11 June, 2010

You can save money, by splitting term plans

When an individual is working, the family is secured by the investments made, assets built and insurances taken by the income earner. These are the three pillars of security for the family. In the early stages, investments and assets may be rather low and insurance is the only available alternative to prop up the security cover requirement. But, insurance costs money. Most people are not happy to put money especially in term insurance, as it does not give any returns.
At this point, Manav was incredulous. “If I’m not going to get anything at all, is it not a waste of money ?”, hissed Manav through his teeth at the insurance agent who was trying hard to explain. I was quiet as I wanted this to play out. Shailendra, the agent, was explaining the concept of Human Life Value. “ A Human being is invaluable. However, based on the income earning potential of the person to the family, there is a financial value that can be assigned to a person. That can be the present value of all future income he is going to earn”, Shailendra was saying. “ Future income ofcourse has to be projected approximately and major increases in salary can increase the present value of the future income”, he said. Manav was lost. He was nodding ofcourse, but from the faraway look in his eyes, he could have been in New York!
I chipped in.” We can just say that if you have some corpus that will grow at a certain interest, it will be equal to your income stream in the future”. After saying this I realized that I was also not being very lucid. In a spark of inspiration, I ventured to take an analogy and explain. “ Suppose you put in Rs.100 in the bank at 8%, you would get Rs.108 after a year, right? So, we can also say that Rs.100/- today has the same value as Rs.108/-, one year hence. Rs.100 is the present value and Rs.108 is the future value. What Shailendra means by present value of your income is, what is the value today of the future money”, I said hoping to unravel the mystery for Manav.
Manav had clearly moved on. “I want to pay as low an amount as possible, if I’m not going to get anything back”, he said. Shailendra started explaining the benefits of a term policy and how it is extremely low-cost etc. I was able to sense again that Manav was not absorbing that. There was another thing that he needed to know.
There is a way of structuring a policy such that your premium outgo, even in a term policy is minimized, without any reduction in their life cover requirements. Let us look at how this could be done.
Normally, as the number of years in a policy goes by, the need for insurance comes 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 every year, on survival.
Also, savings and asset buildup would have taken place over the years which again decreases the risk of exposure to the family and the need for insurance cover. 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. Hence, one will require lesser and lesser cover, going forward.

One of the important facets of term insurance policy is that the premiums go up as the number of years increase. This is unlike in 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 Manav wants to take a 50 Lakh cover. For the same cover, Manish needs to pay Rs.9,707/- for a 10 year term, Rs.11,182/- for a 15 year term and Rs.13,093/- for 20 year term, in case of ICICI Prulife Pure protect policy. 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.

Company Plan Sum Assured Term Premium
ICICI Prulife Pure Protect Elite 50 Lakhs 10 9,707
ICICI Prulife Pure Protect Elite 50 Lakhs 15 11,182
ICICI Prulife Pure Protect Elite 50 Lakhs 20 13,093
ICICI Prulife Pure Protect Elite 50 Lakhs 25 15,277
BSLI HNWT-NS 50 Lakhs 10 9,320
BSLI HNWT-NS 50 Lakhs 15 10,643
BSLI HNWT-NS 50 Lakhs 20 13,070
BSLI HNWT-NS 50 Lakhs 25 15,497

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 1.5 crores for 20 years, the same policy could be split into, say, 3 policies of Rs 50 lakhs each with terms like 10,15,20. The point to understand is that Rs.1.5 Crores cover will not be needed for the entire 20 years, if you were to work out and may be required only in the initial few years. 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 10 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.
In Manav’s case who is 35 years old, suppose he takes a Rs 1.5 crore policy for 20 years, the premium for ICICI Pru pure protect comes to Rs 39,279/- pa. However, if he splits the policy into three of 10/15/20 year terms, he will pay a total premium of Rs 33,982 pa (see table ) which is a difference of Rs 5,297/- pa.
Now after 10 years, one policy would have ended and a premium of Rs 9,707 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 1.5 crore for 20 years, he would pay a premium of Rs 7,85,580/- over that time period.
In the other scenario, where he takes three different policies, he will be paying in all, Rs 5,26,660/-. That is a staggering difference of Rs 2,58,920/-, over the period. 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?
Manav was happy to note the huge savings that would be possible. He was smiling now. He even patted Shailendra on the back. I winked at Shailendra. Shrewd as he was, Shailendra was on his way to the exit. Even from behind it was apparent, he was smiling from ear to ear.

Published in Money Mantra , March 2010

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