Ladder up your Insurance

“Fun is like life insurance; the older you get the more it costs”Kin Hubbard

We have all heard about the importance of rupee cost averaging when it comes to investments but very rarely do we realise that the concept can and should be used even when buying financial protection through life insurance. This is where the concept of “ladder up” your insurance comes in.

In our earlier posts, we talked about how insurance gets more expensive with age and have also covered the basics of how to determine how much insurance is adequate for an individual. Just as a recap, insurance requirements change with time and life stage and should largely be a derivation of the needs you are trying to provide for – whether its normal family expenses in the event you are not around or specific financial requirements for events such as a child’s marriage, education etc.

In the figure attached we try and explain the importance of starting early and increasing your insurance cover with time to be adequately insured whilst reducing your premiums through rupee cost averaging by locking in lower premiums at lower ages.

1. The most important consideration is to make sure that you take insurance early on in life for the maximum term (duration of the policy) that is available. The amount of premium increases with both the amount of sum assured as well as the term of the policy. In the early years of your earning life, affordability can be an important consideration i.e. the ability to pay the insurance premium. While trying to fit the premium within your affordability limits it might be beneficial to reduce the cover amount a bit but not reduce the term of the policy. This approach makes sense on account of two reasons:
• It locks in the lower premium (due to the lower age) for a longer duration of time.
• Your insurance requirement is actually low in the early years (on account of minimal liabilities and / or financial dependents)
2. For the purpose of this example we will take premiums of an existing Term insurance product in the market. The attached illustration assumes a 25 year old male taking a Rs. 10 lac policy for 30 years such that the age to which he is covered is 55 years. The premium for this coverage is Rs. 2,200 (A)
3. A few years down the line (at age 30) his insurance requirement is assumed to be Rs. 35 lacs. At this stage he tops up his existing insurance with an additional Rs. 25 lac insurance (35 lacs – existing 10 lacs) up to the age at maturity. The premium for the additional Rs. 20 lacs coverage at age 30 for 25 years is Rs. 5,818 (B)
4. At age 35 the insurance requirement is assumed at Rs. 50 lacs – he tops up his existing coverage (10+25=35) by another 15 lacs. The premium for this additional coverage at age 35 for 20 years is Rs. 4,434 (C)
5. At age 40, the insurance requirement is assumed at Rs. 1 crore – he tops up his existing coverage (10+25+15=50) by another 50 lacs. The premium for this additional coverage at age 40 for 15 years is Rs. 17,593 (D)

This approach results in having total insurance coverage of Rs. 1 crore by age 40 with an effective premium of Rs. 30,045 (A+B+C+D). Now compare this with buying a 1 crore policy after reaching age 40 for 15 years – this will result in a higher premium of Rs. 34,634; not to mention the lack of any financial protection up to the age of 40.

The approach toward purchasing insurance has to be one of locking in as long a duration as possible for your cover at lower ages and keep topping it up incrementally with time to be adequately insured at lower effective premiums at all times.

© 2010