2016-06-02 16:23:00 UTC
Life insurance financially protects your dependents in the event of your death before you build a significant net worth. You definitely need adequate assets and savings, so that your family can pay off any existing loans and maintain their standard of living, even with the loss of a breadwinner.
However, as we have seen in previous articles, there are various insurance options and widely varying premiums to pay, which makes the job of deciding what sort of life cover to buy a difficult choice. In today’s post, we make the decision process easier for you, by actually doing the math.
The rest of this post compares the benefits of term life vs other life insurance covers. This is done with a view to calculate the benefits provided by all the different types of plans, so as to make clear to the reader what he/she should expect from various plans. Let’s get started:
Term Life Insurance: As we have already seen term life is a life insurance policy that covers only a specific term(ie. duration) in return for a constant annual premium over the covered term.
Let us take the example of a 30 year old, male, non smoker, can have premiums as low as ₹4500 per annum( ₹4695 inclusive of all taxes) for a 20 year term policy for a life cover of ₹50 lacs.
Whole Life Insurance: Whole life is similar to a term insurance product that covers you until death; ie your entire life is the term of the policy. For a 30-year-old male, premiums can be as high as ₹2,92,000 per annum for a life cover of ₹50 lacs.
Whole life insurance is a more complicated product than term life insurance. Whole life guarantees an insurance payout and, over time, the policies accrue a cash value. Let us look at the whole policy mentioned above in more details.
generic whole life plan
* Simple non-guaranteed reversionary bonus accrued during premium payment term is payable as lump sum at the end of the premium payment term i.e. after 20 years as indicated in policy brochure, although no definitive sums are mentioned or guaranteed. Further, after 20 years, Cash Bonus is payable at the end of each year until end of the policy term (until 99 years of age), death, or surrender whichever is earlier. Here again no figures are mentioned. To be fair, it is impossible for insurers to stick their neck out and make predictions about payments that far into the future, as the interest rates and inflation pay a major role in such calculations.
To understand the difference between the two policies, we analyse the returns(tabulated below). The analysis shows what would occur if you took the difference in premiums between the whole life insurance policy and a term life insurance policy and invested it.
We can then estimate the ultimate value of saved premiums and compare with the expected returns of the whole life product over the same period. Public Provident Fund( PPF) investments up to ₹1,50,000 per annum are exempt from tax, as are Equity Linked Savings Schemes (ELSS) investments and life insurance premiums.
PPF fetches a return of 8.1% (annually compounded rate) today and assuming the interest rates change over the 20 year period, let us use a conservative 6% or 7% instead for calculating the returns from both PPF/ELSS investments.
comparison of returns of whole life policy vs term life(if you invested the difference)
** computed at 40% of the premiums paid in 20 years. Note that even 100% premium return amounts to only ₹58.4 lacs ,which is still much lower than the returns from investing the difference approach at 6% .
If you invested the difference between the two premiums in PPF and ELSS based on average risk appetite , you would expect the difference in premiums to grow to at least ₹ 1,14,65,626 over 20 years . This represents a significantly higher value over a whole life policy‘s expected bonus at the same point in time even at 100% premium return. In this example – which we developed using a typical term life premium and a premier life plan quote, after 20 years the expected returns of the whole life policy is around 40% of the premiums paid( These amounts are not guaranteed; this is the inference we could draw from the illustration in the brochure).
Whole life insurance pays out a death benefit whenever you die; term life only pays if you die during the term(which is 20 years in this example). Therefore, let us take into consideration the death benefit payout , which is a certainty with whole life.
Assume you die immediately after the expiry of your term life policy, you would not have got any death benefit from your term life plan, but will get a payout of ₹50 lacs from the whole life policy. If you add this to the return of 40% premium, the returns still favour the ‘investing the difference’ approach i.e ₹74 lacs ( 50+23.36 ) for whole life versus ₹1.15 crores for investing the difference approach.
Note that even if 100% of the premium is returned , whole life insurance is still not favourable. Unfortunately, this is the best-case scenario for whole life plan in the comparison with term life.
Suppose you live longer up to say 60, 70 or 80 years. The sum assured is still the same, but the whole life plan offers additional bonus payments every year until death. You can evaluate the value of future death(at age 60, 70 or 80) benefit payouts at age 50 to make a comparison with term life possible.
As you can see from the table, a death benefit of 50 lacs 30 years later when adjusted for inflation is equivalent to only ₹8.7 lacs at age 50.
Even with the yearly bonus payments promised( but not guaranteed) between end of premium payment and death, the whole life policy is not even close to returns from a term life plan and invest the difference approach. Also, remember the sum of money you have from investing the difference approach, ₹ 1.15 crores will earn even more interest until your death to make the whole life plan particularly unattractive by comparison.
Therefore, as you live longer and longer, term life plan becomes even more attractive and the choice is almost a no brainer.
The difference in the ultimate value of the two policies is possibly due to the substantial hidden policy administration charges and incentives to agents.
So that proves that term life is better for your finances than whole life. Let us compare term life with another type of life insurance now.
Term Life plan: For a 30 year old male, non smoker annual premiums are around ₹3500 ( ₹3600 inclusive of cess and service tax) for a 25 year term policy for a life cover of ₹25 lacs.
ULIP plan: For a 30-year-old male, ULIP premiums are ₹1, 00,000 per annum ( actually ₹ 1,02,000 if you add cess and service tax) for a life cover of ₹25 lacs.
term life vs ULIP comparison of returns
* The difference in premium is invested in PPF with the same tax benefits.
** The expected returns from ULIP is between circa ₹ 33 lacs and ₹63 lacs as indicated in product brochure and the returns are compared at both lower and higher ends.
In the example above, again investing the difference strategy proves beneficial, especially if the returns from ULIP are around the lower bracket of ₹33 lacs. Even at the higher end, it is still lower than the money you make investing the difference in premium between the two plans based on a conservative 7% annual compounded rate.
This probably means the life insurance and other administrative costs in a Unit Linked insurance plan are significantly higher than simple term plans and this should be factored in the decision making process.
It should also be recognized that when you invest your money in PPF, ELSS, mutual funds or fixed deposits, the entire sum is invested, but insurance premiums are subject to service tax every year and the service tax for the first year is higher than the subsequent years. This can affect your overall returns over time, as 2-3% of the annual payment into a ULIP plan is lost in taxes.
Over the years , ULIPs don’t have a consistent track record and have more often than not provided returns closer to the lower projections i.e 33 lacs in the above example and you must certainly set the bar of expectations pretty low if you are shopping for a Unit Linked insurance plan( ULIP)
Nowadays, with attractive term life plans available online, it makes sense to evaluate your needs and choose an appropriate policy that suits your needs.
Insurance sellers( in some cases, banks themselves) will often direct you to a whole life, endowment or ULIP cover, for various reasons, chief among them higher commissions. But in today’s age, where even investments are just a click away, it makes a lot more financial sense to get a term life policy to provide you pure insurance cover, and maintain PPF/ELSS investments to grow your money, and provide yourself that extra financial security.
The above illustrations have some limitations, as the returns from whole life plans or ULIP plans are not guaranteed or documented to make a like for like comparison with term life plans possible. Nevertheless, our numbers show enough evidence to point us in the right direction; and that is term life.