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What is Underinsurance & The Dangers of Being Underinsured

Under-insurance is where the life insurance coverage is insufficient to protect your family's financial needs. Know what underinsurance is and the risk and dangers of being underinsured.

  • Nov 12, 2019

Key takeaways

  • It has been noticed that people in India do not understand the necessity of buying insurance policies. The insurance penetration in the country is noticeably lower as compared to the universal average. Even most of the insured people in India are grossly under-insured. If you are someone, who comes under this category, it is important that you understand the consequences of being under-insured and take action to secure the future of your family.

What is underinsurance?

To understand what is underinsurance, you have to know the goal of a life insurance cover. It is designed to provide financial cover to the family of the policyholder in case of their untimely demise. Under-insurance is the condition where the life insurance cover is not enough to take care of the financial needs of your loved ones. It means the sum insured by your policy is not adequate. Underinsurance can put your family in a financial crisis when you are not there to take care of them.

Example of underinsurance

Imagine if your current lifestyle requires ₹50 lakh as financial support for your family for the next five years, but your term insurance cover is ₹30 lakh. That means you are under-insured by ₹20 lakh.

Reasons for being under-insured

Now that you understand the underinsured meaning, you need to know what results in underinsurance. These are some of the most defining reasons:

  • Investing in insurance to save taxes
  • Most life insurance products come with huge tax benefits. So, many people buy insurance policies to save taxes and forget that the main purpose of life insurance is to offer death benefits. Hence, they end up settling for underinsurance.

  • Greedy agents
  • Most insurance agents try to sell you products that can ensure them a hefty commission. Hence, they do not prioritize the benefit that you require. This results in underinsurance.

  • Wrong product
  • There is a huge range of life insurance products available. However, not every product is designed to meet the needs of every single policyholder. If you end up buying the wrong product, you will either unnecessarily pay a higher premium or end up with an inadequate cover.

  • The risks of being under-insured
  • There are many disadvantages of being underinsured, and the biggest one is that your family will suffer financially when you cannot be there for them. They will receive less than the amount of money they need to meet their financial responsibilities. It also means what you invest as a premium will be wasted.

  • Underinsured Renovating Cost

Similarly, when you only insure your building’s market price and not the re-build cost, then you’ll lose the insurance amount you have put while re-building it or renovating it.

How to identify when you are under-insured

A term insurance plan can be a very fruitful investment if you are not underinsured. So, how do you even know when you are underinsured? Firstly, you have to calculate your yearly household expenses, which must include rent, bills, groceries, and repairs. Add to that the loans that you need to repay and the investments that you hold. Also, do not forget to include the expenses for your children’s education and marriage.

Once you have an idea about the yearly average expense, multiply it by 15, and that number is the required sum assured to make sure that your family will be financially covered for a long time.

You can consider buying online term insurance, as that way you can easily compare different products and their specifications. This will ensure that you buy a suitable life insurance plan for the family.

What happens when you are underinsured?

The most serious risk of under-insurance is that it produces a false sense of security in the mind of the individual acquiring the life insurance policy, which is actually worse than not having any protection at all. Only after an unexpected incident does the family realise that the quantity of insurance is insufficient to pay off obligations, let alone develop a corpus for the children’s education and a replacement income stream, etc.

This is covered in underinsurance

Term insurance

It is much better to keep investments and insurance separate than to combine them, and term insurance allows you to acquire a lot larger cover at a fraction of the cost.

Furthermore, in a growing economy like India, where inflation is causing prices to rise on a daily basis (especially medical and educational inflation, which is in the double digits), 10 lacs today will not have the same value as it will ten years from now and will certainly not provide you with the same purchasing power. As a result, treating insurance purchases as a one-time “fill it, close it, forget it” activity is insufficient.

Underinsurance vs over insurance

  • Underinsurance generally means that your out-of-pocket healthcare costs exceed 10% of your family income or that your deductible exceeds 5% of your income.
  • Underinsurance can lead to people going without medical care or incurring debt.
  • Insurance add-ons can help fill coverage gaps, but they are not cheap.
  • There are free and low-cost healthcare services available for the uninsured and underinsured.

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Ref. No. KLI/22-23/E-BB/2435


- A Consumer Education Initiative series by Kotak Life

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