Planning for term insurance is a crucial step in securing your family's financial future, especially in the face of unforeseen circumstances. When considering term insurance in India, there are several factors to consider, pitfalls to avoid, and best practices to follow. Let's break down each aspect of your query to give you a comprehensive understanding.
Factors to Consider
Coverage Amount
Determine how much coverage you need based on your family's financial needs, your income, liabilities, and future obligations (like children's education).
Example Scenario: ABC is a 35-year-old IT professional earning ₹12,00,000 annually. He has two children aged 5 and 8 and a home loan with a remaining balance of ₹40,00,000. He wants to ensure his family maintains their lifestyle, covers the children's education up to undergraduate studies, and pays off the home loan in case of his untimely demise.
Annual Income: ₹12,00,000
Liabilities: ₹40,00,000 (Home Loan)
Future Obligations: Children's education estimated at ₹20,00,000 for both.
Coverage Amount Calculation:
Income Replacement: 10 times the annual income = ₹1,20,00,000
Liabilities: ₹40,00,000
Future Obligations: ₹20,00,000
Total Coverage Needed: ₹1,80,00,000
ABC should consider a term insurance policy with a coverage amount of at least ₹1,80,00,000.
Policy Term
The duration of the policy should cover the period until which you expect to have financial dependents.
Example Scenario: XYZ, a 30-year-old entrepreneur with a newborn, wants to ensure her child’s financial security.
Financial Dependence:Â She expects her child to be financially independent by 25.
Current Age:Â 30
Child's Age:Â 0
Policy Term Calculation:
Priya needs the policy to cover her until her child turns 25, which is in 25 years.
Policy Term Needed:Â 25 years
XYZ should look for a term insurance policy with a duration of at least 25 years.
Premium Payment Term
Decide whether you want to pay the premium for the entire policy term or prefer a limited payment term.
Example Scenario:Â ABC prefers to pay premiums while he is working and not worry about them after retirement.
Current Age:Â 40
Retirement Age:Â 60
Policy Term:Â 30 years (until ABC is 70)
Premium Payment Term Decision:
ABC can choose a limited premium payment term of 20 years to ensure all premiums are paid before retirement while being covered until 70.
Claim Settlement Ratio
Look at the insurer's claim settlement ratio, which indicates the proportion of claims settled by the insurer.
Example Scenario:Â XYZ is comparing two insurers for her term insurance needs. Insurer A has a claim settlement ratio of 98%, while Insurer B has a ratio of 92%.
Decision:Â Given the higher likelihood of claim settlement, Neeta leans towards Insurer A for her term insurance, assuming other factors like coverage and premium are comparable.
Insurer’s Reputation
Consider the insurer’s financial health, customer service, and the ease of the claim process.
Example Scenario:Â ABC is choosing between two insurers; one is a well-known company with excellent customer reviews, particularly regarding ease of claim processing. The other is less well-known with mixed reviews.
Decision:Â ABC decides to go with the well-known insurer with positive reviews, valuing peace of mind and reliability over potentially lower premiums from the lesser-known insurer.
Pitfalls to Avoid
Underinsuring
Opting for a lower coverage amount to save on premiums can leave your family financially vulnerable.
Example Scenario: ABC decides to purchase a term insurance policy with a sum assured of ₹50,00,000, aiming to save on premium costs. Her annual income is ₹15,00,000. She has a mortgage and two children to support.
Outcome:Â Unfortunately, ABC passed away unexpectedly. Her coverage amount wasn't enough to cover the mortgage, provide for her children's education, and support her family's daily living expenses for the long term. Her family had to make significant lifestyle adjustments and take on debt to manage financial obligations.
Ignoring Inflation
The coverage amount should factor in inflation to ensure that the future financial needs of your family are adequately met.
Example Scenario: XYZ secures a term insurance policy with a sum assured of ₹1 crore, believing it to be sufficient for his family's future needs based on their current lifestyle and expenses.
Outcome: 20 years later, due to an average inflation rate of 6% per annum, the purchasing power of ₹1 crore significantly diminished. When XYZ passed away, his family found that the sum assured could not cover their living expenses, children's higher education, and other future financial goals as intended. The family had to compromise on their standard of living and future plans.
Not Disclosing Medical History
Failing to disclose your medical history accurately can lead to claim rejection.
Example Scenario:Â ABC, while applying for a term insurance policy, decided not to disclose his pre-existing condition of hypertension, fearing it might increase his premium or lead to policy rejection.
Outcome:Â A few years later, ABC suffered a heart attack and passed away. During the claim process, the insurance company investigated and discovered his undisclosed medical condition. Citing non-disclosure, the insurer rejected the claim, leaving ABC's family without the financial safety net he intended to provide, facing financial difficulties during an already challenging time.
Popular Providers and Plans
Some of the popular term insurance providers in India include:
LIC (Life Insurance Corporation of India)
HDFC Life
ICICI Prudential
SBI Life
Max Life
Each of these insurers offers various term insurance plans with different features and benefits. It's important to compare these plans based on your specific needs.
Calculating the Right Insurance Plan
A general rule of thumb is to have a coverage amount that is 10 to 15 times your annual income. However, this can vary based on your liabilities, lifestyle, and the number of dependents. Online insurance calculators provided by insurers can help you estimate the right coverage amount.
By multiplying the annual income by 10 to 15 times, the policy aims to provide a sum that, when managed wisely, could support the family for a significant period, typically until major dependents become financially independent or significant liabilities are paid off.
Riders to Consider
Riders are additional benefits that you can add to your policy for extra protection. Popular riders include:
Critical Illness Rider
Provides a lump sum amount if diagnosed with a critical illness.
Example Scenario:Â ABC, a 40-year-old software developer, has a term insurance policy with a critical illness rider. Two years into the policy, she is diagnosed with a severe heart condition that requires immediate and expensive treatment.
Critical Illness Rider Benefit:Â The rider is activated upon diagnosis, and ABC receives a lump sum payment. This amount can be used to cover her medical expenses, recovery costs, and any financial shortfall due to her inability to work during the treatment and recovery period.
Outcome:Â The financial support from the critical illness rider allows ABC to afford the best possible care without depleting her savings or compromising her family's financial security.
Accidental Death Benefit Rider
Additional sum assured in case of death due to an accident.
Example Scenario:Â XYZ, a 35-year-old entrepreneur, has a term insurance policy with an accidental death benefit rider. Tragically, he dies in a car accident three years after purchasing the policy.
Accidental Death Benefit Rider Activation:Â In addition to the base sum assured of his term insurance policy, XYZ's family receives an additional sum assured because his death resulted from an accident.
Outcome:Â The extra financial support provided by the accidental death benefit rider helps XYZ's family manage the sudden financial strain, ensuring their long-term financial goals remain on track despite the loss of XYZ's income.
Waiver of Premium Rider
Waives off future premiums in case of disability or critical illness.
Example Scenario:Â ABC, a 30-year-old teacher, has a term insurance policy with a waiver of premium rider. Five years into the policy term, ABC is diagnosed with a critical illness that leaves her permanently disabled and unable to continue working.
Waiver of Premium Rider Activation:Â Following her diagnosis and disability claim, the insurance company waives off all future premiums on her term insurance policy.
Outcome:Â Despite her inability to earn an income, ABC's life insurance coverage continues without the need for premium payments, ensuring her family is protected financially. This relieves ABC of the financial burden of continuing premium payments during a period of reduced income.
Best Practices
Review and Update Your Policy
Regularly review your policy to ensure it still meets your family's needs, especially after major life events.
Example Scenario: ABC and XYZ are a married couple with a 5-year-old son, PQR. When PQR was born, ABC purchased a term insurance policy with a coverage amount of ₹1 crore, believing it would be sufficient to support XYZ and PQR in case something happened to him. The policy also included critical illness and accidental death benefit riders.
Major Life Event:Â Five years later, ABC and XYZ are blessed with twins. Around the same time, ABC receives a significant promotion at work, leading to a substantial increase in his annual income. Recognizing these changes, ABC decides it's time to review his term insurance policy.
Review Process:
Increased Financial Responsibilities: With the addition of two more children, ABC understands that his financial responsibilities have increased significantly. The original sum assured of ₹1 crore might not be sufficient to support a larger family and cover future expenses such as education for three children.
Higher Income Level:Â ABC's promotion and increased income also mean he can afford a higher premium for increased coverage. Additionally, his lifestyle and that of his family have upgraded, necessitating a reassessment of how much financial support his family would need to maintain this new standard of living in his absence.
Policy Update:
After consulting with his insurance advisor, ABC decides to increase the sum assured of his term insurance policy to ₹2 crore to better reflect his family's current needs and lifestyle.
He also adds an education rider, ensuring that there will be enough funds specifically allocated for his children's education, should anything happen to him.
Lastly, ABC updates his policy's beneficiaries to include his twins, ensuring that the policy reflects his current family structure.
Outcome:Â By reviewing and updating his policy, ABC ensures that his term insurance coverage accurately reflects his family's needs and secures their financial future more effectively. This proactive step provides him peace of mind, knowing his growing family is well protected.
Compare Multiple Plans
Always compare different plans and read the fine print before making a decision.
Consider Online Policies
Online policies tend to be cheaper than their offline counterparts due to lower operational costs.
Modelling and Simulation
To give you an example of mathematical modeling and simulation for planning term insurance, let's do a simple calculation. Let's assume you want to determine the coverage amount considering future inflation.
Suppose:
Current annual expense: ₹5,00,000
Expected inflation rate: 6%
Number of years coverage needed: 20
Let's calculate the future value of annual expenses considering inflation and then determine the total coverage needed over the policy term.
Based on the calculation:
Your current annual expense is ₹5,00,000.
In 20 years, considering a 6% annual inflation rate, your annual expense would rise to approximately ₹16,03,568.
To maintain your family's current lifestyle for 20 years without your income, you would need total coverage of approximately ₹3,20,71,355.
This model simplifies the calculation by assuming expenses remain constant in real terms and does not factor in potential increases in income, changes in lifestyle, or the decreasing value of money due to inflation. It also does not account for any specific financial goals or liabilities. For a more personalized analysis, consider consulting a financial advisor who can incorporate a more complex model tailored to your specific situation, including investment returns, tax implications, and more dynamic changes in expenses and income over time.
Remember, the right term insurance plan and coverage amount depend on a comprehensive understanding of your financial situation and future needs. Take the time to evaluate your options carefully and consider seeking professional advice to make the best decision for you and your family. ​​