We attempt to uncomplicate life insurance and give you a brief on why you should or should not opt for the many add-ons which have now become a part of term life insurance.
Thanks to the media and the financial planner fraternity, most of you aware that marrying your investment needs with insurance is not a wise option. It is best to separate both and go for plain vanilla term plans when it comes to life insurance.
At the cost of adding to the clutter of various articles being written on the above subject, let me reiterate the reasoning behind this. Life insurance is meant to buy you peace of mind so that in case of an untimely death your dependents are spared the financial burden of having to get on with life without the bread winner!
When it comes to life insurance, most of us ask “While I pay premium what do I get if nothing happens to me?” The answer to this is simple – “You paid for the peace of mind that you would be providing for your family even if something were happen to you”. Well, this answer just doesn’t suffice and we are happier with a product which pays us if there is loss of life and pays something even if we were to live up to a ripe old age and survive the policy period. Money-back and endowment policies endeavor to do just that and give you a policy with a bit of insurance and a bit of investments. The problem is the insurance offered is often so small that it’s meaningless andthe investments rarely give you returns in excess of 7% inflation. The matter gets further complicated since these policies have huge penalties attached, should you realize your folly later and try to cut your losses short.
We all agree on the virtues of a simple online term plan. Term plans however are not as simple as they used to be. Various clever ways have been now designed to increase your premium to offer you perceived benefits. Let us take a look at some of these iterations/add-ons and give you our thoughts on these
Tenure of insurance beyond retirement age: Term insurance is a risk transference tool by which you transfer the risk of loss of income for dependents due to your untimely death. Since there is no income post retirement the entire purpose of term insurance is defeated and it normally does not make sense to continue your term insurance post retirement.
However unlike health insurance, in life insurance the premium is fixed for the entire tenure of the insurance. The premium is primarily dependent on the age at which you take the insurance apart from factors like smoking, general health, etc. This premium will remain the same throughout your insurance period and does not increase with age. Say if you were to take insurance for Rs. 1 crore at age 40 and your premium is Rs 20000. The premium will remain 20000 even at age 65. Meanwhile the value of the 20000 would have diminished to close to Rs 4000 in 25 years at an average inflation of 7%. Therefore with reduced value of money, the premium will actually seem very small and insignificant in 25 years from now. If the insurer is willing to insure you why forgo it after so many years? The sum insured could form part of estate of the deceased.
In view of the above we believe longer insurance term actually makes sense!
Accident Death Benefit: With this feature as an add on, the sum insured is doubled or increased on death due to accident for payment of a small additional premium.
The amount of life cover you require depends on current expenses, financial goals and assets in hand. When you arrive at the amount to be insured in a scientific manner you can be rest assured that your obligation will be met irrespective of your presence.
What one needs to bear in mind is irrespective of the reason for death, the amount required to fulfill your obligation will remain the same. An exception would be the hospital expenses incurred in case of an accident.
We suggest you do not combine accident insurance with term life primarily because the purpose of an accident insurance is to protect you in case of disability and the ensuing loss of income due to the accident. In view of this we suggest that you go in for a separate accident insurance to cover you in case of disability whether permanent or temporary.
One time premium payment option: This option lets you pay premium one time and have insurance cover as per the tenure selected. Considering the value of your money keeps diminishing due to inflation and you are losing out on the opportunity cost, this is not such a good option in our opinion.
Limited premium pay option: This option allows you to pay premium for a restricted number of years and enjoy the tenure for a longer time. Essentially you could pay higher premium for say 20 years even though your tenure is 25 years. The argument against this is the same as the previous point since as the value of money keeps diminishing, financially it is a better option to pay less today rather than pay more now to avoid paying at a later date especially so since the premium does not increase later.
Sum assured paid as part lump sum and part annuity: In this option the insurer offers to pay part of the sum insured upon death and rest as annuity spread out over specified number of years. This may suit survivors who do not have the ability to earn basic return on investment or the discipline to set the insurance proceeds aside to take care of life’s emergencies.
By and large it is advisable to take the entire sum insured and outsource the job of earning decent returns without undue risk to a qualified financial planner like a CFP, in case the nominees do not have the band width to do the same.
Return of premium
When you buy a term plan with return of premium, the sum assured is paid to nominee in case of death and the premiums are returned to the life insured in case he/she survives the entire tenure. This gives you the illusion of free insurance. You need to factor in the potential of the premium paid to earn interest and reduction in value of money due to inflation. This option does not seem attractive.
For example normal term plan with ICICI prudential for a 35 year old male for 10 lakhs sum insured and tenure of 10 year would cost you 2878 but return of premium plan will cost 37,193. If the difference in premium were to be invested in a safe instrument giving 8% returns post tax it would build you a corpus of 5,36,874 which is far in excess of return of premium which would be 3,71,930. This difference is taking a very conservative return of 8%, given the long period for which you stay invested, you could easily better this returns increasing the gap wider. Plain term insurance is therefore better than return of premium plan.