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Understanding Motor Insurance Premium

Motor Insurance / Auto Insurance / Car Insurance is a subject we normally struggle with every year at the time of annual renewal of car insurance policy. Proper understanding of various terms and how premium is determined will not only enable us to understand different component of the insurance premium but also let us negotiate better deal.

Motor Insurance policies are broadly of two types:

A.    Liability Only Policy: Motor Insurance policy is required to be taken for all motor vehicles plying on road. Motor vehicles can cause bodily injury to third parties or cause damage to public or private property. To cover this risk, Liability Only Policy is compulsorily required by law. This policy covers Third Party Liability for bodily injury and/ or death and Property Damage. Personal Accident Cover for Owner-Driver is also included.

B.    Package Policy: Also referred to as Comprehensive Policy, it covers loss or damage to the vehicle insured in addition to (1) above. It is more prudent to take a Package Policy which would give a wider cover, including cover for your vehicle. Majority of the motor insurance policies are package policies. Premium for Package policy can be arrived at by adding Own Damage Premium to premium for Liability Only Policy.

Premium for Liability Only Policy

Third Party Liability insurance is mandatory for all vehicles plying on public roads in India. This covers Liability for injuries and damages to others that you are responsible for. The premium cost for Third Party Risk cover is decided by the Insurance Regulatory and Development Agency (IRDA) and is the same for all companies providing car insurance in India.

Premium for Liability Only Policy is sum of the following:

1.     Basic Third Party Liability: Rates applicable are as follows:

Private cars
Third Party Premium from 1-Apr-2014 (Rs)
Not exceeding 1000 cc
1,129
Exceeding 1000 cc but not exceeding 1500 cc
1,332
Exceeding 1500 cc
4,109

It is to be noted that the Third Party Premium rates were revised by IRDA with effect from 1st April 2014. Rates applicable prior to revision was as below:

Private cars
Third Party Premium from 1-Apr-2013 (Rs)
Not exceeding 1000 cc
941
Exceeding 1000 cc but not exceeding 1500 cc
1,110
Exceeding 1500 cc
3,424

2.     Compulsory Personal Accident Cover for Owner-Driver: Rs 100 is charged and Sum Insured is Rs 2 lakhs.

3.     Optional Personal Accident Cover for persons other than Owner-Driver: Rs 100 is charged and Sum insured is Rs 2 lakhs, for unnamed passengers as per the registered carrying capacity of the vehicle.

4.     Legal liability for paid driver: Rs 50 is charged

Premium for Package Policy

Premium for Package Policy is arrived at by adding Own Damage Premium to premium for Liability Only Policy.

Own Damage Premium: Calculation of Own Damage Premium depends on the factors such as Insured’s Declared Value (IDV), Tariff Rate, No Claim Bonus and Discounts. Premium is arrived at by multiplying IDV with Tariff Rate, and deducting No Claim Bonus and various discounts thereon. Let us understand each of the terms.
  
1.     IDV of the vehicle: IDV is the Sum Assured or the cover provided by the insurer. IDV is the maximum amount which the insurer agrees to compensate you with in case your vehicle is stolen or damaged beyond repair. IDV is calculated as the market value of the car at the time of insurance. For new cars, IDV is calculated on the basis of car's ex-showroom price. While renewing the insurance, the IDV will be adjusted for any depreciation it has undergone over the time, as per below table:

Age of the Vehicle
% of Depreciation for Fixing IDV
Not exceeding 6 months
5%
6 months to 1 year
15%
1 to 2 years
20%
2 to 3 years
30%
3 to 4 years
40%
4 to 5 years
50%

The IDV of vehicles aged over 5 years is calculated by mutual agreement between insurer and the insured.

2.     Tariff rate: refers to the rate at which insurance premium is payable. These rates are prescribed by IRDA and vary according to geographical location, cubic capacity and age of the vehicle.

i.      Geographical Zones: Motor insurance premium depends on registration place of vehicle. The premium in Tier I cities is comparatively more than Tier II and Tier III cities. That is because probability of insurance claim is more in Tier I cities because of higher costs, higher possibility of thefts, etc. For the purpose of Tariff Rates, two zones as below are prescribed:

·        Zone A: Ahmedabad, Bangalore, Chennai, Hyderabad, Kolkata, Mumbai, New Delhi and Pune
·         Zone B: Rest of India

ii.    Cubic Capacity: refers to the capacity of vehicle engine. More the cubic capacity of the vehicle, higher will be the insurance premium.

iii.   Age: Older the vehicle, higher is the premium.

Tariff Rates for Own Damage cover is as below:

Age
of
the
vehicle
Zone B
Zone A
Cubic Capacity
Cubic Capacity
Less than
1000 cc
More than 1000 cc but Less than 1500 cc
More than 1500 cc
Less than
1000 cc
More than 1000 cc but Less than 1500 cc
More than 1500 cc
Less than
5 years
3.039%
3.191%
3.343%
3.127%
3.283%
3.440%
More than 5 years but Less than 10 years
3.191%
3.351%
3.510%
3.283%
3.447%
3.612%
More than 10 years
3.267%
3.430%
3.594%
3.362%
3.529%
3.698%

3.     No Claim Bonus (NCB): is an important variable which affects the premium amount. NCB discount is available if no claim is made in the previous year. NCB gets accumulated over the years and can go upto 50%. However, NCB is lost as soon as any claim is made. It is to be noted that NCB can be earned only on Own Damage Premium. NCB is available at the renewal of a policy after the expiry of the full duration of 12 months. No Claim Bonus, wherever applicable, will be as below:


Discount
No claim made during preceding 1 year of insurance
20%
No claim made during preceding 2 years of insurance
25%
No claim made during preceding 3 years of insurance
35%
No claim made during preceding 4 years of insurance
45%
No claim made during preceding 5 years of insurance
50%

4.     Discounts: In addition to NCB, IRDA has prescribed discount on Own Damage Premium for Installation of anti-theft devices, membership of Automobile Association of India, opting for voluntary deductible/excess, etc.

Most important factor to keep in mind while finalizing motor insurance premium is the discount on Tariff Rate. Motor Insurance premium rates are largely tariff driven and prescribed by IRDA. While Tariff Rate for own damage premium are prescribed by IRDA, insurance companies have freedom to offer discount on the Tariff Rate. Negotiate with insurance company for higher discount on Tariff Rate in order to lower Motor Insurance premium.

HRA Exemption - PAN Number of Landlord

Central Board of Direct Taxes (CBDT) had issued a circular on 10th October 2013 regarding House Rent Allowance (HRA) exemption under section 10(13A) of the Income Tax Act, 1961. As per the circular, if annual rent paid by the employee exceeds Rs 100,000 per annum, it is mandatory for the employee to report Permanent Account Number (PAN) of the landlord to the employer.

Is it a new requirement?
No it is not. Requirement to report landlord’s PAN has been there since financial year 2011-12, wherein it was applicable for employees who were paying rent of more than Rs 15,000 per month. All that has happened is that this limit of rent paid for reporting of landlord’s PAN has been reduced from Rs 180,000 per annum to Rs 100,000 per annum.

What if the landlord doesn’t have PAN?
In case the landlord does not have a PAN, a “No PAN Declaration” to this effect from the landlord along with the name and address of the landlord should be filed by the employee. This declaration can be obtained on a plain A4 size paper. No specific format of the declaration has been prescribed. 

Please click here to download sample NO PAN DECLARATION.

What if the landlord refuses to share PAN details?
In case the landlord refuses to share PAN details and also doesn’t provide No PAN Declaration, employee would not be able to claim HRA exemption. If you face such a situation, there isn’t much you can do other than looking for a new place to rent!

SmartPaisa Tip: Typically identity proof of both landlord and tenant is required to be included in the Rent / Leave & License Agreement. Insist on the landlord to provide copy of PAN card as proof of identity to be included in the agreement. This will ensure that PAN details of the landlord are available with you for reporting to your employer at a later date. 

Why this provision?
Question arises as to why the Income Tax authorities have made claiming HRA exemption cumbersome for the salaried employees. Idea is not to harass the honest taxpayers but ensure exemption provisions are not misused. Probably this step has been taken by the tax authorities to correct the following malpractices:

- Landlords not paying tax on rental income: Quite often people do not report the rental income in their Income Tax return. Now with the PAN number of landlords available with tax authorities, it is possible to cross verify the amount reported by employee as rent paid and rental income reported by the landlord. This provision will ensure that more and more people correctly disclose their rental income while filing the IT return.

- Employees submitting fake rental receipts to claim HRA exemption: Sometimes the employees were also submitting fake rent receipts or rent receipts for higher amount than actual rent paid. Now with the landlord’s PAN available with tax authorities, these inconsistencies can be potentially detected by the tax authorities and questioned. Hence this practice will also come down.

Income Tax Rates for AY 2015-16 (FY 2014-15)

Income Tax Rates applicable for Individuals, Hindu Undivided Family (HUF), Association of Persons (AOP) and Body of Individuals (BOI) in India is as under:






Assessment Year 2015-16, Relevant to Financial Year 2014-15 

For Individuals below 60 years age (including Woman Assessees):
Income
Tax Rate
Upto 200,000
Nil
200,000 to 500,000
10% of the amount exceeding 200,000
500,000 to 1,000,000
Rs.30,000 + 20% of the amount exceeding 500,000
1,000,000 & above
Rs.130,000 + 30% of the amount exceeding 1,000,000

For Individuals aged 60 years and above but below 80 years (Senior Citizen):
Income
Tax Rate
Upto 250,000
Nil
250,000 to 500,000
10% of the amount exceeding 250,000
500,000 to 1,000,000
Rs.25,000 + 20% of the amount exceeding 500,000
1,000,000 & above
Rs.125,000 + 30% of the amount exceeding 1,000,000

For Individuals aged 80 years and above (Very Senior Citizen):
Income
Tax Rate
Upto 500,000
Nil
500,000 to 1,000,000
20% of the amount exceeding 500,000
1,000,000 & above
Rs.100,000 + 30% of the amount exceeding 1,000,000

Tax Credit: Rs. 2,000 for every person whose income doesn’t exceed Rs. 500,000

Surcharge on Income Tax: 10% of the Income Tax payable, in case the total taxable income exceeds Rs.10,000,000. Surcharge shall not exceed the amount of income that exceeds Rs.10,000,000.

Education Cess: 3% of Income Tax plus Surcharge

Note: The above rates have been proposed in the Vote On Account presented by the government pending Lok Sabha elections and are valid till 30th June 2014. By then the new government is expected to be in place and would present full budget for AY 2015-16, wherein the income tax rates could undergo a change. Thus for AY 2015-16, till the time full budget is passed, Tax Deducted at Source (TDS) liability would be computed as per these rates.

Home Loan EMI Cash Back Offer Analysis

Pay just 0.15% extra and get 1% cash back. Wow - Great deal, No brainer! So you thought!!

Many of us would have heard about cash back scheme on Home Loan Equated Monthly Instalments (EMI) being offered by various banks. Under the cash back scheme, bank would periodically pay back part of the EMI paid as cash back to the customer. In return, all the bank is asking for is slightly higher interest rate. Sounds fair and looks like this is a great deal being offered.

Let's dig a little deeper.

Many banks including ICICI Bank and Axis Bank have in the past introduced some variant of the Home Loan EMI cash back scheme. We have analysed the EMI cash back scheme which was being offered by ICICI Bank. Under the cash back scheme, the bank would offer 1% cash back on the EMIs paid by the customer. First cash back is given, either by way of credit to your bank account or by reduction of principal outstanding of the Home Loan, at the end of 3 years for the total of 36 EMI payments done. Thereafter cash back is given on annual basis for total of 12 EMIs paid in the preceding year. Of course, there are terms which require regular EMI payment to be done by the customer and there being no overdues in order to qualify for cash back, which for the purpose of this analysis, we assume is being fully complied with. 

Interest rate on Home Loan availed under cash back scheme is marginally higher (Note typically the bank will offer Home Loan without cash back option also). For instance ICICI Bank is charging a premium of 0.15% on the interest. Thus if the Rate of Interest (ROI) for a normal Home Loan is 10.25%, ROI for Home Loan with cash back offer would be 10.40%. Bank or the Direct Sales Agent (DSA) of the bank would probably make a strong pitch for the offer, explaining just how beneficial the scheme is. Just pay 0.15% interest extra and get whole 1% back.

It would be fallacious to compare 0.15% with 1%. This is the trap most of the people will fall into. Please understand that 0.15% extra interest would be charged on the entire loan amount, while 1% cash back would be refunded on the EMI. Let us try and understand by way of an example.

For a Home Loan of Rs 50 Lakhs for 20 years at ROI of 10.25%, EMI come to Rs 49,082. If cash back offer is availed, applicable interest rate is 10.40% and EMI would go up to Rs 49,584. Thus on a monthly basis, extra outgo on account of higher EMI is Rs 502 per month. Against that cash back amount of 1% of EMI comes to Rs 496 per month. While extra interest is being paid every month, inflow of cash back will be received only on end of 3 years and end of year thereafter. In order to take care of timing difference in the cashflows, we have to calculate the Present Value (PV) of both the cost (extra EMI outgo) and benefit (cash back on EMI). We have used the Home Loan rate of 10.40% as discount rate to compute PV.

Result of Analysis
Cost = PV of extra EMI payment = Rs 50,600
Benefit = PV of cash back = Rs 46,194

Thus on a PV basis there is a loss of Rs 4,406 by availing the cash back offer. The cash back scheme which is being cleverly packaged and marketed as giving overall cash back of approx Rs 1.2 Lakhs on a Rs 50 Lakhs Home Loan, optically looks very appealing but in reality it is a losing proposition.

Please DOWNLOAD the excel model to see detailed calculation. You can play around with variables such as Loan Amount, ROI, extra interest rate for availing cash back offer and cash back rate to analyse various scenarios.

Flat Interest Rate vs Diminishing Balance Interest Rate


What does Flat Interest Rate mean?

When you take Home Loan or Car Loan or Education Loan or Personal Loan or Credit Card Loan for a particular tenor, you need to not only repay the principal amount within that tenor but also pay the interest on the loan. It is important to understand interest calculation methodology. ‘X% p.a.’ Flat Interest Rate is not same as ‘X% p.a.’ Diminishing Balance Interest Rate (also referred to as Reducing Balance Interest Rate or Effective Interest Rate).

Flat Rate of Interest basically means that interest is charged on full amount of the loan throughout the entire loan tenor. Thus the Flat Rate does not take account of the fact that periodic repayments, which include both interest and principal, gradually reduce the outstanding loan amount.

Let us understand by way of an example. For instance you take a loan of Rs 100,000 with a flat rate of interest of 10% p.a. for 5 years, then you would pay Rs 20,000 (principal repayment @ 100,000 / 5) + Rs 10,000 (interest @10% of 100,000) = Rs 30,000 every year or Rs 2,500 per month. Over the tenure of the loan, you would end up paying Rs 150,000 (2,500 * 12 * 5).

What does Diminishing Balance Interest Rate mean?

In Diminishing Balance Interest Rate method, interest is calculated every month on the outstanding loan balance as reduced by the principal repayment every month. EMI payment every month contains interest payable for the outstanding loan amount for the month plus principal repayment. On every EMI payment, outstanding loan amount reduces by the amount of principal repayment. Thus interest for next month is calculated only on the outstanding loan amount as reduced by the principal repayment this month.

For example, if instead of 10% p.a. flat rate (in the above example), interest is charged at 10% p.a. reducing balance rate, EMI amount would be Rs 2,124.70. You would pay Rs 833.33 as interest in the first month and Rs 1,291.37 (2,124.70 – 833.33) would be Principal Repayment. For next month interest will be charged only on reduced principal, i.e. 100,000 less 1,291.37 = 98,708.63. Interest for second month would be Rs 822.57 (98,708.63 * 10% / 12) and principal repayment would be Rs 1,302.13 (2,124.70 – 822.57). Thus over the tenure of the loan, you would end up paying Rs 127,482 (2,124.70 * 12 * 5).

Which is better?

Undoubtedly Diminishing Balance Interest Rate is better from the perspective that it is more transparent and signifies the “Effective Interest Rate”. Flat Interest Rate is generally misleading and is often used to entice customers with too good to resist offers. Imagine being offered 5 year loan at only 10% Interest Rate. Sounds good, but may be on little digging you realize that Interest Rate is quoted on Flat basis and the Effective Interest Rate (i.e. Diminishing Balance Interest Rate) is actually 17.27%.

Please use the below link to download excel based calculator to compute EMI for a given Interest Rate on Flat and Diminishing Balance basis. The calculator also computes equivalent Diminishing Balance Interest Rate for a given Flat Interest Rate, and vice versa.

Fixed Deposit Maturity Value Calculator

Fixed Deposits as an Investment Option

Fixed Deposits have traditionally been one of the most safe investment option preferred by people with low risk appetite. Generally fixed deposits are offered by banks, but fixed deposit can also be offered by certain Non-Banking Finance Companies (NBFC) and other companies. However before putting in money in any non-bank fixed deposit, where interest rates offered are typically higher than bank fixed deposits, one should be very careful about the credit quality of the company where fixed deposit is placed.

Fixed deposit or Term deposit is a very simple investment product. As the name denotes it provides a fixed return, i.e. interest on the amount of investment. The interest is calculated and credited periodically depending on the compounding period.

What is compounding period?

Compounding period refers to the frequency with which the interest is calculated and credited to the fixed deposit amount. For example, if compounding of interest is monthly, interest for fixed deposit is calculated on a monthly basis and added to the principal amount. Thus interest for second month is calculated on the principal amount and interest for first month. Similarly interest for third month is calculated on the principal amount and interest for initial two months.

Let's see an example to understand this better. Suppose we have to calculate maturity amount of Rs. 100,000 fixed deposit for 3 months with interest rate of 12% compounded monthly. Interest for 1st month is calculated on Rs. 100,000 at 12%, which comes to Rs. 1,000. Fixed deposit principal amount at the end of 1st month becomes Rs. 101,000. Thus interest for 2nd month is calculated on Rs. 101,000, which comes to Rs. 1,010. Similarly interest for 3rd month is calculated on Rs. 102,010, which comes to Rs. 1,020.10. Thus maturity amount for 3 month deposit comes to Rs. 103,030.10.

Why is compounding period important?

This question is best answered by adding a variation to the previous example. Suppose in the example above, instead of interest being compounded monthly, it is compounded on a quarterly basis, let’s see the impact on final maturity value of the fixed deposit. Interest for 3 months comes to Rs. 3,000 and final maturity value of fixed deposit is Rs. 103,000. Note the final maturity value has declined when the compounding period has been increased. Thus we can say shorter the compounding period, higher is the effective return on fixed deposit. Reason is simple and intuitive. Shorter compounding period means interest on fixed deposit is calculated more frequently and added to the outstanding principal amount for the purpose of interest calculation for the next compounding period. This translates into more interest income on interest, which effectively is the essence of compounding.

Note that in India, interest on bank fixed deposits is normally compounded on a quarterly basis.

Fixed Deposit as Tax Saving Investment option

Investment in Fixed deposits with scheduled bank for minimum tenor of 5 years qualifies for deduction under Section 80C.

Fixed Deposit Maturity Value Calculator

Use the Fixed Deposit Maturity Value Calculator for calculating the maturity amount of Fixed Deposit under various compounding options, viz. Yearly, Half-yearly, Quarterly, Monthly, Daily and without any compounding. In the calculator, Interest payment has been assumed on cumulative basis, i.e. on maturity.

You can also use the Calculator to compute the Fixed Deposit amount required to be done to get desired maturity amount.