BT Insight: All that you must know about term insurance policies

Beginning of the year is the best time to analyse your financial goals. While you review your progress, financial security of your family should get the highest priority. Achieving life goals is a long-term process and may often stretch until your retirement. But, what if you are no longer around? How will your loved ones survive and pursue their life dreams? So, you cannot take a chance with the financial security of your family. That said, buying term insurance should be the first resolution that you must take and execute as you do your financial planning. It will make sure that your family is financially secure even after you are gone.

Term plans are the cheapest insurance plans. A person in the age bracket of 25-30 can easily get a life cover of Rs 1 crore for as low as Rs 500-600 premium per month. Unlike investment plans, there is no payout if the policyholder survives the policy period because the term plan is a pure insurance product meant for making good the financial loss in case the policyholder is not around.

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One must know that insurance is not meant for wealth creation but for the mitigation of financial loss for your family in your absence. It gives you peace of the mind that the expenses of your family will be well taken care of for a long period of time, that is, your children getting well settled in life and your spouse enjoying financial independence.

We tell you why term plans are important, how much coverage you may need and things to keep in mind before buying one:

Understanding term Insurance

Term insurance plans are pure risk plans in which the policyholder gets the full sum assured in case of death, else nothing. It offers a high amount of cover for a very small premium, which, on the death of the life insured, is paid to the nominee. These plans provide coverage for a specified period. In term insurance, there's flexibility in the mode of paying premiums. Either you can go for a regular premium payment option or a single premium payment. In regular payment, you have the options of full-term regular payment or limited-term regular payment. In a limited-term regular payment, the coverage is for a longer period while you pay a regular premium only for limited years. Even in the regular premium, you get different frequency options as you can select, monthly, quarterly, semi-annual or annual premium payment options.

Which term plan to buy

Various types of term insurance plans are available in the market - level term insurance, increasing term insurance, term with return of premium (TROP), and decreasing term insurance (also called mortgage redemption). 

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Level term insurance: The premium remains the same through the policy period.

Increasing term insurance: The death benefit increases at fixed time intervals but the premium remains the same. It ensures that the death benefit is adjusted for inflation because family expenses even at the current value will cost more in the future.

Decreasing Term Insurance: The sum assured decreases every year with the same premium amount. These policies come in handy when someone has huge debts and loans on them, says Santosh Agarwal, Chief Business Officer- Life Insurance, Policybazaar.com.

TROP Plans: In this plan, if the insured passes away during the term of the policy, the sum assured is payable to the nominee, and if insured survives until maturity all premiums are returned.

How much cover you need

In insurance, no one size fits all. Premanshu Singh, CEO, Coverfox says jumping on the bandwagon of buying a Rs 1 crore term plan is not a wise choice. The thumb rule is to opt for a sum assured that is 15-20 times one's annual income. So, if a person has an annual income of Rs 8 lakh, the ideal life cover for him will be in the range of Rs 8,00,000 x 15 (1.20 crore )and Rs 8,00,000 x 20 (Rs 1.60 crore), says Singh.

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How to pick the best plan

Umpteenth insurance policies are available in the market. Going for a plan with the lowest premium is not how it works. You must understand your needs to choose the best-suited plan. Most importantly, the earlier you buy a term plan, the better. The premium amount increases as per the age, therefore it is wise to buy a term plan before you hit 30 years of age.

Once you know the amount of cover that you require, you must do an online comparison of all available term insurance plans in terms of premium and features. "Go for regular premium pay term policy as under single pay policy an investor can only avail tax benefit once but under regular pay policy one can avail the tax benefit throughout the pay term," says Agarwal of Policybazaar.com.

He also advises to add additional riders that might help you in different circumstances of life such as accidental death benefit, critical illness benefit, accidental disability benefit and waiver of premium etc. You must also check the reputation of the insurance company by checking its solvency and claim settlement ratio. Once done, you can see which plan is the most pocket-friendly for you. "It is wise to choose a term plan that is feature-loaded as well as light on the pocket. Also, ensure that you do not conceal any facts while filling the proposal form. Being completely honest helps in speedy settlement of the claim on the life insured's demise," Naval Goel, CEO & founder of PolicyX.com says.

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Choose pay-out option wisely

Term insurance offers various modes of pay-outs to the family after the demise of the insured. "The death benefit can be received by the nominee either as a lump sum or part in a lump sum and part as monthly income or as a monthly income for a set number of years. The nominee also has an option to receive a level or increasing monthly income," Singh of Coverfox adds.

For example, if you are buying a plan for your spouse who is financially savvy, you should go for a lumpsum one-time pay-out so that your spouse can utilise some of it for immediate requirements and rest can be invested. However, if your spouse is not a financially savvy person, he or she may need regular monthly income for which you can look for regular payout option. If your dependents also include children, an increasing monthly income along with some lumpsum payout is advisable.

Do you need whole life insurance?

Term insurance policies lapse after a specified period. Unlike term insurance, whole life plans give you coverage for the lifetime but at a much higher though fixed premium (payable for a pre-defined limited period). The insurer uses a portion of the premium to provide life protection, while the rest of it is invested and returned to the insured as cash value or bonus at a certain age or when the policy matures. Thus, whole life plan gives you life cover along with a means to build corpus over the long-term as a legacy to be passed on to your loved ones.

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Should you prefer whole life over term plan?

Let's understand this with an example. ICICI Pru's term plan 'iProtect Smart' charges from an 18-year old a premium of Rs 837 per month with a sum assured of Rs 1 crore for a policy period of 70 years. The same person will have to shell out Rs 1,777 per month to get the same plan for whole life.

Since the insurer can invest only invest the collected premium only in debt instruments, it will generate returns of nearly 7-8 per cent over the long-term. However, if you invest the differential Rs 940 in equities for the same duration, you may collect more money than what insurer will offer you as cash value.

"If you are an individual in your 20s or 30s, a term plan is the best option for you, but if you are a married person with one or two kids, a mix of whole and term life represents a great choice. You can do this by buying a term rider on top of the whole life policy. On one hand, the whole life policy offers you cash value that can be used at various points of your life, on the other, the term rider will protect your dependents with high monetary benefits," says Goyal of PolicyX.