Understanding Life Insurance - Ask Yourself a Few Questions

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Here’s another question by a reader (see Amazing Fact about Life Insurance comment no 5 dated 25 April, 2009), who thinks that LIC’s Endowment Plans and Whole Life Plans are really value for money insurance policies. He writes,

“What about LIC policies like Jeevan Anand which provide a life cover throughout life even after maturity and lump sum payment (tax free).

I say this because I have one and people consistently suggest me to terminate it in favour of a term insurance, which I feel is not prudent under the circumstances!”

It doesn’t matter whether the policy is named Jeevan Anand, Jeevan Mitra, Jeevan Surabhi, Jeevan Shree, Jeevan Nidhi, Jeevan Amrit, Jeevan Saathi, Jeevan Tarang, Jeevan Bharati or Jeevan Varsha. They are all traditional life insurance plans, (whether endowment, money-back, whole life or a mix of those) the worst kind of life insurance policies.

Anyway, try answering the following questions:

1. What’s the difference between insurance and investment?

2. What is the sole purpose of life insurance?

3. Do you really need insurance in your old age?

4. What’s your life insurance coverage ratio? Put another way, how much life insurance coverage do you have in relation to your annual income or your needs?

5. What if something unfortunate happens to you? Would the money from the so- called life insurance policy be enough to take care of the financial needs of your family / dependents in the near future? How long the claims proceeds will last?

6. What’s the ratio of sum assured (S.A.) to annual premium? In other words, how much premium you’re paying in relation to the sum assured? What if you face a sudden liquidity crunch and unable to pay your premium?

7. What’s the expected IRR of your insurance policy?

I hope that by the time you finish answering all the above questions, you’ll become wise enough to understand and appreciate the true purport of insurance.

Furthermore, regarding the notion of “tax free returns”, let me tell you another amazing fact – the real beneficiary of these tax concessions are the insurance companies and not the insured. It’s sheer mockery of the tax incentives! But I know you won’t understand it because we hear only what we want to hear. This is how our mind works which makes the job of insurance companies a lot easier. Confused? Read another post – Is it Complexity or Confusopoly? , Or feel free to put your views in the comment box.

Also see:

1. SBI Life-SMART ULIP: Review

2. Term Plans – Top Most Amazing Fact about Life Insurance

3. Is it Complexity or Confusopoly?

4. ULIPs vs Traditional Insurance Plans

5. How to Exit or Surrender a Life Insurance Policy

6. 5 Common Myths about Life Insurance

7. 7 Must Know Points about Life Insurance Policies

HRA Tax Calculator

I’ve already dealt with the subject of HRA tax exemption quite extensively in my earlier posts – How to Calculate HRA Tax Exemption, HRA FAQs & Tips, and Claiming HRA along with Home Loan Tax Benefits.

However, I’ve received a few requests to develop a HRA Tax Calculator in excel to make it easier for a layman to understand and calculate. So, here’s a HRA tax calculator.

You need to input the following information for calculating taxable and exempt portion of the HRA:

1. Basic Pay + DA (if any) p.m.
2. HRA received p.m.
3. Rent paid p.m.
4. City of Residence (Enter "M" for Metro & "N" for Non-Metro)

However, it is very rare that all the four variables remain constant during the entire financial year. There can be increase in the basic pay and HRA received (due to annual increments or change of job); city of residence and rent paid might also change. As already pointed out in HRA FAQs, when there is change in any of the four factors, HRA tax exemption is to be computed on monthly basis.

Thus, I’ve prepared two HRA tax calculators. The first HRA calculator is meant for calculating HRA tax exemption when all the four parameters remain same through out the financial year. Second HRA calculator is to be used if there is a change in any of the four variables. In case you still need any clarification, please feel free to ask.


Also see:


1. Know your effective tax rate

2. How to calculate your income tax liability

3. How to calculate HRA tax exemption

4. HRA - FAQs & Tips

5. Income tax calculator FY 09-10

6. How to claim HRA alongwith home loan tax benefits

Health Mediclaim Insurance: 5 Important Reasons to Continue Your Existing Policy

It is always better to renew the health / mediclaim policy well in time (at least 15 days before the due date) so that you don’t lose the added benefits which come from continuity of the policy. Don’t ever think that the company or your agent is going to send you a reminder. Insurer may send you renewal notice as a matter of courtesy, but it’s not obligatory for them. Therefore, make sure that you remember the renewal date of your health mediclaim insurance policy like you remember your anniversaries.

Following is the list of benefits which you get entitled for over a period of time due to continuous renewal of your health mediclaim policy from the same insurer and stand to lose out due to non-renewal of your policy in time or due to change of insurer:


Health Mediclaim Insurance - Benefits of Continued Coverage / Timely Renewal

1. No Claim Bonus (NCB) / Discount
Unlike other general insurance policies, a health mediclaim policy doesn’t give you any discount in renewal premiums for claim free years. Instead health mediclaim policies such as Bajaj Allianz Family Floater Health Guard Policy and National Mediclaim Insurance Policy-Individual allow you an increase in sum assured by 5% for every claim free years subject to a maximum cumulative bonus of 50% of the basic sum insured (i.e., 10 claim free years of insurance).

However, there are exceptions also; for example, Star Family Health Optima Policy allows No Claim Discount @ 10 per cent (non-cumulative) for every claim free years. Similarly, ICICI Lombard HealthCare Insurance (a family floater health plan) gives No Claim Discount of 5% on premium for every claim free year (subject to a maximum of 25%) instead of no-claim bonus. Reliance HealthWise Policy provides for a renewal discount of 5% of renewal premium (if no claims made in the previous year) subject to a maximum accumulation of 50%.


2. Coverage for pre-existing diseases and temporary exclusions
As already mentioned in the earlier post – Health Mediclaim Coverage & Exclusions, in most of the health mediclaim policies, pre-existing diseases gets covered usually after 4-5 years and there are certain diseases (even if they are not pre-existing) which are covered from 2nd or 3rd year onwards.

Now, if there’s a gap in renewal of your health mediclaim policy or if you shift to another insurer, the exclusion period again starts from scratch, nullifying all your timely renewals during the previous years. For example, suppose you make timely renewals of your health mediclaim policy during first 3 years and in fourth year there is a slight delay of a few days, this would make the effective exclusion period 7-8 years for pre-existing diseases and 4-5 years for temporary exclusions.


3. Waiting Period
As you know that most health mediclaim policies don’t allow for any claims during the first 30 days; in case of non-renewal of policy in time or change of insurer this waiting period of 30 days also starts afresh.


4. Free Health Check-ups
Most health mediclaim policies provide that after 4 claim free years (without any break) you get entitled for reimbursement for the cost of medical check-up limited to 1% of the sum insured. For example, FGI Health Suraksha Family Floater allows free medical check-up of any two members subject to 1% of the sum insured up to a maximum of Rs 4,000 for a family policy. Similarly, while Apollo DKV Easy Health Family Floater Standard Plan reimburses 1% of the sum insured every fourth year, Premium Plan reimburses 1% of the sum insured subject to a maximum of Rs 5,000 per person every 2nd year.


5. Ailment suffered during the previous coverage
Even the ailments suffered (irrespective of whether you made a claim or not) during the previous coverage period would also become pre-existing diseases due to not renewing your health mediclaim insurance policy in time as the policy purchased after the due date would be construed as new policy.


Timely renewal of health covers is very important because a single day gap can prove to be a costly affair. Unlike life insurance policies, health mediclaim policies usually don’t allow any grace period for payment of renewal premium. However, there is good news. IRDA has issued new regulations recently which are applicable to all health insurance policies issued or renewed (by general insurance companies) on or after 1st June 2009.

According to the IRDA circular dated 31st March, 2009, a uniform grace period of 15 days has been made compulsory. In other words, now your health policy won’t lapse just because you delayed a payment by a few days provided you pay it with in 15 days from the due date. But, please remember that unlike life insurance where you remain covered during the grace period, health insurance claims made during this gap period won’t be allowed. Anyhow, the continuity of your existing health policy won’t suffer unlike in the past where due to delay of even just one day, your health policy was treated as fresh policy.

In a nutshell, to avoid losing ‘continuity of cover’ it is very important to renew your health / mediclaim policy in time. If there is a break in the policy, you stand to lose out many benefits which you acquire over a period of time.

Also see:

1. Health / Mediclaim Insurance - Coverage & Exclusions
2. Health / Mediclaim vs. Critical Illness Insurance
3. Health Insurance Guide
4. Understanding Life Insurance
5. Top most Amazing Fact about Life Insurance
6. Is it Complexity or Confusopoly?

Confusopoly - Reason behind Increasing Complexity of Financial Products

“You can fool some of the people all of the time, and all of the people some of the time, but you can not fool all of the people all of the time.”

-Abraham Lincoln

Absolutely wrong! Just go and ask any CEO of a bank, mutual fund house or an insurance company. They can tell how easy it is to fool all of the people all of the time. SBI Life - SMART ULIP is the latest example of this growing phenomenon.

However, the moot question is: why the financial products such as loans, credit cards, insurance or mutual funds are getting more and more complex with each passing day? Is the complexity for the benefit of consumer / investor, or is there something else behind it?

Answer is confusology. Perhaps you’ve never heard of it before and wondering: what does it mean? Actually, the word “Confusology” is coined by none other than Scott Adams, the man behind the satirical comic strip ‘Dilbert’ in his 1997 classic The Dilbert Future – Thriving on Business Stupidity in the 21st Century.

Before discussing it any further, let me tell you that I am a big fan of ‘Dilbert’ and in my view it should be made a compulsory read (along with a course in ethics) in all professional courses (particularly for MBA) because it teaches us more and better about human stupidity and organizational behavior than the entire management curriculum.

Anyway, coming back to the point, confusology means to confuse the customer to such an extent that it’s not worth the time & effort involved to decipher the product or service and virtually impossible to make a comparison with other similar product or services.

To quote Scott Adams, from his recent blog post Government efficiency

“A confusopoly is a situation in which companies pretend to compete on price, service and features but in fact they are just trying to confuse customers so no one can do comparison shopping.

Cell phone companies are the best examples of confusopolies. The average customer finds it impossible to decipher which carrier has the best deal, so carriers don’t have normal market pressure to lower prices. It’s a virtual cartel without the illegal part.”

Read more about Confusology in the following articles:
1. Confusopoly, or Scott Adams, Prophet of Finance
2. Rise of the Confusopoly

Have you also encountered confusopoly while buying financial products & services? Air your views by posting a comment.

Direct Stock Investing vs Mutual Funds: How to Decide?

The most common dilemma faced by first time investors is whether to go for direct stock investing or route through mutual funds. Which one is a smarter investment strategy? Unfortunately, there’s no easy answer to this question because there are so many factors involved. Let’s try to understand pro and cons of each investment style:

Direct Stock Investing vs. Mutual Funds: A Comparison

Mutual Funds offer several advantages over direct stock picking. Here are few benefits of mutual funds investing:

PROS of mutual fund investing:

1. Professionally-managed portfolio
Mutual funds are managed by professionals who take investment decisions based on thorough economy, industry and company research rather than ad-hoc decisions based on market tips and broker’s advice. Besides, they keep a regular watch even after investing. Thus, mutual funds are an easy way to take advantage of professional expertise at an affordable price.


2. In-built Diversification
Top-most benefit of investing in mutual funds is built-in diversification. Mutual funds offer convenient and effective way to achieve instant diversification.

Although you can achieve the objective of diversification through direct investing also but for that you require quite huge amount of money. On the other hand, you can do the same through mutual funds by making a single investment of just a few bucks.

For example, suppose you are having Rs 10,000 to invest. If you invest directly in stocks, how many numbers of different stocks can you buy? One or may be two. Now, if you go for a mutual fund, let’s say, diversified equity mutual fund, you get exposure to 40-60 stocks just by investing a very small amount.

In short, mutual funds allow you the benefit of diversification without investing large sums of money that would be required to create an individual portfolio.

Why do you need to diversify? Because, diversification reduces risk by spreading your investments among various companies belonging to different industries. A downturn of a company/sector gets offset by the better performance of other companies/sectors.


3. Transparency
Mutual fund industry is regulated by SEBI & AMFI. Gradually, over a period of time, the investment practices have more become more transparent due to stringent regulations regarding manner of investments, maximum exposure limits, expense ratio’s, entry & exit loads, manner of calculating and disclosing NAVs. Thus, it is safer to invest in mutual funds. Chances of getting duped are minimal.


CONS of Mutual Fund Investing

But there is other side of the coin too. You should also know that there are certain demerits associated with mutual fund investing:

1. Too Bulky Portfolios
Holding too many stocks in a portfolio can lead to unnecessary duplication and sub-optimal performance. This is particularly relevant to over-sized funds investing in small and mid-caps. Due to high illiquidity in small and mid-cap segments, a mutual fund can not take large exposures.

The problem with too big portfolio’s (over-diversification) is that rather than out performing the market, portfolio simply mimics the market returns which in turns defeats the very purpose of active investing.


2. Too much churning of portfolios
In the over-enthusiasm to outperform their index counterparts, a lot many fund managers indulge in frequent churning of portfolios which amounts to timing the markets and shows a lack of long term approach. Also, it doesn’t ordinarily result in higher returns due to high brokerage and other costs.


3. Rampant mis-selling
While investing in mutual funds, you rely on the advice of so-called advisors who are just agents/ distributors of financial products with half-baked knowledge and more interested in earning their commissions rather than keeping the investor’s interest in mind. For further details check out: Myths about Mutual Fund Investing.


4. Herd Mentality
Portfolio of most funds in the same category (funds with similar objective) is more or less the same?

In the words of Peter Lynch, (Excerpts from his book “LEARN to EARN: A Beginner’s Guide to the Basics of Investing and Business”)

“…herd of fund managers tend to graze in the same pasture of stocks. They feel comfortable buying the same stocks the other managers are buying and they avoid wandering off into unfamiliar territory. So they miss the exciting prospects that can be found outside the boundaries of the herd”.

But why? There are two basic reasons behind it. First is called herd instinct (the comfort of going with the crowds is powerfully attractive because to humans a group offers security) and second is that underperformance of fund managers can be treated quite harshly.

Because mandate given to fund managers is to beat the benchmark index, fear of underperformance drives them towards mediocre performance by conforming to the peers and invest mostly in benchmark index securities rather than taking risks by surfing in unchartered waters. If a fund manager holds the same ICICI, ACC or DLF’s and they drop, the economy can be blamed. However, if they show more creativity with stock picking, the onus will fall directly on them.

If you invest directly you are in a privileged position as compared to fund managers because unlike them you are not answerable to anybody and therefore need not chase returns. Furthermore, what’s more important to you is real absolute returns and not the relative outperformance.


5. Paradox of Choice
One argument against direct investing is that retail investor has neither the time nor the expertise required to research and pick individual stocks. But this multitude of choice also exists in mutual fund space. There are thousands of mutual fund schemes available in the market. At present, around 30 fund houses with more than 2000 schemes are present in India. If you want to invest in mutual funds, say, equity diversified schemes; you’ll have to research over 200 schemes. Even if you leave aside the recently launched funds and concentrate only on funds with a long term performance, there are more than 100 diversified equity schemes with a track record of more than 5 years.

However, unlike direct stock picking, there is a way out – to remove the clutter – as rating of mutual fund schemes is periodically done and published by VALUE RESEARCH, Economic Times and Outlook Money.


To sum up, invest directly if you have the requisite time and skill to do proper & thorough research and also keep a regular vigil on your investments. On the other hand, if you are too busy in your work and can’t spare time or don’t have the inclination towards stock markets, it is better to hand over your money to mutual funds. It’s an easy and convenient way to invest.

Anyhow, whether you want to rely on your own wisdom or on the wisdom of so-called specialist, the choice is yours. However, if you decide in favor of mutual fund investing, please keep in mind the following Smart principles of mutual fund investing.

And if you decide to take a direct plunge into the markets which requires a lot of patience and discipline, remember to start small, learn some basic investment principles, be wary of human irrationality and flaws in our decision making and don’t forget to do regular portfolio rebalancing. I’ll be covering the direct stock investing principles and decisions flaws in my future posts. In the meantime, you can put your own views in the comment box.


Also see:

1. Top 5 Stock Investing Pitfalls
2. Investing in Gold ETFs - FAQs
3. PPF vs NSC - Which is better?
4. How to Select the Best Equity Funds?

What’s Your Effective Tax Rate?

What’s your tax bracket? You must have heard this question quite often. But has anyone ever asked you about your effective tax burden? Did you ever thought about your effective rate of tax? Have you ever tried to calculate it?

We keep on carping about the high taxes by keeping in view only maximum marginal tax rates, without ever giving a thought to the exemptions and deductions we avail.

Taxes are determined based on your taxable income. Taxable income is broken down into different brackets or slabs, each to which a different tax rate applies. The highest tax slab rate relative to a taxable income is called marginal tax rate. Put simply, the highest rate of tax applicable on your marginal or additional income is called marginal rate of tax and is the rate you pay on your last rupee of income.

Marginal vs. Effective Tax Rate
Marginal tax rate is important because while making investment decisions, you need to consider your marginal tax rate. However, marginal tax rates do not fully describe the impact of taxation.

The effective tax rate refers to the actual rate of tax borne by you. It is the average rate of tax which you actually pay on your total earnings / income (i.e., both taxable plus non-taxable income). It is obtained by dividing the total amount of tax paid by you by your total earnings expressed as a percentage and indicates your effective tax burden which is always lower than your maximum marginal rate.

Two basic reasons for substantial difference between your marginal tax rate and your effective tax rate are:

1.Your entire income doesn’t get taxed. For example, you are entitled for various exemptions (e.g. HRA, long term capital gains on sale of equity shares, dividends etc) and deductions (such as section 80C and 80d) due to which your taxable income is much lower than your actual total earnings during a particular year.

2. Further, unlike corporate tax rates, your total taxable income doesn’t get taxed at a flat rate. There are different slab rates of tax applicable to individuals. Right now, the lowest tax slab rate is 10% and the highest is 30% (plus surcharge and education cess). Besides, there are certain other incomes which are taxed at concessional rate of tax. For example, short term capital gains under section 111A are taxed at a flat rate of 15% (plus surcharge, if applicable and education cess).

Furthermore, ‘Effective rate of tax’ is also different from ‘Average rate of tax’ which is average rate levied on your ‘Taxable Income’ and is calculated by dividing ‘total tax obligation’ with ‘Taxable income’. Your ‘effective rate of tax’, on the other hand, reveals the average rate of tax for all your income (taxable as well as non-taxable).

Let’s clarify the difference with the help of an example. Suppose that you’re having a total annual income of Rs 17 lakh out of which Rs 4 lakh is exempt (i.e., not taxable) from income tax. Further, let’s say that you are entitled to deductions amounting to Rs 1.6 lakh under various sections of income tax such as section 24(b) and section 80. Thus, your taxable income comes to Rs. 11.4 lakh (which includes short term capital gains of Rs 2,30,000 taxable u/s 111A @ 15%). Based on the tax rates applicable to ‘other individual’ (i.e., neither women nor senior-citizen) for the assessment year 2009-10 (PY 2008-09), the total tax liability works out to be Rs 2,40,760. So, we arrive at an effective tax rate of 14.16 per cent, which is less than half of marginal tax rate and almost two-third of average tax rate (marginal tax rate of 33.99% and average rate of tax of 21.12% ).



Now, finally calculate your effective tax rate. Isn’t it revealing? Feel free to share it with others by writing in the comment box.

Also see:

1. Income Tax Calculator (PY 08-09, AY 09-10)

2. HRA Tax Calculator

3. 4-in-1 Loan Calculator

Money Teaser (#1): Which is the most important Insurance Cover you require?

From time to time, I’ll be asking you a few money teasers to allow you to actively participate in the discussion and debate on the money matters by putting forth your personal views.

Here is the first money teaser:

Which is the most important insurance cover you require? Why?

In my earlier post -- Term Plans: The Most Amazing Fact about Life Insurance, I’ve pointed out the importance & significance of term insurance plans. However, there is an insurance cover which is even more important than pure-risk life insurance cover.

Now, I would like you to answer: Which is that insurance cover and why is it more important than a life cover? The best two or three answers will get a special mention on this blog. So, start airing your thoughts in the comment section by answering this question. Best of luck!

UPDATE (20 June 2009): There was only one answer to this money teaser which was incorrect. For correct answer, check out: 5 Common Myths about Life Insurance.

Also see:

1. Health / Mediclaim Insurance - 10 Practical Tips

2. Understanding Life Insurance - Ask Yourself a Few Questions

3. Most Amazing Fact about Life Insurance

4. Second Money Teaser: Tax Rates