If you really want to purchase a life insurance cover that is meaningful there is no alternative to Term Life Insurance.
Have you ever asked yourself the true purpose of purchasing a life insurance policy? We get many responses to this fundamental question – mostly incorrect. Invariably, the responses tend to be – “to save taxes” or “to invest and make the money grow”. These are noble objectives, but not for life insurance. The primary purpose of life insurance is to provide a financial cover to your dependents if you die early.
Let us assume that you are young, probably in your thirties and have a family comprising two young children. Professionally, you are doing and earning well. Your family is used to a high quality lifestyle. You have some financial liabilities such as a home loan, probably a car loan and some loans for durables. These financial commitments are under control because you have a good stable career. It feels as if nothing could go wrong. That assumption is normally true except that, sometimes, a sudden and unexpected death can derail everything.
Admittedly, early death is a rare event. Very few families go through this. But, the thing to remember is that for those that have the misfortune to go through this, the impact is cataclysmic. Such events set a family back by a decade or more. Many fail to recover. Look around in your family and friend circles and you will spot examples of how early death adversely transforms a family. The true purpose of life insurance is to fundamentally address this low probability but high impact event, because you do not want your family to go through this trauma.
The first question while insuring yourself should be “How much should I provision for and how much would it cost?” Everything else is secondary.
“Premature death is a low probability but high impact event, which you do not want your family to suffer from. This is the only reason for taking a life insurance policy”
Let’s address the question “How much should be the cover?” To answer this, one needs to step back and look at the financial commitments required. You would like the house to be provisioned for, and hence the loan outstanding needs to be part of the cover. The same logic holds for all other loans. The living expenses (groceries, electricity, school fees, college education, life-style expense), need to be catered to, for at least the time required for the children to grow up into adulthood. All of this, would work out to anywhere between 8-15 times your annual income (depending on factors such as how much you have already saved, assets you might have inherited, etc.). To make it simple, at least 8 times your annual income is the minimum amount that you must provision for to have any meaningful insurance. How do you achieve this? Is provisioning of an amount 8 times your annual income possible at all?
“8-10 years of income is the minimum life cover required to provide any meaningful protection to your dependents. If you can afford more, go for it. Anything less is insufficient”
Term Life Insurance is an instrument that gives you exactly this kind of leverage. If you are a person earning say Rs 7 lakhs per annum and are about 30 years of age, you can buy a term insurance policy for Rs 15,000 which provides your dependents a cover of Rs 50 Lakhs. In other words, by paying an annual premium which is just 2% of your annual salary, you can leverage a cover which is 700% your annual income, for your dependents. Is there any other life insurance policy, or any other instrument, that can give this sort of leverage? The answer is a resounding “No”. Any other life insurance policy will be at least 10-12 times costlier, and not affordable. No thinking person will put 20% of his income into provisioning for an event that has a low probability of occurrence, howsoever frightening that event might be. You do want to provision for the future but not at the cost of complete sacrifice today.
“Do not get so caught up in a low probability event that you completely forego the present. Use the leverage that term life insurance provides – A cover that is 350 times the annual premium for a 30 year old”
Let us illustrate the above by taking an example of two products of LIC. For any other life insurance companies the difference will be about the same. However the actual premiums do differ widely from company to company and there are 24 of them!
• Term insurance LIC Amulya Jeevan
• New Money Back Policy - 25 Years
In both cases take a person born on 1/1/1981 (30 years old) as our example. We take a tenure of 25 years for both and sum assured of 50 Lakhs
Annual premium for the two products are given below (Money Back Policy is 16 times more expensive)
• LIC Amulya Jeevan 25 year term policy - annual premium 15,450
• LIC New Money Back Policy - 25 Years - annual premium Rs 260,630
For a Money-Back Policy of 25 years, 15% of the sum assured becomes payable each after 5, 10, 15 and 20 years, and the balance 40% plus the accrued bonus become payable at the 25th year.
Typical payouts will be
• 5 years - 7.5L
• 10 years - 7.5L
• 15 years - 7.5L
• 20 years - 7.5L
• 25 years - 90 L
Advocates of the Money Back policy will talk about how much it saves for you. We demolish such thoughts on two counts – a) No one can pay such an amount and will have to slash his cover by a factor of at least 8-10 (which implies an hopelessly inadequate cover) and b) Plain FDs perform better. We will proceed to demonstrate exactly why this is not very good.
Take two choices as case A and Case B (In both cases the person is setting aside Rs 260,630 every year)
Case A – person takes term life and pays 15,450 every year. He puts 245,180 into bank FD every year which gets him 8% interest.
Case B – person takes money back policy and pays 260,630 every year. The amount that is paid back every 5 years is put in FD, which gets him 8% interest.
From the three scenarios we examined above, you can clearly see the following:
a) Term life is better for the person in all scenarios - whether the policyholder dies quickly or lives through the entire tenure
b) Purchasing a money back for insurance is unaffordable - how can a person earning 8-10L give this much premium? It is absurd to save so much that there is no present left.
In actual life, no one will save like this. What they end up doing is that they go for a money back policy, and pay a premium of 30-35,000 pa annum and get a cover of about 6 Lakhs. This is poor planning because it just does not cover for the event at all. The amount can barely cover a year of expenses.
“What we advise is that you get your cover right, and invest as much as you can in simple instruments like bank FDs. As your income increases over time, you start putting more and more money in such instruments and build the corpus that serves you.”
And in case you are wondering – all the tax benefits that you get with the money back policies are applicable to the term life policies as well. We don’t consider this to be an important factor, though.
Which brings us to the point we started with – “If you truly want to cover for the unexpected and provide protection to your dependents, Term Life Insurance is not only the best but also the only option that you have."
However, your search doesn’t end here. You will find that there are 24 life insurance companies in India and most of them offer term life insurance. What you may not know is that the premium rates vary significantly for each of them. In fact, the premium charges of the most expensive product out there are almost 3 times the one that is cheapest. It is here that you need professional advice, someone who can work through the maze and select the policy which is most suitable for you at the lowest price. As insurance brokers, who are independent and not tied to a specific insurance company, this is where we add value to your decision making. And, this doesn’t cost you anything.
“Insurance buying can be confusing. It is here that a professional independent broker adds value to your purchase – selecting the right product at the best possible price from a plethora of offerings of various companies”