How to Select the Right Term Insurance Plan?

Posted by Jenny Dsouza on December 3rd, 2016

If you are reading this article, first off, I must congratulate you. It seems you are almost sure about buying an insurance policy; and it's icing on the cake that you are planning to opt for the term insurance plans. You are sailing in the right direction. You care for your family and want to ensure that your loved ones live in peace even in your absence. However, your job is still half done.

As you know, we live in an age of options. Whether you are shopping for clothes or insurance, you get multiple options. Can you imagine yourself buying a pair of Kurti-leggings or a T-shirt and Jeans before visiting at least 3-4 shops or a couple of e-commerce websites? Very unlikely.

Even insurance companies provide you a number of options not only across categories but also within categories. Therefore, you have term insurance policies, endowment policies, whole life policies and money back policies and so on. As remains the question of providing options within the category; there are many variations. For example, term insurance plans have a few versions these days which include; level term insurance, increasing term insurance, decreasing term insurance, return of premium term insurance, joint life term insurance plans and there are a few more as well.

Your aim should be to cover yourself with adequate amount of insurance and save as much on premium as you can without compromising on your needs.

Rule of thumb

You might be inclined to use the rule of thumb which says you should opt for a cover worth 10-15 times of your annual pay. Suppose you earn Rs 10 lakh a year and have no other term insurance plans policy you may buy an insurance policy with the sum assured of Rs 1 crore to Rs 1.5 crore. But what's a thumb rule, remains a thumb rule; you should use more refined methods to gauge your insurance needs.

Example:

A thirty-three year old Chartered Accountant, Amit Kumar Banerjee works with an FMCG company and earns about a lakh of rupees per month. If he applies the rule of thumb and buys insurance equaling his 10 years of pay, he would need an insurance cover of Rs 1.2 crore and if he decides to be more conservative and goes for a cover equivalent to 15 times of his annual pay, he would need a cover of Rs 1.8 crore.

Amit is planning to take up a home loan worth Rs 50 lakh and has an existing portfolio of investments worth Rs 5 lakh. He is married to Aabha, who is a housewife. She just celebrated her 30th birthday. Amit wants to buy an insurance policy and has several options. Let's consider them one by one

Decreasing Term Insurance Plans

He may go with decreasing term insurance plans in which the amount of cover decreases every year, let's say, by 5% (basically at the pre-determined rate).

Premium on this policy would be cheaper. But if you have noticed, the rule of thumb didn't consider the loan of Rs 50 lakh. It just accounted for 10-15 years of income replacement. Hence, for Amit, buying decreasing insurance would be a double blow. First, insurance cover would decrease every year and in case if something happens to him during the policy term; his surviving wife would get inadequate compensation. Please don't forget the lending bank. It will also have a claim in the policy equaling to the outstanding loan amount and interest thereon.

This clearly indicates that, buying decreasing term insurance plans won't help Amit. Decreasing insurance option expects the policy buyer to build a sound portfolio of investments over the years to make good the fall in the life cover. Had it been a case where Amit already had an insurance policy and needed an additional one to cover his loan; decreasing term insurance would have served the purpose.

Increasing Term Insurance

Let's check if increasing term insurance on the other hand suits him. He still doesn't have a child, but sooner or later he may want to have. He would then have to ensure that, not only his wife but also the depending children don't suffer in his absence. And then he would have a loan too. As far as that is concerned, he will have to lien the policy with the lender and in case of any unfortunate event, the lender would be the first one to get the claim for outstanding loan amount. In this case his cover of 1.2 crore (10 year's income replacement) or worth Rs 1.8 crore (15 years of income replacement) would keep increasing at say 5% every year throughout the policy tenure.

Increasing term insurance cover may be adequate enough for Amit's wife even after accounting for inflation and loan repayment. But usually the premium on this policy may be higher than that on the decreasing or level term insurance plan.

Source: https://www.booninsurance.com/term/How-to-Select-the-Right-Term-Insurance-Plan/6