A few days ago, a senior official of a private life insurance company was telling that the sale of riders with base policies has gone up significantly since September following a drop in sales of regular premium policies.

Riders are additional risk-specific covers that you may buy based on your needs at an extra cost and add to your basic life insurance policy. For example, you may buy a critical illness cover on top of your basic life insurance cover. If you are diagnosed with any of the critical illnesses specified in a policy, the insurer will pay you the sum assured contracted for under the rider. The life cover under the basic policy will continue.

There are many riders that insurers are selling these days such as accidental death cover and hospital cash benefit. However, the maximum sum assured or benefits under these riders will depend on the premium that you pay.

Under the IRDA’s regulations, the annual premium for a rider option cannot be more than 30 per cent of the premium paid for the base life insurance policy.

The question is whether you should buy a rider along with your base policy? If so, how should you determine which rider option to buy and how much should be the cover?

This riddle is solved if you understand your insurance needs.

Know your needs

Insurance is basically a risk management technique — how to hedge against a contingent loss.

It is basically a passing game that ultimately reduces the probability of losses from a particular risk.

At the individual policyholder level, you buy an insurance product (or the protection against any loss arising out of a particular risk if it happens) and pass on the risk to the insurer selling the policy.

The insurer minimises its losses (arising out of claims from policyholders in case the risk occurs) by distributing the risk among many policyholders.

The probability of death of all the policyholders of an insurer during a given period of time is zero. But the probability of death of some policyholders during the given time period is high and the insurer retains the risk of losing money to service these death claims. The chances of an insurer making money are high if the number of policyholders with low probability is higher than the number of policyholders with greater probability of death. This is the rule of general average.

Once you have understood how insurance (the risk management technique) works, the next thing you should find out is what are your insurance needs. Insurance needs are very personal and dependent on one’s socio-economic set-up.

Here, one should remember that only those risks that are quantifiable get insurance cover. So, another way of looking at your insurance needs will be to identify the potential areas from where a financial loss can arise. Your approach while buying insurance should be to get that loss amount covered.

Financial losses can arise because of loss of life. There could be non-life losses as well such as damage or stealing of property.

Cover basics

A basic life insurance policy provides protection against financial losses on account of death, natural or accidental. What are the financial losses when a person dies? It is the future income that the person would have earned had he not died.

Thus, a basic life insurance policy is more important to a person who is well within his/her working age, while it’s superfluous for a person who doesn’t have any income, for example a 70-year-old retired person.

What should be the amount of life insurance you need? Suppose Ram is 25-years-old and has an annual income of Rs 5 lakh. Till he attains the superannuation age at 60, he would have earned Rs 1.75 crore (=Rs 5 lakh x 35) at least. So, Ram should get a life cover for Rs 1.75 crore.

But can he afford to buy a policy with such a high sum assured? He should get a term life cover, which is a pure risk cover, and costs the least among all life insurance products. Ram can buy a term assurance of Rs 1.75 crore for 35 years online and he can get the cheapest one from Aviva Life for as low as Rs 1,034 a month or less than Rs 35 a day!

Once he has got an adequate life cover, Ram can now look for other potential areas of loss of income such as disability caused by an accident or disease. Broadly, there could be two main areas where one needs additional cover. These are illness and accidental disability.

Buy separate policies

Now the question is whether Ram should go in for riders with the basic life insurance policy or he should get these covers from non-life insurers?

Let us analyse this with an example. Aviva’s critical illness rider will cost Ram Rs 1,805 a year for a sum assured of Rs 5 lakh for 35 years. However, Ram can get a critical illness care cover of Rs 6 lakh from ICICI Lombard for as low as Rs 1,589 a year. He can get a Rs 5 lakh cover for Rs 1,581 from Tata AIG General Insurance.

Similarly, covers for disability from accidents are also cheaper if bought from non-life insurance companies than from a life insurer.

However, there is a basic difference between a health policy of a general insurance company and that of a life insurance company. While a life insurance company will pay the policyholder the entire sum assured contracted for under the critical illness rider once a disease has been diagnosed, a general insurance company will pay the cost of treating the ailment subject to the maximum limit of the sum assured.

To sum up, buy a term assurance policy from a life insurer to get protection against death and buy additional covers for disability or health problems from a non-life insurer.