“Buy Term Life Insurance of at least 12x death coverage of your yearly income“

What is Life Insurance per se?

It is a kind of insurance to ensure your dependants for your earning capacity in case of your untimely death.

If you die within the coverage period, your legal heirs get the sum assured (life cover).

Ideally, every earning member of the family should buy Life Insurance at least upto the age of retirement.

Why buy death coverage of at least 12x of your yearly income?

Based on the current scenario, it is estimated that long term investments will fetch 8% yearly income. When a person buys life coverage worth 12x of income, the interest from the sum assured can replace yearly income in case of policy holder’s death.

If your income is 8 Lacs, and you buy term life policy of 1 Crore (12.5x), the interest from that sum assured can replace your income in case of your untimely death.

You can buy even upto 20x considering inflation adjustments and other life goals.

Before going into types of policies, here are 3 general classifications of products being sold by Life Insurance companies:

1. Pure Savings

2. Pure Risk Coverage

3. Savings with Risk Coverage

Pure Saving: This product is drafted for individuals and groups to accumulate some funds to use them later. These policies work as a deposit with life insurance companies and not much popular these days. We do not advice this product under our advisory plans.

Pure Risk Coverage: This kind of policy is available in both general and life insurance. As against saving policies, these policies do not provide any maturity benefit. Investments from premium collected are made by insurance companies for paying policyholders only in the event of claim. After completion of policy period, no maturity benefit is paid to insured and in case of death in between, sum assured is paid. Term Life Insurance comes under this category.

Savings with Risk Coverage: These policies are combination of both products. The returns generated from investment are net-off risk coverage premium. After completion of policy period maturity benefits are paid to insured and in case of death in between, sum assured and investment returns are paid.

The following are the policies available in Indian markets, note that names might be changing from different companies and elements may vary a bit:

1. Term Life Insurance:

This is a pure risk coverage kind of policy; these policies are cheapest and most marketed (and rightly so). Policy holder need to pay premium at the beginning of every year. If policy holder dies within the policy period, sum assured is paid to beneficiary. If policyholder survives, no maturity benefit is available.

Single Pay, Limited Pay Vs. Regular Pay

Some of the companies have now introduced single pay, or limited pay term life insurance policy, where they collect the premium for only once or for limited years, say 5 years, while the policy period may be of 40 years.

We advise our clients to buy regular pay term life policies rather than single or limited pay:

-         Save on locking huge amount at once.

-         Investment income from saved amount will cover regular pay premium.

-         Just in case, policy holders die early (well I don’t wish that), they can save on keep paying regular premium, while in single pay policy, that amount may not be refunded.

Calculation for a Life Cover of 1 Crore for a person aged 27 till the age of 60 (Policy coverage 33 Years):

A single pay policy costs around Rupees 11,500 per year till the age of 60 = Total of 3.8 Lacs

And limited pay for 5 years costs around Rupees 46,900 per year (for 5 years only) = Total of 2.35 Lacs

While apparently it may look like discount in limited pay option, but there is a catch that you are paying too high amount in the initial years only, that may be used to invest elsewhere, which can generate extra returns than the discount given.

And just in case, policyholder dies within the age of 48, he will end up paying less in regular pay without even considering investment returns.

The sub types of term insurance policy are increasing term life insurance, level term life insurance and decreasing term life insurance.

As the name suggests, in Increasing Term Life Policy, sum assured keeps increasing by a specific amount or percentage every year, so does the premium payable.

Decreasing Term Life Policy is exact opposite of Increasing Term Life Policy; and

Level Term Life Policy is a policy where sum assured and premium amount remain same throughout the policy period.

Exclusion List:

In the following events, sum assured may not be paid in Term plans

(List may vary for different companies):

-         Murder of the person insured

-         Suicide

-         Concealing Smoking/drinking habit

-         Death while drunk driving

-         Death due to taking part in risky activities, adventure sports

-         Death of mother while childbirth

-         Death by natural calamity

What are the things to do/check before buying Term Life Insurance?

-         Insurance being a long term contract, buy it from a reputed Insurance Company

-         More than 95% Claim settlement Ratio (They settle 95 out of 100 claims they receive)

-         Provide accurate information about pre-existing disease and addictions (tobacco / alcohol)

-     If you don’t mind paying a little extra premium, add riders like waiver of premium payment if you get critical illness or permanent disability.

Where to buy Term Life Insurance?

You can buy any Insurance from mainly 3 channels; all have their pros and cons:

1.    Agency Channel – Generally most expensive, but you get a dedicated agent to help you with claims and forms. You can port your running policy from one company to another; your agent may also change.

2.   Bancassurance Channel – Where banks acts as an agent of Insurance Company, but some of the companies do not allow porting your running policy in this case.

3.    Online Channel – Where you can directly buy from Insurance Company or from insurance aggregator comparing multiple products. This channel is least costly, but you may not get a dedicated person to help you.

The other types of Life Insurance Policy which we generally do not recommend are mix of Investment and Insurance:

Term Insurance with Return of Premium:

In this Policy, if you pay double of your regular pay term plan premium, you get the entire premium paid back at the end of policy coverage. In this case, half of the money acts as a risk coverage premium and half as investment. Getting the calculations done, this policy gives less than 5% of IRR!

It is better to avoid this and invest the extra sum elsewhere that fetches more return and capital also remains freely available.

In the above example of regular paying Rupees 11,500 premium,

Term Insurance with Return of Premium will, instead, cost you 23,000 and Rupees 7.6 Lacs (entire premium paid for 33 years) will be refunded back at the end of policy period.

Sounds good?

But that’s only 3.8% IRR for 33 years!

Unit Linked Insurance Plan (ULIP):

ULIP is a combination of Investments in Units (like mutual funds) and Insurance.

When you pay the premium, a major part of your money is invested by fund manager in debt and/or equity (as you choose), and units are allotted to you.

It has a lock-in period of five years.

The returns are not guaranteed and linked to market performance.

The Premium so paid is available as deduction under section 80C.

You will get 10x Life Insurance Cover of your yearly premium.

So if you make a yearly Investment of 1 Lac in ULIP, you get a Life Insurance of 10 Lacs (only!)

Why to avoid ULIPs?

-         Very low Insurance cover compared to term plans

-         Higher Lock in Period than ELSS Mutual Funds

-         Higher Cost Structure (Only Fund Management Charges are capped to 1.5%)

-         Keeping Insurance and Investment together may adversely impact your life cover if you miss premium payment due to cash crunch (while the chances of that is low for term plan)

But, what about the tax benefit, if I avoid ULIPs?

The same 80C deduction is available in ELSS Mutual Funds, with lesser lock in period of 3 years.

Endowment Plan and Money Back Policy:

Both the plans are also combination of Insurance and Investment. Returns on Investment are guaranteed by Insurance Company and bonus may be given.

The difference is, in Endowment plan Investment is accumulated and paid back at the end of policy period, while Money Back Policy gives periodic returns after limited pay premium term gets over.

The Investment so made is available as deduction under section 80C. As the returns are guaranteed and not linked to market performance, these are also called non-linked policies.

Just like ULIPs, you will get 10x Life Insurance Cover of your yearly premium.

So if you pay a yearly Premium of 1 Lac, you get a Life Insurance of 10 Lacs (only!)

Generally, IRR in these policies come around 5-6%, which makes it unsuitable considering longer period of policies.

Alternatives of these policies for tax benefit?

-      Tax Saving Fixed Deposits (Lock-in for 5 years, IRR around 6.5%)

-      Provident Fund (Lock-in for 15 years, IRR more than 7%)

-      National Pension Scheme (Lock-in upto 60 years of age of Investor, IRR around 8-10%, depending upon debt- equity mix)

Why to avoid non-linked investment and insurance plans?

-      Very low Insurance cover compared to term plans

-      Low Return over a long period of time

-      Low Surrender Value (hardly 50% of investments made)

-      Keeping Insurance and Investment together may adversely impact your life cover if you miss premium payment due to cash crunch (while the chances of that is low for term plan)

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