There are dozens of term insurance plans to choose from. And selecting the right plan is of paramount importance for the financial security of your family. In this article, I give you five detailed steps which will help you zero-in on the perfect term insurance plan
Life was so much easier in the 1990s
In the year 1992, a new potato chip was launched in the market with the name “Uncle Chipps”.
Some of you older folks like me might remember 🙂
It was also the time when buying potato chips from the local kirana shop was a 30 second affair. Afterall there were only two brands to choose from i.e. Golden Crisp and Uncle Chipps. And all you had to do was to hand over 5 rupees to the shopkeeper, collect the bag of chips, rip it open and enjoy those golden brown chips.
Almost two decades later, having simple potato wafers is an exercise in decision-making. You now have a wide selection of brands offering this product in multiple variants. I was at the local supermarket yesterday and found there were potato chips which were –
- Low fat
- Low salt
- Diet chips
- Triangle shaped
- Flavours like sour cheese, kadai paneer, Chinese tadka or what not
Why am I telling you all this?
My Term Insurance Buying Story
I have, thus far, bought two term insurance plans.
My experience of buying my first term insurance policy in 2010 was a lot like the 1992 Uncle Chips story. There were just 3-4 companies offering this product then with basic restrictions. Like – the highest age for cover was 65 years, you only have the death cover option and you can only pay in the annual mode.
Simple and uncomplicated.
And by the time I came around to buying my second term insurance in 2016, I was rippled, low salted, triangle shaped and flavoured into a prolonged decision making exercise.
It took me a couple of weeks and over 10 phone calls from insurance agents zero-in on the right plan
In this post, I will separate the wheat from the chaff. I will help you identify the most important variables you need to consider when buying a term insurance plan.
Different Types of Term Insurance Plans
First things first. There are many benefits of term insurance and I recommend every breadwinner in the family to have one.
This might come as a surprise to most but term insurance plans have been in existence in India for decades. The issue was never availability but the focus of insurance companies and distributors to market term insurance.
For many years, LIC (Life Insurance Corporation of India) was the monopoly player in India. Their business was completely agent driven. Thus, the construction of product, marketing, pricing etc. were all geared towards helping the distributors reach more consumers & sell more.
In these years, term insurance never gained popularity. Further, term insurance plan commissions were either zero or extremely low to warrant any interest from insurance distributors. In the insurance industry, no marketing + no distribution + no awareness = Nothing!
The Evolution of Term Insurance Plans
Then a little over a decade back, online term insurance plans were introduced. Aegon Life Insurance was probably the first insurance company to introduce online term insurance plans.
These plans had a simple construct. They would offer –
- A basic death cover
- Coverage upto the policyholder attaining 65 years of age
- Pay your premium in annual mode only
- And, there was just one rider (accidental death rider)
That’s it. Really simple.
In the early 2010s, more insurers started offering online term insurance plans. The regulatory changes in ULIP plan accelerated this move as more insurers wanted to derisk their portfolio. Protection products like term insurance offered that diversification and also offered higher margins to insurers.
As a result, a layer of complexity started building in.
Today there are single premium plans, limited premium payment plans, increasing cover plans, staggered payout plans etc. Heck, there are even term insurance plans that return the entire premium back if you survive the full term. This is called Return of Premium plans.
While this profusion of choices is good news, it is also becoming a problem. Most millennials are getting adequately confused and are unable to decide which policy to buy.
To twist-quote Spiderman here:
With great many choices comes many great confusionsMY INNER SPIDERMAN
We’ll now look at the five considerations you need to check for before choosing a term insurance plan
1. Identify Your Needs and the Term Insurance Coverage you seek
Choosing the right coverage for your term life insurance policy is vital.
The term insurance cover (sum assured) should be a broadly accurate assessment of how much financial resources you will need to provide your dependents if you were to meet an untimely death.
A number of consumers have no idea how to arrive at the coverage amount. They generally stick to an advertising originated number like “₹1 crore term insurance for ₹____ per month”. This ₹1 crore may or may not be what the user really needs to have protection for
The essence of this point is that arriving at your term insurance requirement is a mathematical exercise. One should not be guided by advertisements which prompt you to go for a crore of coverage.
So, how to do this?
How to determine your life insurance coverage?
The best way to determine your life insurance coverage requirements is to grab a piece of paper and follow the below steps:
- Estimate your dependent family’s monthly expenses for the next 15 years. You don’t need to worry about inflation here as I have factored inflation using this 15x multiple. Simply enter your family’s current monthly expenses and multiply it by 12 (months) and then multiply it by 15 (years)
- Add your liabilities. Add outstanding debts like home loans, credit card bills, personal loans, business loans etc.
- Deduct any liquid assets. A liquid asset is something that your family can access within a week of your demise. Liquid assets are an emergency net you have already created to take care of your & your family’s short term needs. These assets include balance in bank savings account, fixed deposits (which can be broken), stocks (which can be sold), mutual funds (which can be redeemed) etc.
- Add your expenses on account of important life goals. A life goal is a planned event that is likely to happen in the next 15 years. Some examples include your children’s higher studies, children’s marriage etc.
- Add the retirement corpus you want to leave your spouse. Your spouse might most probably start working again post your demise to support the family. But there are times when that too is not possible due to a medical condition or lack of necessary skills. While your term insurance coverage will take care of your spouse for a few years, it might come short to support his/her retirement. It is a good idea to factor this possibility.
The total of all above five considerations gives you a broadly scientific way of determining how much of risk cover one should endeavour for.
Difference between Your Insurance Requirement and Your Insurance Eligibility
What we have learnt thus far is your life insurance requirement
Now we need to see your life insurance eligibility.
Life insurance companies calculate your term insurance coverage eligibility using a thumb-rule based approach. This is where a multiple is applied on one’s annual income to estimate the life insurance eligibility.
Here is how insurance companies calculate your term insurance eligibility:
|18 to 40 years||Annual income * 20 times|
|41 to 50 years||Annual income * 15 times|
|51 to 60 years||Annual income * 10 times|
|Over 60 years||Annual income * 7 times|
This way, you now have two numbers with you:
- Your life insurance requirement and
- Your life insurance eligibility.
One might ask. What happens if my life insurance requirement is higher than my life insurance eligibility?
In that case, go ahead and purchase a term insurance plan per the highest eligibility offered. You can always buy a second term insurance plan 3-4 years from now, when your annual income increases. Then you’ll be eligible for a higher coverage.
Your aim should be to have an insurance coverage that is above your life insurance requirements.
2. Determine the Tenure of Your Life Insurance Plan
Once you know how much cover you need, it’s important to determine till what age you need the cover for.
You don’t want the tenure to be too little as your policy might lapse before your financial obligations are over.
You also don’t want the tenure to be too high because the premium charged will be high on account of the longer tenure.
Oh. In that case, what should you be doing?
A very good and scientific way of estimating the right tenure of your term insurance plan is to determine by what year your liquid net worth after subtracting your liabilities will be more than the life insurance requirement.
Remember. We had explained the process of calculating your term insurance requirement earlier in this article. We had also learned about liquid assets *
To your liquid assets, don’t forget to subtract the liabilities like home loan outstanding, personal loan, credit card payments etc.
Got it. Then what?
The age at which these two numbers (i.e. life insurance requirement and [liquid assets* – liabilities]) coincide will be the age until which you need coverage. You are not likely to need a life insurance coverage post that age as your assets will be enough to take care of your dependents upon your demise.
A Quick Tip:
While calculating the coverage and tenure requirements, it is better to be conservative. So if the amount you get in point 1 is x, it is better to up it by 20-30%. This will provide a margin of safety in your calculations. Similarly, if the tenure you calculate in point 2 is say 65 years, add an additional 5 years to be on the safer side.
* Liquid Assets
We had defined liquid assets as those investments that can be sold off or liquidated within a week. In other words, the assets can be converted into cash within a week. Liquid assets include money in a bank savings account, mutual funds, fixed deposit, shares etc.
There are some more assets you can include which are not super liquid but generally you can liquidate these over 3-4 months. These can be the deceased person’s provident fund, retirement fund, gold etc. It won’t be wise to add real estate to this list.
3. Target to achieve the highest peace-of-mind per rupee of premium paid
The premium is one of the more important factors that needs to be considered.
Your goal should be to get the highest peace-of-mind per rupee of premium.
Note again – I did not say highest coverage per rupee of premium. I said the highest piece-of-mind per rupee of premium
Before I explain this, it is important to note that in many cases, term insurance policies that are sold online on platforms like ETMONEY are cheaper than policies sold offline in branches or by agents. In the case of HDFC Click 2 Protect Plus, the insurance company offers a 5.5% discount on an online purchase through it’s website and online platforms. Likewise, there is a 5% discount on ICICI Prudential iProtect Smart.
This discount is not just applicable for the first year but for all renewal years aswell. To put this into perspective, 5% saving on a 40 year policy comes to 200%. Or a saving of 2 years of premium.
Be smart. Ensure that you choose and purchase online term insurance plans as it gives you a clear premium advantage.
Let’s go back to the highest peace-of-mind per rupee of premium point.
In addition to the premium, there are some intangibles at play. This includes items like the stability of the insurance provider or its reputation in the eyes of the policyholder. Since a term insurance is a long term contract often running into 30 or 40 or 50 years, it is important for you to be happy with your decision. This will be a combination of the premium and your perception of the insurance company.
To check the stability of an insurance company, the metric you need for is the solvency ratio.
Solvency Ratio in Insurance
Solvency ratio of an insurance company is the size of its capital relative to the risks that it has taken. The capital here is the sum of its assets subtracted from the liabilities. In other words, the solvency ratio is a measure of the financial soundness of an insurer and its ability to pay claims.
Insurance companies are mandated by the Insurance Regulatory and Development Authority of India or IRDAI to maintain solvency margins and report it every quarter. The solvency margin is calculated as the available solvency margin to the required solvency margin.
The IRDAI has prescribed methods of valuation of assets and liabilities. Insurers in India have to maintain a minimum solvency ratio of 1.50. When an insurer’s solvency ratio goes close to 1.50, the IRDAI steps in and asks for an explanation. At these times, the insurance company needs to shore up its capital to ensure the solvency ratio is within prescribed limits.
4. Choose your add-ons wisely
Term insurance plans offer riders at reasonable costs. You should certainly be considered by you even if it might seem to not fit your requirements.
There are four major term insurance riders that are available which are –
- Additional cover for death due to accident where an amount in addition to your basic death cover shall be paid if you were to die in an accident
- Critical illness cover where a lumpsum amount is paid on the diagnosis of one of the listed critical illnesses with the life insurer
- Waiver of premium on disability where future premiums are waived off if the policyholder is rendered permanently disabled
- Waiver of premium upon critical illness where future premiums are waived off on diagnosis of a listed critical illness.
Remember. It is always beneficial to read the fine print on all these add-ons which tends to be different for different insurance companies.
For example – the number of critical illnesses in one insurer can be as low as 8 while another can have about 35 critical illnesses listed in his dossier.
Of the four riders, the two waiver of premium riders come at low premiums. On the other hand, the critical illness rider is generally the most expensive one.
You have to run some permutations and combinations to see if the additional benefit matches up with the premium charged.
5. Broadly look at the Claim Settlement Ratio
Claim settlement ratio attracts a lot of searches. And for good measure as it gives you a clear indication of the efficiency at which the policies are being settled. So, when you see a number of 95% in the claim settlement ratio column, it means 95 out of the 100 claims reported to the insurance company were settled.
A word of caution here.
The claim settlement ratio is merely an indication. If this ratio is over 95% then the company has been very efficient about settling claims.
However lately, we have seen consumers showing a bias towards an insurer which has a 98.5% claim settlement ratio as compared to someone with a 98%. This kind of minuteness is really not warranted. It is advisable to use the claim settlement ratio as a filter rather than a key decision making criteria.
IRDA Claim Settlement Ratio for Life Insurance Companies
The IRDAI released the claim settlement ratios of life insurance companies last year for the financial year 2018-19
The top five life insurance companies with the highest claim settlement ratios are:
- TATA AIA Life
- HDFC Life
- Max Life
- ICICI Prudential Life
- LIC (Life Insurance Corporation of India Limited)
To sum up –
In 2009, I did not buy a term insurance policy even my life insurance requirement was calculated at a crore of rupees. That was my mistake. I corrected that the next year. And when my requirement went over the coverage of my first term plan, I bought a second one to stay above my life insurance requirement.
The lesson here is that a term insurance plan is not a do-it-once affair. Your financial responsibilities towards your family are fluid. You have to review your term insurance requirements every five years as you go through different life events like marriage, birth of children, parent’s retirement, parent’s death, children’s education, their marriage, your retirement etc.
Use the five selection criteria discussed in this article wisely to not only enrol yourself into a term insurance plan.
Let’s recap the sequence of considerations again –
- Calculate your term insurance coverage
- Determine the tenure
- Highest peace-of-mind per rupee of premium
- Evaluate the fitment of add-ons to your term plan
- Use claim settlement ratios as a filter
Do spend an hour with these considerations to pick out a plan that really works for you
Additional Resources You Might Like
Here are some articles you might like:
- Rakesh Jhunjhunwala and his secrets to investing (Part 1)
- Building a high return portfolio with index funds – a step-by-step approach
- Complete SIP Investment Guide (over 8000 words compedium updated until 2020)
- The trillion dollar index fund story that John Bogle started in the 1970s
- Best SIP for achieving long term goals