum assured; over-insure so that your insurance remains relevant for some time. Some asset insurances such as computer-all-risk also lose value over time. That’s because the sum assured is linked to the depreciated value of computers, which is well below replacement cost after 2 or 3 years.
Insurances can be made redundant by changes in law or, in some cases, the absence of expected change. Some years ago the income tax laws were modified to give tax-free status to only those insurances where the sum assured was more than 10 times the premium paid. If you have an old insurance that doesn’t meet this condition then it’s time to change that, provided surrender charges are reasonable. Pension plans have an issue because the expected tax exemptions for annuities did not materialise. According to current law, annuities are treated as income and are taxed. This reduces the effective return on annuities to about 5%, well below inflation, if you are in a high tax bracket. So, re-look pension plans as well.
There are other reasons why you may need to discard an insurance. For example, if you buy term insurance, then an accidental death cover is less relevant because that risk is covered by term plans. Sudden changes in wealth require a portfolio re-look because your financial security needs change. Such a clean-up is not something you need to do each year; once in 5 years is more reasonable. And what better time to start than now as you prepare for new beginnings in 2017.
Published in Mint on Dec 05 2016, Written by Kapil Mehta