Broadly speaking, insurance policies are of two types: pure-risk and savings-cum-risk. For example, term life insurance is a pure-risk type, while endowment life insurance is a savings-cum-risk type. The basis on which one has to decide what percentage of their income should be reserved for each of these insurance types is different.
Savings
Households all over the world save for two main reasons - to pay for expenses when earnings are low and to leave behind assets for the next generation.
The percentage of household income that should be saved is a complex question, depending on factors such as the life stage of earners and the amount of discretionary income left after spending on fixed expenses. However, with an increase in the life expectancy the need to save for a longer post-retirement period is much higher than earlier. A general rule of thumb is to save around 30% of the discretionary income (income after subtracting fixed expenses) of the household. There are now many instruments of savings in India, including gold, real estate, fixed deposits, shares, bonds, mutual funds, pension funds and insurance.
These instruments vary from each other on factors such as capital protection, capital appreciation, yield, tax benefits and liquidity.
The mix of investment instruments in which one should put savings depends on their life stage as well as the current asset mix of the household. Therefore, there is no general rule of thumb on how much of the household savings should be put into insurance (beyond the pure-risk products described in the next section).
Risk protection
Pure risk insurance products include term life, health insurance, personal accident insurance, and motor insurance. Premiums for these products typically depend on the profile of the insured (e.g. age, pre-existing diseases, etc) and the risk coverage that is being sought (e.g. sum insured, disability riders, etc). The link between household income and the amount of premium to be paid for these insurance products is often somewhat indirect.
The table above sets these relationships in a simplistic manner.
Therefore, Indian households should budget around 5%-9% of their annual household incomes towards the premium of pure-risk products, to protect themselves and their families from unforeseen trauma events such as death, hospitalisation and accidents. This percentage will rise with advancing age because of increasing chances of hospitalisation and death.
In particular, for retirees and senior citizens, where household income flattens or declines while premiums rise, the percentage of household income for pure-risk insurance premiums should rise to close to 10%.
(The writer is co-founder of SANA Insurance Brokers Pvt Ltd)