Definitions
Sum assured is the minimum amount payable by the life insurance company in case of death of the policy holder. This is hence the actual coverage. This is the amount which directly determines the amount of premium payable by the policy holder.
Guaranteed return, on the other hand, is the minimum amount that the insured person receives when he/she outlives the life insurance policy's tenure.
For instance
If a 20-year life insurance policy provides a coverage of Rs 10 lakh to the beneficiaries on death of the policy holder and Rs 6 lakh on maturity, the former is sum assured while the latter is guaranteed returns.
If a 20-year life insurance policy provides a coverage of Rs 10 lakh to the beneficiaries on death of the policy holder and Rs 6 lakh on maturity, the former is sum assured while the latter is guaranteed returns.
Who determines what?
While the policy holder can select the sum assured or coverage, it is mandatory for insurance companies to pay out this sum in case of the unfortunate death of the policy holder.
While the policy holder can select the sum assured or coverage, it is mandatory for insurance companies to pay out this sum in case of the unfortunate death of the policy holder.
The amount of guaranteed return is determined solely by the insurance company. Different plans may have different guaranteed returns as specified in the terms and conditions. Many insurance companies today offer guaranteed returns to attract customers who seek returns on their premiums.
How to decide Sum Assured?
How would you know what is a sufficient amount of sum assured in your case? As such there are no formal rules for arriving at this value. It can vary depending on your life style. Ideally it should be enough to last till the dependents are not able to earn themselves. It is suggested to have this amount at 6 to 10 times the current annual income of the person insured. A high Sum Assured (SA) would push the premium to a higher level and may also make a medical check-up necessary.
Which amount should you look at?
A policy buyer looking at insurance as an investment tool is more likely to look at the guaranteed returns aspect, while those intending to secure their loved ones' future will probably opt for a plan that has a higher sum assured.
While these are two different elements of a life insurance policy, you do not have to buy different policies to avail both. Most endowment policies offer sum assured as well as guaranteed returns, as the policy holder will be able to avail of only one benefit.
Conclusion
A good financial acumen tells us that we should not mix up insurance with investment. So, we should restrict ourselves to buying term insurance policies for covering life risks and utilise our investments with the right investment tools. Insurance is not designed to be an investment tool. So, as you look out for a term insurance plan, you will only have 'sum assured' to look at. It will never have any guaranteed returns since you do not get anything on surviving through the policy term.
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The book "From the Rat Race to Financial Freedom" has many such investment concepts explained in a very simple and uncomplicated manner, especially in the Indian context.
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Manoj Arora
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