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Term life insurance: what, why, how much to get and from where?

Posted on 02 Jun 2021
Author: Sayan Sircar

Tags: Basics ; Insurance

17 mins read
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Term insurance gives your dependents the necessary financial support in your absence.

Term life insurance: what, why, how much to get and from where?

What is term insurance?

Term insurance is a type of life insurance that pays a benefit to the named beneficiaries in the event of the insured person’s death, as long as the policy is active. The purpose of term insurance is to provide financial protection for the policyholder’s loved ones in the event of their unexpected death, helping to cover daily expenses, future goals such as children’s education, and loans like home loans.

It is a straightforward insurance product, similar to car insurance, in that it only pays out in the event of a specific occurrence (death) and does not have a savings component like other types of life insurance. The cost of a term insurance policy is extremely low compared to the potential benefit, and the recommended coverage amount is typically 20 times the policyholder’s annual after-tax income.

Every other insurance policy mixes a term plan with a savings component because it knows people cannot digest the “pays nothing if you don’t die” part, and also conveniently suppresses that the savings component is either paltry (you can get more from an FD or PPF) or market-linked/uncertain which you can simply get by investing outside the insurance plan.

Insurance allows risk transfer from a single person to a group of people. Since many people buy insurance, only some are expected to die within the policy’s coverage time. However, it should be present at least for all earning members of the family before retirement age. Term insurance is a critical part of everything you need to do before investing in your goals. Read more here: As someone who has heard about goal-based investing, how do I get started?.

Who should buy term insurance

anyone with dependents: to secure the financial future of the dependents
anyone with a large secured loan. This ensures that the asset (like a home in case of a home loan) is not repossessed by the bank in case the person dies. Term insurance is an absolute must if you are stretching to buy your dream home?
anyone who does something expensive to replace: this is an example of key-man insurance. For example, a non-working spouse may be performing home and childcare activities that are expensive to replace by hiring housekeepers, tutors, and starting daycare

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Why is this needed

Term insurance offers:

Protection against loss of income
A large sum assured at the lowest cost
Peace of mind for the earning member
Safety net for the financial situation of dependents (children, spouse, parents, siblings)
A contract that is easy to enter (online purchase possible)
Tax benefit under section 80C (please always check Income tax law changes before claiming benefit)
Covered under strict regulations from IRDA that all insurers must follow

What should be the policy duration

Term insurance protects income so that daily expenses and goals are not affected. It would be best if you only took term insurance as long as you have income, i.e. up to retirement (typically 58-60). This is because plans until age 70 or 80 are more expensive than plans up to age 60. If invested for 30-40 years, the difference can create a corpus higher than the sum assured of the term policy.

If you are planning to take an accelerated premium plan (either a single period or the typical ten years reduced period payment plan), please note that:

it is highly beneficial for the insurer to get money from you earlier than later
if you retire early or have paid off your goals, then term insurance is unnecessary. But if you have already paid all the premiums, that is money wasted on a policy that is not needed
for a single premium plan, check if it is cheaper to buy a gilt bond and use the coupon to pay the premium
simulate the reduced payment period plan, take the entire period payment plan (say up to retirement, 30 years) and invest the difference between the reduced period (say ten years) and full period premiums in a money market debt fund for ten years. After ten years, start paying the premium from the money market debt fund:

An example below to clarify the last point:

total period payment premium is ₹22,000 until age 60 for 30 years of payment
reduced period payment is ₹48,000 until age 40 for ten years payment
take the first option and pay ₹22,000 per year for ten years and also invest ₹48-22 = ₹26,000 in a money market fund for ten years at around 4% post-tax return
after ten years, start paying the ₹22,000 premium from the corpus accumulated from the money market fund for the following 20 years

Term Insurance extra premium invested

How much term insurance do you need

We will first cover two methods to calculate the term insurance coverage amount. We have explained the concept in detail here: How to calculate term insurance coverage amount?.

HLV Income method

You can use a tool like Excel (free on office.com) or Google Sheets to calculate using the following formula:

Coverage needed = PV(RealRate,Years_to_retire,-AfterTaxAnnualIncome,0,1)

HLV Expense method

Coverage needed = PV(Real_Rate_In_Retirement,Years_In_Retirement,-Current_Annual_Expenses,0,1) + LoansOutstanding - Current_Investments - Existing_Term_Insurance

Minimum term insurance coverage amount

If you are using the Arthgyaan Google sheets-based goal planner then you will see the minimum term insurance you need to have based on:

the shortfall of current goals. If income stops, this amount, if invested, will fund current goals
the amount needed to sustain a retirement-level lifestyle, including inflation adjustment, for the period income was expected to be there.

We also have a simpler term insurance calculator built into the Arthgyaan Google sheets-based goal planner that can be used for free.

Term insurance calculator

You can access the calculator and get instructions regarding how to use the calculator here: How to calculate term insurance coverage amount?.

Do you need separate insurance

If you are already having a policy from your company, you should still take a term policy of your own because:

you might lose your job and the policy will lapse before you join another if there is a gap
you may not have enough coverage as per your needs from the corporate plan
the premiums will increase if you delay due to age or lifestyle diseases

How to buy a term policy

Step 1: Calculate coverage

Use the HLV method above to calculate how much you need. In both ways, a similar result came in the example (new 3cr policy required). However, the different methods require different assumptions (inflation, salary growth, time in retirement etc.). Therefore, the result is only good as the assumptions being made. You can choose whichever method you are comfortable estimating. If you select both, take the policy with higher calculated coverage since the premium difference will be small.

How insurance coverage changes with time

How to calculate term insurance coverage amount?
Your coverage amount will change over time: How your term insurance coverage changes with time

Step 2: Compare rates online

Many insurance portals offer quotes. These are brokers, so the quotes and choices are based on their commission. But they may also provide support on documentation both before purchase and in claim settlement
Cross-check rates from the insurance company site

Step 3: Policy Features

Ignore all riders like critical illness, accidental death etc
Choose annual premium (once a year premium)
Choose policy duration less than or equal to the expected retirement age (say 55-60 years). Do not choose coverage up to 70-100 years or more

Riders make the claim process complicated, since you need to prove the cause of death as well, and may cause issues in claim processing by giving the insurance company more to investigate. You can take such riders as standalone policies, like personal accident insurance, from a general insurance company. You need to keep in mind that in general, rejection without or without litigation is cheaper than paying out the claim.

The annual premium is generally the cheapest compared to monthly/quarterly.

The duration of the policy should be no more or no less than the typical retirement age. The extra premium is wasted for longer durations since there is no income to protect. The money will earn more if invested as part of long-term goals.

Some policies offer shorter premium payment periods at much higher rates. This can be a single premium (which can be very high) or accelerated - a high premium for 7-8 years and nothing afterward. Choose this if and only if there is a chance of not paying all the premiums throughout the period. If regular income is available, the difference between accelerated and average premiums can be invested for long-term goals.

Step 4: Choice of insurer

There are multiple insurers in India offering term insurance. The Life Insurance Corporation (LIC) is well known, and there are many more private insurers. The standard advice here is to

choose the insurer you are most comfortable with
choose the cheapest premium option without additional riders
research regarding customer service of these companies on social media and other sites

Some FAQs/myths on insurer choice and overall term insurance as a product are covered below.

You might be interested to read my personal experience with the LIC’s new Tech term online term plan here: My experience with the LIC Tech Term life insurance policy

Step 5: Fill out the form carefully

Disclose all material facts like financial status, nature of the job, existing policies, medical conditions (no matter how big or small or old) honestly, including smoking and alcohol habits
Complete medical tests (do not agree on tele-medicals: this may cause issues with claim settlement)
Choose nominee(s): this is the whole point of taking insurance
Pay the premium and go for medical tests
The policy will be issued after the tests are done

Misrepresentation of facts at this stage may cause claim rejection later.

Warning: Do not sign a blank Medical Examination Report (MER) Form or any other blank form and give it to the insurance agent for submission. If a wrong entry gets made in the form, the premium may get hiked or the proposal rejected.

Step 6: Set up a sinking fund to pay the premium annually

The annual premium is the cheapest compared to monthly/quarterly. If the annual premium is too high to be paid in a single month, use a sinking fund: see this detailed post to save the premium monthly and pay once a year.

Monthly/quarterly premium payments (apart from higher premiums) may lead to operational issues due to payment failures that can cause the policy to lapse.

FAQs/myths on term insurance

A few of these myths and mistakes are discussed in detail here: Do not make these common mistakes while buying a term insurance policy

Should I take the MWP option for term insurance?

The Married Women’s Property Act 1874 (MWP Act) ensures that upon the husband’s death, the insurance proceeds only go to the wife/children (if the wife/children are nominees) and not to any creditor in case loans are outstanding in the husband’s name. A wife can also take a policy in her name and invoke the MWP option to ensure her children (if they are the nominee) get the proceeds instead of any creditors.

You must avail of the MWP option at the time of buying the policy, and it cannot be opted in once the policy has been issued. Opting into the MWP option does not change anything else in the policy terms.

If I do not die, then the premium is lost

Term plan has the cheapest premium for a given level of coverage. Any return of premium plan (or investment plan like endowment, whole life etc.) has a higher premium but low returns (comparable to FD at best). Instead, a combination of term plan and investment in PPF, stocks and debt mutual funds for long term goals is expected to beat the return offered by all return of premium or mixed plans.

Example:

Term plan for 30y for 1cr coverage is available for 15k while a return of premium plan costs 30k.

Option 1: Term plan for 15k and another 15k invested yearly at an average of 10% say grows to 27 lakhs (use any SIP calculator to check). Even if you invest that 15k using after-tax money (10,500/year after paying 30% tax and then pay 15% tax say investments after 30 years, the pre-tax amount of a 10.5k/year, 30y SIP at 10% average becomes 19 lakhs pre-tax and 16 lakhs post-tax.

Option 2: Term plan with return of premium for 30k over 30 years will give back 30k times 30, i.e. nine lakhs which is a lot lesser than the previous option.

So don’t believe for a second that there is a loss in taking a simple term plan. Another way of looking at a term plan is by comparing it with vehicle insurance. If there is no accident, the premium is “gone” if there is one, then you will be relieved that you had the insurance coverage.

Do private insurers have high claim rejections?

Claim settlement ratio (CSR) is the percentage of life insurance claims an insurer has settled in a year vs the claims it receives in the period, including pending claims from last year. The definition of “settled” includes claims not paid out as well. So, in theory, a company can pay zero rupees in claims and still have 100% CSR.

CSR data is surprising since LIC (supposed to be the best in claims) does not have the best CSR. CSR depends on the individual claim (whether disclosures were correctly made or not and many other factors). See this snippet from IRDA 2019-20 annual report where LIC has 96.69% CSR:

IRDA Annual Report 2019-20

As per Section 45, Insurance laws of 2015 claims cannot be rejected past three years from the date of policy issuance. Also, as per regulations issued in 2017 all claims would need to be paid out in a maximum of 120 days. Please read both these documents in detail.

Private insurers may shut down

In such a case, the policy will be taken over by other insurance companies. The original company cannot simply shut down without a merger with another. As per IRDA laws, the insurer must have a solvency ratio of 1.5, i.e. they must keep 150 rupees of reserves for every 100 of coverage issued. Ultimately the choice of issuer depends on your comfort level with the company.

Who does not need term insurance?

Someone with good savings or government pensions / stable passive income may consider term insurance unnecessary. However, please consider taking term insurance if at least one of the following is true:

long term goals like retirement and children’s education are not yet funded
one spouse is not working
there are outstanding loans
significant expenses are coming: e.g. supporting a child through college
the family will face hardship if one income is not there

This topic is discussed in more detail here:

You do not need term insurance if

Policy issuance date and tax benefit

The premium (including GST) that you pay for term insurance is eligible for deduction under Section 80C under the old tax regime thereby saving tax: How to plan tax deductions for salaried income?. If the premium is ₹15,000 with GST per year, you save around ₹4,500/year in taxes at the 30% tax bracket.

If you are buying the policy near the end of the financial year (FY) in March keep in mind that:

under normal circumstances, the date you paid the first premium will be considered for determining the FY for a tax deduction
if there is a premium increase after the medical test, then the day you accept the higher premium (which might take a few weeks if it is LIC), then that day will be considered for determining FY for tax purposes

Insurance for the spouse without income

If you have a non-working spouse, you can use the expense method to calculate the coverage needed: typically use expenditures like home and childcare (if applicable). Some insurers may offer limited or single premium plans in such cases. This is often missed during financial planning for the family. There are nowadays joint term plans and “Saral Jeevan” plans that cover a non-working spouse.

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