Insurance watch: Why buying a term plan makes sense for most investors, policyholders

Term insurance is a crucial component of an individual's financial strategy in India, however, it the route most avoided. Term insurance plans are specialised life insurance policies that provide a benefit only in the event of the insured's death during the term of the policy. These plans typically do not offer any maturity benefits, as they are designed for pure protection.

This type of insurance is often referred to as a pure protection plan. While term insurance falls under the category of life insurance, it differs from other life insurance plans. Despite the considerable growth in health insurance and life insurance plans, term insurance currently makes up only about 5% of the total policies sold in today's market.

"One should consider a term plan as part of their long-term financial planning as it is the simplest and most affordable option present in the market. A term plan would provide financial security to your loved ones in case of your untimely demise. It is vital to opt for an adequate sum assured to cater to your family’s needs, future goals and other miscellaneous expenses," said Ashok Manwani, Vice President – Products, Go Digit Life Insurance.

Who opts for term plans?

Although the penetration of term plans by salaried taxpayers is relatively low, High-net-worth individuals (HNIs) in India are increasingly turning towards high-value term insurance policies. The trend of opting for policies exceeding Rs 20 crore reflects a shift in financial planning and risk management practices among the affluent. In recent years, there has been a noticeable surge in HNIs selecting term insurance policies valued at Rs 20 Crore and above. A recent report from Policybazaar highlights this change, challenging the traditional notion that online platforms are not suitable for high-value transactions. The report also suggests that policies valued at Rs 5 crore, which were once considered significant, are now becoming more commonplace.

Term plans

Recently, the Life Insurance Corporation of India (LIC) launched new term life insurance plans for providing term insurance and safety net against loan repayments – LIC's Yuva Term, LIC's Digi Term, LIC's Yuva Credit Life, LIC's Digi Credit Life.

How to determine the coverage of term insurance plan

To calculate the appropriate sum assured for your term insurance plan, one approach is to utilize the Income Replacement Method. A general guideline suggests aiming for a sum assured that is 10-15 times your annual income.

Another method to determine the suitable coverage amount is the Need-Based Analysis. By conducting a comprehensive need-based analysis, which includes listing current and future financial obligations such as debt repayment, living expenses, and educational costs, you can determine the necessary level of sum assured. This method involves evaluating various factors that can safeguard your family's financial well-being in your absence.

One can start by reflecting on these six key questions:

> What is the total amount my family would require in order to take care of the household expenses in my absence?

> What is the amount my family would need to maintain their current lifestyle in my absence?

> How much amount under various loans and other financial liabilities needs to be paid offto ensure my family does not have to bear the brunt of paying back the loans?

> Considering inflation, rising costs of education, and potential future changes in family’sfinancial needs, how much money would be required to adequately fund my children's education, wedding expenses and future life milestones?

> How much amount in retirement savings would my spouse need for a comfortable retirement?

> How much money do I have in savings, investments and assets and are they sufficient enough to take care of these needs?
 
Based on these questions, you can draw up the below formula to arrive at the right life insurance coverage:

Term Insurance Coverage amount required = Liabilities - Assets

Liabilities
 
Outstanding loan, debts: This includes all your current financial obligations, such as home loans, car loans, personal loans, credit card balances, and any other outstanding debts.

Corpus for Financial Goals: This encompasses all the big and important financial goals your family needs to achieve in future. These may include savings for your children's education, their wedding expenses, building a retirement fund for your spouse, and other significant financial milestones.

Monthly Household Expenses: This includes all recurring costs associated with managing your household on a monthly basis. These may range from groceries, utility bills, mortgage payments, school fees, medical expenses, dining out, and other miscellaneous expenses.

Assets: This includes your investments and assets, such as fixed deposits, stocks, existing life insurance coverage, mutual funds, other liquid investments, and physical properties (excluding your current residence).

Let's understand this with the help of an example:

Y, is a person living in a city and has a spouse and one child. Let's break his finances down:

Liability

Outstanding Loan, debts = Car loan (Rs 13 lakh) + Rs 25 lakh (Personal loan) + Rs 2 lakh (outstanding credit card bills) = Rs 40 lakh

Corpus for Financial goals = Child's higher education (Rs 60 lakh) + Spouse Retirement Corpus (Rs 1 crore) = Rs 1.60 crore

Household expenses = Rs 50,000 per month

Corpus required to manage monthly Household expenses = Monthly expenses (Rs 50thousand) * (Multiply by 200) = Rs 1 crore

Total Liabilities = Rs 40 lakh + Rs 1.60 crore + Rs 1 crore = Rs 3 crore

Assets = Fixed Deposits (Rs 40 lakh) + Stocks and MFs (Rs 30 lakh) + Life Insurance Cover (10 lakh) + Physical assets (Rs 1 crore) = Rs 1.80 crore

Term Insurance Coverage Amount Required =Liabilities - Assets

Term Insurance Coverage = Rs 3 crore - Rs 1.80 crore

Term Insurance Coverage = Rs 1.2 crore

(Calculations: Go Digit Life Insurance)

Periodically reviewing your term plan is also essential as your life needs and income change over time. This will help in identifying the gap between the current sum assured and the coverage amount required basis any change in life stages or evolving needs.

Moreover, when calculating the right sum assured, be sure to consider inflation as well. Inflation can diminish the value of money over time; so, it's crucial to ensure that your coverage keeps pace. Another important aspect when buying a term plan is the potential addition of riders, such as critical illness coverage or accidental death benefit, to enhance your financial protection.