Term insurance gives your dependents the necessary financial support in your absence.
Term life insurance: what, why, how much to get and from where?
02 Jun 2021 - Contact Sayan Sircar
17 mins read
Term insurance gives your dependents the necessary financial support in your absence.
Term insurance is the simplest possible insurance policy: you pay the premium every year. If you die, the nominee gets money; if you do not die, they don’t. The money you pay to the insurance company is the premium. The money that the nominee(s) gets is called sum assured.
Insurance allows risk transfer from a single person to a group of people. Since many people buy insurance, very few of them 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?.
Table of Contents
- What is term insurance
- Who should buy term insurance
- Why is this needed
- What should be the policy duration
- How much term insurance do you need
- Do you need separate insurance
- How to buy a term policy
- FAQs/myths on term insurance
What is term insurance
Term insurance covers the unexpected death of the insured due to any cause as long as the insurance cover exists. This way:
- daily expenses are not affected
- future goals like children’s education and retirement for the spouse can be covered
- you can pay off loans taken like home loans or higher education
Term insurance is like car insurance. You take it in case your car is damaged; or, alternatively, keep a security guard to watch your house when you are away; or have a backup parachute when skydiving. Most people will never get their car totaled, house burgled or the main parachute fail. But when that unfortunate event does happen you will be very happy to have that safety net.
Term insurance works in the same way. It pays nothing if you don’t die. It pays a lot, compared to the premium when you do. A 1 crore term plan costs 10-15k/year depending on age. Ideal insurance coverage is around 20 times annual after-tax income, depending on the time left up to retirement. We show the calculation method in this article. 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.Recent articles:
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
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
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.
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.
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.
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:
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:
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.If you liked this article, consider subscribing to new posts by email by filling the form below.
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This post titled Term life insurance: what, why, how much to get and from where? first appeared on 02 Jun 2021 at https://arthgyaan.com
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