In a previous article, we have discussed why term plans are best choices in life insurance (please refer to our article Taking term plan can be a smart Insurance choice). A term plan is the purest form of insurance and is a straightforward protection policy. The premium of term insurance plans is much less than other types of insurance plans, and it leaves the policy holders with a much larger investible surplus that they can invest in investment products like mutual funds that give much higher returns in the long term compared to endowment or money back plans. In this article, we will discuss some important steps that insurance buyers should go through, in order to a select the right term insurance plan for them.
1. Choosing the right insurance company: This is the most important consideration in buying an insurance policy. Insurance buyers in India instinctively like to buy policies that are cheaper (lower premium to cover ratios). However, it is very important to note that, a cheaper policy is no good, if the life insurance company for some reason or another cannot fulfil the claim in the event of an untimely death. Even if the life insurer fulfils the claim, if it takes a very long time to fulfil the claim it is certainly not a desirable situation for family of the insured to be in. There are three important metrics, which insurance buyers need to look at while selecting a life insurance provider.
- Claims Settlement Ratio: This is the single most important metric to consider when choosing a life insurance provider. The metric tells us how many insurance claims were made to the insurer in a financial year and how many were fulfilled or paid, and gives you a broad sense of the probability that your insurance claim will be paid. This metric is critical in determining the reliability of the life insurance company.
- Duration wise settlement of death claims: This is the second most important metric in choosing a life insurance provider. Duration wise settlements of death claims help insurance buyers evaluate the efficiency of the claims settlement process. Higher the percentage of claims settled in the quickest possible time, the better is the experience for the family of the insured, in the event of an untimely death of the insured.
- Solvency Ratio: Solvency measures the ability of the insurance companies to pay the death claims. It is calculated as a ratio of assets of insurance company to its liabilities. An insurer is insolvent, if its assets are not adequate or cannot be disposed of in time, to pay the claims arising. IRDA ensures that the Indian insurance companies have adequate solvency. Therefore, insurance buyers should feel assured that all insurance companies have the financial capacity to honour their obligation, should a claim arise.
Data on the above three metrics for all the insurance companies in India is available in the IRDA annual report. For more details on how to choose a life insurance provider, please refer to our article, How to choose a Life Insurance provider.
2. Choosing the adequate amount of cover: A large part of choosing a life insurance policy is determining how much money your dependents will need. Some financial advisers suggest a cover (also known as sum assured) of 10 – 12 times of the annual income. However, insurance buyers should note that this is only a thumb rule, often a legacy of the times when insurance agents mostly sold traditional plans (they still do), and the premiums for a high sum assured in these plans are unaffordable for average insurance buyers. Such thumb rules ignore the financial situation of the insurance buyers and may leave them under insured. Insurance buyers need to consider several factors in deciding how much insurance cover is adequate for them. The insurance cover, also known as sum assured, should be adequate to cover the following:-
- Repayment of the entire outstanding debt (e.g. home loan, car loan etc.) of the policy holder
- After debt repayment, the insurance cover should have surplus funds to generate enough monthly income to cover all the living expenses of the dependents of the policy holder, factoring in inflation.
- After debt repayment and generating monthly income, the insurance cover should also be adequate to meet future obligations of the policy holder, like children’s education, marriage etc.
For more details on determining the amount of life insurance cover, please refer to our article, How much life insurance is adequate. Insurance buyers should note that, premiums of term insurance plans are many times lower premiums of traditional plans. For a reasonable premium amount, term insurance policy holders can buy adequate cover for their dependents. Depending upon the life insurance company and the mode of purchase (online or through an agent), the term insurance premium for Rs 50 lakhs sum assured could be as low as Rs 6000 – 7000.
3. Choosing the term or time period of the plan: This is another critical consideration in buying a term insurance plan. As a general rule, you should have life insurance for as long as you are working and supporting your family. Life insurance companies offer term plans for fixed tenures of 15, 20, 25 and 30 years. Some insurance companies also offer 35 or 40 year terms. The premiums of the term plans increase with tenures. Young insurance buyers may be tempted to buy term plans with lower tenures to save premium. But this is not a wise strategy. Mortality risks increases with age and therefore the term plans should cover the insurance buyers at an age, when they more vulnerable to health issues. For example, if a 25 year old buys a term plan of 15 years instead of 30 years, he will save on premium, but his term insurance policy will expire by the time he is 40, at a time when his health risks are much higher. If he buys a 20 year term plan when he is 40 to cover him till retirement, the premium will be much higher. Therefore, it makes more economical sense, especially for young life insurance buyers, to buy term policies for the maximum tenure possible.
4. Compare premiums of different plans: As discussed, earlier in the article, people often think that lowest premium is the single most important criterion in selecting a life insurance plan. However, the first three steps described above are much more important. You should shortlist insurance plans based on the first three steps, and then take compare quotes from multiple life insurance providers to select a plan with the lowest premiums. Insurance buyers are sometimes tempted to opt for return of premium plans. They should do a cost benefit analysis of the higher premium paid, versus the inflation adjusted value of the premium returned on maturity of the policy. In my opinion, in most cases, the inflation adjusted value of the premium returned on the maturity of the policy do not justify the much higher premiums paid during the term of the policy.
5. Choose premium payment option: Life insurance companies offer flexible premium payment options, e.g. yearly, half-yearly, quarterly or monthly. In some cases, half yearly payment option may be slightly more expensive than yearly payment option. You should choose an option, which is most convenient for you. Our lives are getting busier every day. Whatever option you choose, it is very important that you pay the premiums on time. Most companies also offer a single payment option. However, this means that your premiums are front loaded. In case of early death, the premium for the rest of the term goes waste. In a regular plan, the buyer gets the same insurance benefit by paying far less.
6. Go for Medical Test: Most life insurance companies require medical tests to be performed prior to issuing a term insurance policy. Some insurance companies, like ICICI Prudential, offer both kinds of plans, one that requires medical tests and the other that does not. However, it is prudent to undergo a medical test, so that the one can avoid issues arising out claim rejection on medical grounds. Also, it is better to disclose habits like smoking or drinking (if applicable) and family medical history (if applicable) upfront, rather facing issues with claims later.
Term insurance is the purest form of life insurance. It is widely recommended that a term insurance policy should be an insurance buyer’s first insurance policy. If you choose the right term insurance policy, based on the 6 steps described in this article, you will take a big step forward as far as your long term financial planning is concerned.