Different Types of Term Life Insurance
2016-06-22 15:59:00 UTC
We have previously discussed the various types of life insurance covers including term life and explained that term life is the best life insurance option for most people. The market today has various sub-classifications when it comes to term life products, and here in this post we take a detailed look at term life policies and their variants..
Term insurance is the cheapest way to get a substantial life cover especially for people with limited means and is the most popular pure life cover in the market.
Term life policies are just plain life insurance: if you outlive the term of the policy, the policy just terminates. If you don’t, then your beneficiary gets paid the agreed sum assured. The tenure of a term life policy is generally between 5 and 35 years but can vary from insurer to insurer, and with policyholder age. Premiums also get more expensive as you get older.
Why Term Life cover is good for you
Lower premiums and simple death benefits are the USPs of term life insurance with no investment returns or cash value involved. Term insurance is appropriate for an individual with moderate earnings, especially when he or she needs a large death cover for a specific period at the lowest possible cost. It helps secure the financial future of his or her dependents.
Let us look at specific examples where term life plans may be more beneficial than any other plan.
Safeguard against liabilities for some specific range of time:
- – a life insurance payout may well allow your family to pay off any pending loans, meet your financial obligations, and maintain their standard of living.
Secure your family
- – a life insurance payout possibly will provide for the dependents, while the children are growing up and allow them to cope with the loss of family income. The plan covers the policyholder while his children are still financially dependent and are studying full time.
Keep Insurance and investments separate
- Keep Insurance and investments separate</a>– Term insurance is suitable for those who do not wish to save through insurance policies that have some investment component embedded in them. If you want to keep your insurance and investments separate, it makes sense to buy term insurance for death cover and invest your considerable premium savings in mutual funds, PPF, ELSS and stocks, etc. This approach is substantially more rewarding.
What are the costs involved?
Term life is cost effective compared to other life insurance covers. Many term insurance plans provide the following add-on options called ‘riders’ at a marginal additional cost.
Tax benefit on the insurance premiums
- Premiums paid are exempt from tax up to a maximum of Rs 1 lakh under Section 80C of the Income Tax Act, 1961.
- Payout from a Term Insurance plan to the beneficiaries is tax free under Section 10 (10D) of the Income Tax Act.
What are the variants in term plans?
Due to the popularity of term life plans, insurers have introduced many variants in term life plans in recent times.
Variants based on death benefit value
Level Term Plan:
- Level term means that the death benefit stays the same throughout the duration of the policy, which means this is a “business as usual” kind of term plan. If you stop paying premiums during the term for whatever reason, the policy lapses automatically. More than 95% of term life policies sold are level term policies.
Decreasing term plan:
- In this plan, the death benefit drops over the course of the policy’s term. This is a good solution especially for those who want a cover for a specific exposure, such as an outstanding housing loan via their term life policy. In the initial years of housing loan repayment, the interest component of the EMI is very high and the principal amount only reduces gradually over time. Therefore, by choosing a reducing cover policy, all you are doing is accounting for your increased loan liability in initial years and reduced liability ( when the loan is substantially paid) in later years of your term plan. The premium for this plan is lower than level term plan and that certainly makes it a cost effective way of covering a specific risk. However, if your objective is not to buy a cover for a specific debt or loan, choosing a decreasing term plan does not make sense, as the time value of money must be taken into consideration. At current interest rates of say around 8%, a sum of ₹50 lacs 10, 15 and 20 years from now is worth only 23, 16 and 11 lacs respectively in today’s money when adjusted for inflation. So opting for a decreasing term plan will make the real value of the payout in future insignificant and worthless unless you have a specific reason.
Increasing term plan:
- In this plan, the death benefit increases progressively up to 1.5 times over the course of the policy’s term. This is a good option for young people around 30 years of age. Typically, your liabilities increase later in life when you have college going kids or kids of marriageable age and by opting for an increasing term plan, you can account for this increased responsibility and liability. In addition, as mentioned previously, you may also want to take into consideration the real value of payout in the future in today’s terms. However, the premium for this policy is higher than level term plan.
Term Return of Premium plan (TRoP)
This plan is identical to the level term plan except that the entire premium paid is returned at the end of the term. Term life plans are extremely popular with people and this variation is therefore an attempt by insurers to entice customers with a plan that at face value sounds too good to be true. True, the numerical value of the premium returned may be the same as the premium paid but that tells only a part of the story.
The annual premium for a 20 year plan for a 30 year old non-smoker for a sum assured of ₹50 lacs is around ₹ 3,670, whereas, for a TRoP the annual premium is about ₹ 11,345. This difference in annual premium of ₹ 7,675 is worth ₹ 336,665 in 20 years at 7% annually compounded rate , but the premium returned in TROP is only ₹226,900.
This is therefore not an attractive plan, unless you are extremely pessimistic about returns on your investment.
Convertible Term Insurance Plans
A convertible term plan provides the policyholder the flexibility to switch to a whole life assurance plan or an endowment policy during the term of the plan. Conversion plans are for those who want to defer their decision on which type of life insurance they want to have to a later time. Do read the terms well, as cost of switching will vary depending on when you switch.
Single Life and Joint Life Term Insurance Plans
In most modern urban Indian households, both spouses earn a salary. Therefore, to safeguard the financial well-being of the family, it is best for both husband and wife to be insured. Independent life insurance coverage for a couple can be significantly more expensive compared to a joint life term policy, which provides protection at a fraction of the cost of two independent policies. Except in extraordinary circumstances, the insurance company will only have to pay out one death benefit, which is why the cost is low for joint term life insurance.
Joint term life plan, will pay a death benefit upon the demise of either insured party. The death benefit will be paid to the surviving spouse, who can use the payout to meet the family’s financial obligations. If both partners die at the same time, the beneficiaries of the joint life term policy will receive a full death benefit for each individual’s death. However, it is a good idea to read the policy fine print to know the terms and conditions of such a policy.
Variants in terms Premium Payment frequency
Regular Premium term plans
Where a fixed premium is paid either monthly, half-yearly or annually. This is the most recommended plan as the premium paid fetches you yearly income tax breaks.
Single Premium term plans
One time premium payment i.e. one large premium is paid. If an individual is buying a term life plan at the age of 30, it is hard to imagine someone being able to pay the whole premium in a single installment. Currently only a premium of up to 1 lac/ year is exempt from tax and spreading the premium payment over the years makes sense to avail this tax benefit.
Variants in terms of death benefit payout
Death benefit payout in Lump Sum–
- This is a “business as usual” plan where the sum assured is paid immediately after the death of the policyholder. This is the most popular and recommended plan as it helps the dependents of the policyholder to pay off the housing loan and meet his immediate financial obligations. Most people would opt for this option over others.
Death benefit payment in installments–
- Where the sum assured is paid in equal installments over a certain period upon claim settlement.
However, there are other variants, which are essentially a combination of the above two, where a certain amount of money is paid up front and the rest in installments.
Offline and Online Term Insurance Plans
It’s important to understand the difference between online and offline plans. Offline plans are those that are sold through agents and other traditional insurance channels, while the online plan is self-explanatory and obviously sold through online channels. Online plans are substantially cheaper than offline term plans that offer the same benefits (in some cases by as much as 30-40%). The absence of many intermediaries in online medium makes such plans cost effective.
In addition, agents tend to push plans from a particular insurer whereas online you have access to all the insurers. Historically, insurance agents have always favoured whole life and income plans over term life plans, but as we have said before, a simple term life plan is the only one most people will ever need and therefore when you buy online, you also avoid being mis-sold policies.