The Pandemic has created awareness among people about the need for term insurance. Even among those who have understood the need, there are so many questions about it. Let’s start with the definition.
What is a term Insurance?
A Term insurance is a life insurance in which the nominee/beneficiary gets the Sum Assured on the passing away(death) of the Life Assured. There are generally no survival benefits and is a pure protection plan.
If that sounded too technical to you, ‘You die, they pay’ covers most of what it is about.
Most people ask questions like, “What is the best term insurance plan/company?”. This is a very vague and inaccurate question. My answer for this question has always been “It is not about what is the best, it is about what is the most suitable plan for you?”. So how does one what is suitable. I have listed below the guidelines I use to help people make this choice.
Who needs a term Insurance?
First question of course is how do I know If I need term insurance or not.
Primary need of a term insurance is to protect against loss of income in the absence of the breadwinner of the family. So who needs it primarily,:
If you have financial dependents
The dependents may be spouse, children, dependent parents, dependent in laws or any other family member/individual/institution that is financial dependent on your support. Business that provides for your family, but requires your physical presence is also something that will fall in this category.
If you have a loan liability
If you have any loan be it a home loan, business loan, personal loan, education loan, it is important to have term insurance that cover the loan value comfortably. Don’t assume that home loan can be paid of by selling the home and so I don’t need insurance. It may not be possible or desirable to sell the asset at that point. You may either cover it as a loan liability insurance or cover it as part of your term plan cover. Contrary to what your banker insists, loan liability is not mandatory. It is preferable and cost effective to have your term insurance to cover the loan amount.
Absence may trigger financial commitments
This applies mostly in case of home makers/care takers etc who provide valuable services in taking care of the family. While no financial transaction is involved, replacement of their unpaid activities through external help may be an expensive affair and hence have a monetary value.
While the above are primary reasons, one must take a life insurance for, other popular secondary reasons for taking term insurance are:
To Leave a Legacy
People want to leave a legacy to their children, niece, nephews and also to their charities.
Many High Net worth Individuals are involved in charitable work, and want that to continue beyond their life time. Their children may or may not be interested in the same. So even when they leave their business and primary wealth to their family, they leave a substantial insurance settlement to their charities.
Protection of Future Increase in Wealth
Even when the family is able to maintain current and reasonable standard of living, many industrialists and entrepreneurs realise their early passing away will rob their family of an opportunity of the substantial business expansion that they would have created if they were around.
This is another reason High Net worth Individuals (HNI) buy substantial insurance to provide their family the same opportunity in their absence as it would have been during their presence.
The Riders
Several riders that come with term insurance provides one a low cost way to protect themselves against the uncertainties of life other than death. We will discuss this in more detail in a while.
How much insurance should I have?
Most people just pick an arbitrary number that sounds big like 1 Crore and take out a term plan for that. While this is better than not having a plan at all, it is possible that such an amount is insufficient. There are several ways to calculate one’s insurance needs.
The quick and easy way to calculate is 10X post tax annual income.
This is closely in alignment with how insurance companies calculate human life value and hence comes up with a number that is close to what a insurance company will be willing to insure you for. But every family is different. And so are their needs.
I currently use a more nuanced formula to arrive at the number.
Family Insurance Requirement = (Annual expenses excluding EMI) * No of years to retirement + Outstanding Loans + Future Commitments (such as children education and marriage) – Current Liquid Funds (savings + FD) – existing insurance cover
If both spouses are working it may be split based on their income ratios.
For how long should I be covered?
At the minimum, you should be covered till you will continue to be the financial provider for your family.
-> For most people this would mean a retirement age like 60
-> For people with careers having earlier retirement like actor/sportsmen this could be much lesser like even 40 or 50 or even earlier.
-> For people in profession such as doctors, industrialists, chartered accountants who are solo practitioners or business people with flexible work tenures and may even choose to work as long as they can, the age may be much much higher like 75/85
-> For people who draw a life time pension from their employer like an armed forces personnel, may even go for a whole life policy.
This is only the minimum age to which one should be covered. For reasons such as leaving a legacy, one may choose to go for a higher tenure.
What should be the payment term?
My answer as with most things is ‘It depends’
If you look for expert (read social media experts) advice on this, most people will tell you go for a regular pay i.e payment of an annual premium. Some reasons are like:
-> If you die early, then you save on the premiums paid
-> If you calculate the time value of money, you pay more when you go for shorter payment tenures.
I’d say the first reason is super weird. Although term insurance is an acknowledgment of your mortality, it would be really weird to try and save money by dying early. The focus here is on risk reduction. I’m pretty sure your widow(er) is not going to mourn about the extra thousands you paid to get the same claim amount.
The second reason is pretty technically accurate, but it ignores the human behavior factor. Term Insurance has one of the highest lapses in any kinds of insurance. So an incentive like a shorter pay period (which carries a substantial discount in most cases) and options of return of premium serves as a disincentive for people to stop paying the premium. This serves the important objective of keeping the family protected.
Also if you are planning to take insurance for a tenure beyond your working years, always pay it early and don’t let these financial obligations carry on beyond your estimated working age.
Regular pay has certain advantages too apart from the ‘net present value’ computation.
-> Many riders can be paid only for a one year term and are active only during the premium paying years. If Riders are an important reason for you to take the insurance it is better to go for Regular Pay.
-> In certain cases the price difference on a 65 years/85 year regular pay is so minimal, some reserve the choice to pay or not pay at a later day than restrict it now.
-> Although most terms of insurance including Sum Assured (SA) is fixed, certain contracts allow the insured to increase SA on occurrence of life events such as marriage, home loan, first kid and second kid that increases the insurance needs of Life Assured. The additional premium on the additional SA is based on the age on which life insure is opting for the same. It is lot simpler in a regular pay than in other options to understand the additional premium needs.
Monthly/Quarterly/ Half Yearly payment modes : IRDA i.e the regulator requires the insurance company to take premium amount in full before the risk is covered. So all these convenient payment modes are nothing but a loan you are taking from the insurance company, and hence involves a nominal interest.
What Factors Determine the premium?
-> Gender: Male and Female life’ s have distinctly different premiums has female life expectancy is more and hence is less risky for the insurer.
-> Habits: Consumption of tobacco significantly increases the risk of mortality and hence the premium. Although the insurers have started capturing details on alcohol consumption as well, I am yet to see any increase in premium due to consumption of alcohol. But I am pretty sure it’s on the cards.
-> Current age: It is cheaper to buy insurance early in life as the premiums are fixed throughout the tenure of the policy. In the last couple of years, due to pandemic, the insurers have increased premiums probably as many times as we have had price hikes in fuel. But still India is one of the cheapest countries to buy insurance, so there is still much scope to increase it. No time to waste !!
-> Age to which life cover is sought: Death is certain. The uncertainty only lies with the time of the death. The probability of a person dying by 80 is a lot higher than a person dying by 60, and this additional risk is reflected in the premiums.
If you see the list1st factor is determined at your birth, 2nd one is a life choice you make, 3rd one is also an inevitable reality. The last one is the most important thing that is in your choice and determines your premium.
Can an Insurer reject my application?
Any insurance especially a term insurance is a high risk product for the company. A single premium can cover risk of even 1000 times. So, obviously the insurance company is extremely careful about what risks to accept and what to reject. Prior to the pandemic, many insurers issued policies with only tele medicals and no physical tests. But the scenario has changed and the medical tests have become mandatory for most providers.
Once you submit your application with all details, the possible scenarios are:
- Accepted at Ordinary Rate
- Accepted with additional premium
- Postponed due to medical not being satisfactory
- Rejected
Accepted at Ordinary Rate – Great. You are covered.
Additional Premium called loading is charged when the applicant has more risk. This increased risk could be due to health conditions, work profile etc
Postponed means one can apply again after 6 months following the same process. It allows the applicant to apply again unlike a rejection which is of a more permanent nature. Rejections may also happen due to inability of the applicant to show proper financial records to the satisfaction of the underwriting team.
This is why it always said, Insurance is a subject matter of solicitation. While your advisor may be able to put through your case they have very little influence in the final decision of the underwriting team. If your term insurance is rejected you may consider other life insurance such as an endowment policy for covering your risks which have less strict criteria’s for evaluation and approval.
What does it include/exclude?
Death due to any reason causes a loss of income to the family. So unless the insured was involved in an illegal activity at the time of death, or the application did not disclose all important facts the insurance cover gets paid out.
Even suicide is covered after 1st year, as it is considered, generally such tendencies don’t tend to last beyond a few months.
Many companies do have certain generic exclusion clauses such as war, insurgency, natural calamities to avoid large scale claims that affect viability. But in practice almost everything is paid out, and death being a binary scenario, there is little scope for dispute. That’s why all companies proudly flash their above 95% claim settlement ratios.
Does the risk commence immediately?
Yes. Although you have a free look in period of 15 days, the risk of the insurance company commences immediately. In other words, if your policy is issued today and you die tomorrow unexpectedly, your nominee will be paid the full Sum Assured by the insurance company.
What riders should I choose?
Riders are a very inexpensive way to cover risks that may cause a loss of income other than your death. Every rider serves a purpose and what I am sharing here is my opinion. You or your advisor may have a different opinion. Please feel free to evaluate and decide what works for you.
Accident Death Benefit Rider: This is a very inexpensive rider to literally double your cover at a minimal cost. But I generally do not recommend this rider. A family’s income needs are not determined by whether a person dies in a road accident or heart attack. Many who need a 2 Cr cover end up taking a 1 Crore cover with a 1 Crore Accident Death Benefit rider and think they have a 2 Crore cover. Unfortunately, this rider has become a reason for many to be under insured.
Accident Disability Rider: A permanent disability like loss of eyesight, speech , arms may vastly reduce your future productive years. This is more relevant for people in some profession than the others. But If you think it applies to you, it is an inexpensive rider that covers this risk.
Critical Illness Rider: This rider covers the risk of loss income due to prolonged illness such as early stage cancer or an organ replacements. The illness is usually not terminal but requires prolonged hospitalization which causes loss of income. The list of what it covers differs from one policy to another.
According to me this is one of the most useful riders that come with an insurance. Although there are ways to purchase it separately or as part of your health plan, for most people this is the most economic way to cover this risk.
Hospital Care Rider: This is a rider that covers loss of income during hospitalization similar to hospital cash in a health insurance. However practically I see little use of a rider like this and its best to cover it as part of health insurance.
Insurance companies come up with new and innovative riders all the time trying to address a need or an opportunity. As an end user, it is important for you to understand your needs first in detail before you go about evaluating the companies and their plans.
Conclusion:
An insurance is a life long contract and requires much customisation to suit to your needs. This is where it is important for you to consult with an advisor to take the right decision as the impact of this will be felt by your family when you are no longer around to protect them.
Insurance is a necessary cornerstone of wealth protection and financial security, the one that gives the best sleep at night. It is surprising how little we know about it or how little we participate in it.
The true reward of mitigating risk is peaceful sleep. What can be more valuable than that !!