What is Sum Assured in Insurance and How Does it Work?

Regarding insurance, terms like "sum assured" and "sum insured" are often used interchangeably, causing confusion among policyholders. However, they are distinct concepts catering to different insurance policy types. 

This article aims to help you understand these terms, their significance, and how they differ. By the end, you will better grasp these fundamental insurance concepts in simple and relatable language.

Read on to know more about what is sum assured in life insurance.

Think of the sum assured as a promise - a guaranteed amount that your insurance company commits to paying to the nominee/heir/beneficiary under specific circumstances, provided that the policy premiums are paid in full. This term is most commonly associated with life insurance policies.

It is a fixed benefit you or your loved ones will receive in the event of a specific incident, like death or maturity of the policy.

Some insurance providers also offer life insurance policies inclusive of health insurance benefits. In such cases, the policyholder will be able to avail the benefits of the sum assured amount in case he/she faces a financial emergency due to disability or critical illness. Additionally, one can also add riders or top-ups to an insurance plan to enhance the benefits offered by a life insurance policy, like critical illness rider, term rider, etc.

Key Features of Sum Assured:

Let's break down the main characteristics that make Sum Assured unique:

• Fixed Amount: The sum assured is decided when purchasing the policy and does not change over time unless the policy has riders or bonuses.
• Life Insurance Context: Sum assured is primarily used in life insurance products, including term life insurance, whole life insurance, and endowment policies.
• Death Benefit: The amount your beneficiaries will receive if you pass away during the policy term.
• Living Benefits: In some policies, like endowment plans, you might receive the sum assured even while living, usually when the policy matures.
• Guaranteed Payout: Regardless of market fluctuations, the sum assured remains unchanged.

1. Payout on Death

2. Fixed Amount

3. No Partial Claims

4. Safety Net

Most people face a dilemma when deciding the sum assured of their life insurance policy. The minimum sum assured should be enough to cover the present-day financial needs of your family and any potential additions to that list in the future. 

Using the Human Life Value (HLV) formula, you can estimate your ideal sum assured amount. Many insurance providers offer this online calculator on their websites. 

The HLV calculator lets you calculate your capitalised value while considering inflation. To use it, you simply need to enter some details, such as your present and future expense estimate, your age, income, etc. The calculator will then provide you with an estimate of the sum assured. 

You can also calculate Human Life Value manually by following the steps mentioned below:

Step 1: Calculate your current annual income. 

Step 2: Subtract your expenses, insurance premiums, loan repayments and other liabilities. 

Step 3: Determine the number of working years left before your retirement, the expected rate of return on your investments and the inflation rate.

Step 4: Calculate the present value of your future income and assets by adjusting inflation. This will offer you an estimate of your HLV. 

Sum Insured, on the other hand, represents the maximum financial coverage the insurer provides in case of a loss or damage. It is typically associated with general insurance policies such as health, motor, or home insurance.

The sum insured works on the indemnity principle, which compensates you for the actual financial loss incurred up to the coverage limit.

Key Features of Sum Insured:

Understanding the characteristics of sum insured will help you see how it differs from sum assured:

• Maximum Coverage: The sum insured is the upper limit on what the insurer will pay for a claim.
• Applicable to General Insurance: It applies to policies like health, motor, travel, or property insurance.
• Reimbursement Model: Unlike sum assured, which is fixed, the sum insured reimburses actual expenses or losses, subject to policy terms.
• Based on Asset Value: The sum insured is calculated based on the value of the insured asset or expected medical expenses.
• Market Value Consideration: The amount often needs to reflect the current market value of the insured asset.

There are some factors you should consider while estimating the ideal sum assured amount for your insurance plan. It is crucial to decide an amount that will provide adequate financial coverage to your dependents in your absence. 

Some of the general factors that you should consider while determining the minimum sum assured are:

• Your age, 
• The current health situation of you and your family members, 
• Current income and future income potential
• Existing debts and liabilities, 
• Regular lifestyle expenses, 
• Planned & unplanned future expenses
• Current family income and inflation, 
• Accidents, illnesses and emergency funds. 

The premium payable towards your policy also plays a major role in determining the sum assured. If you are young and starting early, you may start by paying low premium amounts, which can increase as your income increases.

Mistake 1:

Many people confuse the terms "sum assured" and "sum insured" when comparing insurance options, which can lead to choosing the wrong type of policy.

First, it’s important to know the difference between these two terms. The "sum assured" usually refers to life insurance, which guarantees a payout upon death or at the end of a policy term. 

On the other hand, "sum insured" is more commonly used in general insurance, like health or property insurance, where it reflects the value of the coverage for specific risks or losses.

Mistake 2:

Some people choose a lower sum insured to keep their insurance premiums down. However, this can leave them with financial shortfalls in case of a claim.

It’s crucial to evaluate what you own and what you might need coverage for. If you own valuable assets or anticipate significant medical expenses, calculate their current value accurately. This will help you select a sum insured that provides adequate protection. 

Remember, saving a bit now could lead to much higher costs if you don’t have enough coverage when something goes wrong.

Mistake 3:

When individuals select a fixed sum assured or sum insured, they often fail to consider how inflation will affect the value of their coverage over time.

To avoid this pitfall, reviewing your insurance policies regularly is a good idea. Talk to your insurance agent or do your research to adjust your coverage amount periodically in line with inflation rates and any changes in your personal circumstances.

This will ensure that your coverage retains its value and remains sufficient to meet your needs over time.