Term Insurance

You have been earning really well for a few years now. You are happy the way things are going. You have a mind blowing health insurance in place and meticulously investing every month on a great mutual fund. You feel very secured with your life. You bought a 20 Lakh car recently with 16 lakhs loan on it. You have been paying the EMIs regularly without fail. You and your spouse plan on having a new house. Your salary can accommodate a big EMI and you close in on a great deal for a beautiful 3 BHK house in the middle of the city with all the modern amenities. You have 2 beautiful kids going to school. Your life is just perfect.

Your family is everything to you. Be it your spouse, kids or your parents. Have you ever wondered what will happen to them if something unfortunate happens to you. God Forbid. Let's face this. This is the reality, unfortunately.

Your passing will put them off emotionally. Now imagine if they were dependent on you financially. How bad would their situation get into if you happen to die. Your spouse may now have to repay all the debts you borrowed. Even if your spouse is working, the house you bought few years ago would be based on the capabilities of both of you paying it together. What about the car loan ? What about the high fees for your childs education? What about your parents medical bills ? What about the dreams you and your spouse had for your kids' higher education in top universities? Who will fund it now? Everything goes for a toss in just a matter of few seconds.

We humans, do not like to think about it. We like to be optimistic and think all be fine tomorrow. We do not like to feel so unsecure that the thought can put off our moods completely. So we end up not taking a protection against such scenarios.

Imagine a situation where your family gets paid a lumpsum amount if in case you die. They of course loose the most valuable asset of their life in you. But at least you have ensured that their life is secured and can run smoothly even with out you. And in most cases, you have served your purpose as a breadwinner for the house. They can use that lumpsum amount to fund your debts, education, medicine anything and everything.

Trust me, it is not easy to take the burden of finances when your loved one passes away. I had to take up the responsibilities of my family's finances when my father passed away. He left behind the house loan and jewelry loan for me to repay. I wandered around the banks requesting them to write it off as my father was the sole breadwinner and I was yet to find a job. They were reluctant. They knew we had to find a way as they had the collaterals with them. They could send a few months of notice and just put our house at auction to recover the money. They may look heartless, but they are just doing their job and what is good for them. Eventually, I had to repay all the laons and it took me a few years to close.

What is a term plan?

Think of it as an premium you pay to an insurance company which is ready to take care of your families finances if you die naturally. This money can be used to all future expenses, EMIs, loans, childrens higher education, new house etc. You are financially securing your family in your absence.

At outset, you may feel like you are losing the money you pay for the term plan. However, you stand to gain a lot more. You may want to prefer the "Endowment policies" or famously called as "Money back guarantee policies". You would belive that your premiums on a pure term insurance is a gone forever while on money back policies you get them back at maturity. The difference between the two is explained in a different chapter.

For now, understand that the insurance amount from a money back policy is way too low to secure your family. The maximum part of your premium is invested in the equity market and very little is utilised for securing your insurance amount. They then share a part of that income from the market with you as a bonus.

Your premiums will be higher in money back policies as they know that these have to returened back to you. While in term insurance, the premiums are dead cheap in comparision. If you invest the differential amount in a safe mutual fund, you stand to gain much more than what the money back policy would give in return including the bonus (which is not guaranteed).

At this point in time you might have few questions popping up. What if my fund does not return as expected? What if I am not well versed with investing? Doesn’t the insurer or the agents who push these money back policy know this stuff? Well, they do. Then why do these agents push the money back policy so hard on us? Its as simple as they get commissions. Insurance companies know that they stand to gain higher margins with your money and repay only a part of their gains. In case you die, the cover is too small to repay. Afterall these are the easiest policies to sell. The agent’s pitch is as simple as this – “You pay a few bucks. You get them all back in case you survive. If not, your family will get 10x the premium you pay”. It sounds as if you stand to lose nothing if you buy the policy.

Not many can do the math like the way you can do it now. On investments and returns, we will discuss them in detail in later chapters. Remember, the insurance company also “invests” your money in the equity market and the returns they get in the market is shared with between you and the insurer. It is just the word play with the term “bonus” which excites your brain.

How much of a life cover do you need?

Lot of us think term cover as the amount that would be needed to cover all the debts and expenses. A typical calculation would be based on paying out all the debts with the lumpsum money you get. In fact, the calculation is much more tricky than this.

The idea is to keep the fund in FD and the monthly interest payout should be able to cover the EMIs and the expenses you incur today and you foresee to incur in future. By doing this, we don’t deplete your money while you cover all the necessities as well. Smart ? 😉

Let us assume the monthly expense comes out to be 25,000. If you buy a 50 Lakh cover and on your passing the amount is put in FD at an interest rate of 6%. Your family is bound to get a monthly payout of 25,000. But we have not considered inflation yet. You are buying a policy for next few decades. Expenses are only going to increase. If you are planning to buy a house the EMI for the house will also be added to these expenses. What if the FD interest rate falls to 5% in few years? So, the smarter thing to do here would be to buy a 1Cr or more policy in this case. With this your family can get a better cover without dipping into the funds to close your debts or any other expenses. There are many online calculators available to calculate the amount of insurance you would need.

What should be the policy duration?

Premiums can increase by over 30% if you increase the duration by 10 years. You may be able to pay high premiums today but you have to ensure that you pay your premiums diligently every year without fail. You have to make sure that the premiums are not too high as well. The fundamental reason you are buying a term policy is to safeguard your dependents financially if you die young. By the age of 60-65, you are supposed to be settled, save enough money for retirement and your kids would’ve been grown up enough to live an independent life. Ideally, by the age of 60, you may not be having a lot of dependents on you. You are doing fine if your policy is covered up to 60 years of age, may be 65. Post that be aware that your premiums will be very high.

Riders could be great if you can afford them.

Rider 1: Waiver of premiums – In case you happen to get permanently disabled due to an unforeseen situation like accident, you may have to quit your job or may have to find a different source of income. In such cases, this rider will take affect and you will not have to pay any premiums going forward while keeping your policy intact. Of course, this comes with a cost but can be of great help in situations like these.

Rider 2: Critical Illness benefit – In today’s world, we are not entirely sure of what critical disease can hit us irrespective of our age. When diagnosed with such disease one, you will have to spend a lot on your medication and two, you may have to temporarily quit or take leave from your job. With this rider, the insurer will pay out a small portion of your cover in lumpsum say 25 lakhs to tide over the situation with out much worry.

There are host of other riders which can add a lot of value. However they all come at a premium. The above riders in my opinion are good. They are not a must to have if you can't afford the extra premiums. Below are few other riders you can opt for.

Rider 3: Accidental beniefit – you get extra cover in case you die of accident.

Rider 4: Life stage benefit – You get an option to increase your cover at a later stage in life.

Rider 5: Terminal Illness benefit – In case your doctor declares that you do not have much life left in you, you get the entire amount even before you die. You can choose to get the best treatment across the world with the money you get or enjoy the days left. However, the likely hood of your doctor declaring the same is way too less.

Term plan vs Money Back Policy