10 April, 2009

Term insurance provides the cheapest form of life cover for policyholders. Financial planners have been stressing on this point so that an insurance seeker can keep their investments and insurance separate. And while many have recently woken up this fact, the strategy used may still require some tweaking. The way one structures life insurance requirements through term plans, can ensure that they pay lesser premiums without any reduction in their life cover requirements. Let us look at how this could be done.


Typically, as the number of years in a policy passes by, the need for insurance goes down. That is because, the income that needs to be covered keeps reducing with every passing year. This means that the insurance requirements would have reduced in the next year, on survival. 

Also, savings and asset buildup may have taken place in that year, which again decreases the risk exposure to the family.  As the number of years of life cover required reduces. Simultaneously, there is asset buildup and savings which happens in this period, which reduces the need for insurance. Since insurance is a tool to cover the risk financially, the cover requirement keeps coming down, year-on-year, as the residual present value of future potential earnings, keeps coming down.

One of the important facets of term insurance policy is that the premiums go up as the number of years increase. This is unlike any other policy where it goes down – that is, higher the term, lower the premium. If you were to look at the table, this will become clear. Let us say Manish wants to take a 20 Lakh cover. For the same cover, Manish needs to pay Rs.6,313/- for a 5 year term, Rs.6,776/- for a 20 year term and Rs.8,097/- for 25 year term. This is because the mortality charges go up year on year. The longer the term, the higher will be the average charges for all the years covered.  In an Endowment or a money back policy, the longer tenure policies have lower premiums as the life cover itself in the policies are low and bulk of it goes for investment. The longer the client pays, the more beneficial it is in these policies.

Given these facts, it makes sense to split your life insurance needs by buying a number of policies instead of just one. Let us understand this with an example. If one requires an insurance cover of Rs 1 crore for 25 years, the same policy could be split into, say, 5 policies of Rs 20 lakhs each with terms like 5,10,15,20,25.  This way, there will be two advantages.

First, after completion of the period, the premium for that policy stops, boosting cash flows. In this example, after 5 years, the first policy would stop and consequently, that premium need not be paid. Secondly, since these polices are of shorter tenure, the policy holder will be paying lower premiums as well.  This is a double benefit that can make a huge difference in the premium, without compromising on the protection requirement.

Let us take the case of Manish, who is 33 years old. Suppose, he takes a Rs 1 crore policy for 25 years, the premium for ICICI Pru Lifeguard (WROP) comes to Rs 35,991 a year. However, if he splits the policy into five of 5/10/15/20/25 year terms, he will pay a total premium of Rs 33,812 a year (see table ) which is a difference of Rs 2,179 per year.

Now after 5 years, one policy would have ended and a premium of Rs 6,313 would not have to be paid. Over time, one policy after another will keep on closing and premiums to be paid becomes less and less. If we were to calculate the premiums in the first scenario where he takes one policy of Rs 1 crore for 25 years, he would pay a premium of Rs 8,99,775 (Rs 9 lakh) over that time period.

In the other scenario, where he takes five different policies, he will be paying in all, Rs 5,27,335 (Rs 5.27 lakh). That is a staggering difference of Rs 3,72,440 (Rs 3.72 lakh). This is without compromising on the life cover requirements.  It does make sense to have a clutch of policies with different terms, doesn’t it? 

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