Insurance has been one of the strategies (as transfer of risk) for managing risks. Afterall, protection of wealth is one of the important stages of Wealth Management.Life Insurance and Property & Casualty Insurance (the latter commonly referred to as General Insurance or Non-Life Insurance in India) are the two different classes of insurance. What’s then, the fundamental difference between the two?

While the General Insurance (as it is commonly referred to in India as) provides compensation against the loss of an asset, Life Insurance provides coverage against loss of income, due to premature death or disability or reduction in income, for example, due to critical illness or disability. While death is a certainty, premature death is indeed a risk.

Life Insurance companies also cover another important risk, the risk of living too long. Afterall, once a person retires from active working life (be it a salaried job or business or self-employment), one doesn’t stop living! This means that one does need to provide for a passive source of income, once the active income stops. The accumulation stage of wealth management deals with this accumulation of corpus and the distribution stage pertains to the aspect of withdrawal of streams of cashflows, to provide for one’s income post retirement from active work life.

For example, let’s take the example of Mr. Gupta, who is currently aged 30 years of age. He is currently earning Rs. 50,000 per month and wants to retire at the age of 60 years. He thinks his life expectancy shall be 85 years. Inflation is expected to be 5% and the rate of return on investments is expected to be 8%. Mr. Gupta wants to maintain his existing lifestyle post retirement and wants to know from the wealth manager as to how much of corpus would he require at the age of 60 so as to enable him get the income he requires, inflation-adjusted, during his golden years.

A Financial Planner does the calculations and helps him understand that the monthly expenses, inflating @ 5%, shall be Rs. 2,16,097 per month, immediately after retirement. In order to maintain his lifestyle (keeping in mind the inflation adjusted investment returns), the Wealth Manager informs Mr. Gupta that he shall require a corpus of Rs. 4.66 crores (approx.). Mr. Gupta can now plan to accumulate this corpus choosing amongst a myriad mix of asset classes.

However, what if Mr. Gupta outlives the life expectancy outlives the life expectancy of 85 years? Afterall, as the planning has been done till the age of 85 years, the accumulated corpus is supposed to end at the age of 85, after Mr. Gupta keeps withdrawing the stream of monthly cashflows, duly accounted for inflation.

This is where Life Insurance, as an asset class, provides coverage towards the risk of living too long, by providing annuities (commonly referred to as pension) till the client or the spouse survives, irrespective of the duration.This is known as the immediate annuity option.

Let us understand more about immediate annuities from five different aspects.

These are:

i) How is annuity purchased

ii) How often is annuity paid

iii) When is the annuity payment due to begin

iv) Duration of annuity payment

v) Whether the annuity is fixed or variable

Let us understand all these five points one by one.

i) How is annuity purchased:

The immediate annuity solution could be bought by the client, by making the payment in lump-sum.

ii) How often is annuity paid?

The annuity payments (streams of cashflows or pension) could be made as opted for by the annuitant. It could be daily; fortnightly; monthly; quarterly; half-yearly or yearly, as opted for by the client

iii) When is the annuity payment is due to begin:

The annuity payments could begin immediately upon retirement (also referred to as annuity due) or could commence after one period (could be month or year, as opted for by the client), post-retirement.

iv) Length of the annuity payment:

This is about the duration of the annuity. This is, again, as per the choice of the annuitant.

Following are the options that the annuitant could choose from:

• Annuity for Life (single life): with or without return of purchase price. With return of purchase price means that the entire corpus paid by the client, to buy the annuity, is returned to the nominee, after the death of the annuitants. The annuity shall be higher in case of without return of purchase price option.
• Annuity for Life (joint life last survivor): with or without return of purchase price. Here, the annuity is paid till the time either of the survivor (for example, the client or the spouse) is alive.
• Increasing annuity, in line with a certain rate, let’s say the rate of inflation.
• Annuity for a certain duration. Let’s say, minimum for 5 / 10 / 15 years
• Many other options could also be worked out, as per the choice and requirements of the annuitant(s).

v) Whether the annuity is fixed or variable

Again, this depends on the choice made by the client. If the annuitant wants, the annuity could be fixed, throughout the term. However, if the annuitant wants it to be varying in line with some index, for example inflation, it could be so.

Let us summarise our understanding about annuities with a short case study:

• Mr. Manikant Tripathi (60) has got retired and wants to buy an immediate annuity solution for his post-retired life, with the corpus of Rs. 2 crores that he has.
• He opts for Annuity for Joint life – last survivor: withreturn of purchase price
• The insurance company pays him Rs.83,000 per month (just as an example) as pension
• The pension would continue, till he or his wife, whosoever is alive
• Thereafter, the corpus of Rs. 2 crores (which was the purchase price) would go to the nominee (their son or daughter).

Thus, Life Insurance helps protect loss of income, whether the person dies prematurely, for example through term insurance solutions, or whether the person lives too long, through immediate annuity solutions.