The Dangers of Being Underinsured (Inadequate Insurance)

Shubham is one of the cautious and frugal investors and manages his money penny for penny. He is very particular about meeting his tax-saving limits and keeping the tax outflow as low as possible. So, when his tax-saving investments fell short by some ₹9000, he searched frantically for a tax-saving investment to cover the gap.

He figured he had no choice but to go for a term insurance cover, for the low premium cost, and as he had heard, ‘it’s a need.’ He selected the cover amount and benefits, keeping in mind his tax-saving budget.

So, at the age of 32, he finally secured online life insurance of ₹1 crore with a lump sum payout option and accidental death and disability cover. His annual take-home income is ₹15 lakhs, and he is currently responsible for his wife and a three-year-old child.

He bought a house using ₹30 lakhs as a home loan a few months ago. Other than that, he does not have any liabilities.

The Risks Shubham’s Family Carries

Now, let us look at the vulnerabilities Shubham has adopted by simply buying a term cover without looking at the benefits:

• His term cover may be inadequate for the family, as 30 lakhs will go towards the home loan repayment
  
• His homemaker spouse will have to make major investment decisions to:
  1. Generate a regular monthly income out of the remaining term insurance proceeds.
  2. Save enough money for the child’s future goals.
     
• He has no insurance for any critical illnesses. So, in case of contracting one of the terminal diseases, he will need to use his savings for the treatments.
  

What is Underinsurance?

Underinsurance doesn’t just mean low sum assured for your term cover; it also means that you are not covering all the risks. In other words, you may have an umbrella for the rainy days, but one, it’s too small to cover your entire family, and two, it protects from only rain and not the sunlight or snowfall.

Underinsurance by amount is the truth for the Indian market as a whole, with the largest gap or protection margin of 92.2%. Protection margin refers to the gap between the required and availed life cover protection by the policyholder.

When combined with the lack of sufficient insurance policies, many families end up facing the financial burden of uninsured risks.

Potential Dangers of Inadequate Insurance Coverage

Inadequate insurance coverage can leave families financially vulnerable in more ways than one. Here are some of the potential risks of being underinsured:

• Even minor events like long hospitalisation can affect your income and long-term savings
• In case of death, the family’s lifestyle will decline in the absence of adequate regular income
• The family may have to compromise on children’s important life goals, such as higher education, pushing the next generation a few steps back financially.
• Loved ones may be forced to liquidate long-term assets or take on high-interest loans to meet immediate expenses.
• Spouse or elderly parents may struggle with ongoing medical expenses without sufficient support.
• Sudden disruptions in income can derail retirement planning and create long-term financial stress for surviving dependents.

Inadequate insurance cover, in reality, will fail to serve its core purpose, which is ‘to help your family maintain their lifestyle and financial status.’

How to Cover the Gap or Get Adequate Life Insurance?

First thing is to figure out how much life cover you will need. Although this can be a simple equation given that there are other risks to your family’s financial well-being, you also need to plan for contingency.

For example, in case of accidental disability, your ability to earn money would be affected, and your income may change. In case of critical illnesses, you may need huge financial support for the treatments and to run your household effectively.

So, in case of any contingency, your insurance plan should provide you with:

• The Household Expenses: One thing that is common for any risk cover is your household expenses. This is a regular need and is best covered by a regular income. Since the household budget also defines the family’s lifestyle, you need a regular income to at least grow to cover inflation.
• Treatment & Other Costs: Critical illnesses and accidents may involve long-term care and treatment costs. You may need a large pool of funds to take care of these expenses. So, your long-term investments can continue towards their goals.
• Future Financial Goals of the Family: Most long-term financial goals, like a child’s higher education and marriage goals, take consistent, regular investments. In the event of your early death, these investments will stop midway. Thus, the term insurance cover should provide for these goals as well.

How Much Insurance is Sufficient?

Ideally, your financial advisor will estimate the cost of all your goals and the amount needed to run your household expenses to give you adequate life cover. The amount is typically 15 to 20 times your annual income if you are in your 30s.

So, for a faster estimate, we can use this rule to get close to the adequate life cover amount. But getting term insurance 15 times your annual income is not enough. How?

Remember that your family needs a regular income to look after the household and lifestyle expenses. Therefore, you need to ensure they can receive regular income after your demise.

Fortunately, with term plans from Canara HSBC Life Insurance, you can divide your total sum assured into two parts:

• A lump sum to the family

• A secure monthly income to ensure ongoing financial support

With the regular income option, you can also opt for a growing income to account for inflation in lifestyle, and you should. A fixed, regular income for a long time would cause a decline in the family’s lifestyle over time due to inflation.

What About the Other Insurance Covers?

You can add the other insurance covers, like the critical illness, accidental death, and disability, as add-on covers to your base term insurance. You can also select a separate sum assured for each.

The sum assured for these benefits, however, depends on the prevailing healthcare costs instead of your lifestyle. So, you can choose the maximum eligible amount as per the insurer's limits, which will be based on your annual income.

Hopefully, this will help you and your family avoid the dangers of being underinsured.

Final Words

Underinsurance is a silent risk, as most people don’t realise they’re underinsured until a crisis strikes. Shubham’s story is not unique. Like many, he secured a term plan to save tax and meet a perceived requirement, but didn’t account for the complete financial risks his family might face. A large part of his coverage would be absorbed by his existing liabilities, leaving very little for his family’s long-term needs.

Adequate insurance coverage should not only account for liabilities like home loans, but also regular household expenses, future goals like education and marriage, and emergency costs like critical illness treatments. A well-rounded life insurance plan, including riders for disability and critical illness, can shield your family from multiple financial shocks.

When buying insurance, think beyond tax benefits and low premiums. Evaluate your actual financial obligations and responsibilities. Make sure your cover provides a lump sum for immediate needs and a steady income stream to maintain your family’s standard of living.

By choosing a plan that aligns with your financial profile and goals, such as those offered by Canara HSBC Life Insurance, you can avoid the pitfalls of underinsurance and give your loved ones the long-term security they deserve.