Understanding Term Insurance.
Term Insurance is the second most important component of personal finance (after Emergency fund).
Let us understand in detail what is Term Insurance.
Term Insurance is a type of insurance in which you pay a specific amount of money every year for a certain period and in case, you die because of any reason, be it disease or accident or anything, your family members get a huge amount of money.
Sounds simple or confusing? Or maybe too good to be true?
Let us break it down with an example.
Suppose you are a 35-year-old married man with a wife and 2 children. Your parents also live with you. You are the only earning member of your family and you work in a private company or maybe you own a small business or a shop or anything.
You buy term insurance from a company in which the rules are:
1) You will pay 20,000 rs every year (not per month) for the next 30 years (till the age of 65).
2) In case you die in these 30 years because of any reason, be it an accident or any disease or even suicide, your family will get 50 lakh rupees.
3) In case you do not die in these 30 years, your family will not get anything and the amount that you paid for 30 years (ie 20,000 rs every year for 30 years=6 lakhs), is wasted.
This is what Term insurance simply is.
Term Insurance is a product that you do not buy for yourself. It is a product that you buy for your family's wellbeing and backup, in case something happens to you.
Points to discuss:
1) What is the benefit of buying term insurance?
- The benefit of buying term insurance is that you buy a type of backup from the company that will only be given to your family in case you die. You must understand one thing. If you are alive, no matter how tough it gets, you will somehow manage your family's expenses and take care of their needs, no matter how much hard work you will have to do. Every person who has a family will agree that family comes first and well being of the family matters the most. So, till you are alive, you will take care of your family by working hard if you do not come from a rich background. But in case, you suddenly die because of any unforeseen event or reason, what will happen to your family? How will the family manage their expenses, education, hospital bills, etc?
This is where Term Insurance comes into play.
Suppose you are 35 years old man. You have a wife, 2 young children, and your parents. And you work in a company. Suppose at the age of 40, you die while coming from the office in a road accident or you die due to cancer, your family will depend on your savings or they will have to cut down their expenses or they will have to start working to manage their finances or they might have to ask others for financial help. But what if, in case you die, your family gets 50 lakh rupees from the bank?
Will that not be of great help to your family in such a scenario?
Money cannot compensate for life but money helps in bringing some comfort.
2) What are the actual rules?
The actual rules are simple:
a) While buying term insurance, you should mention honestly if you smoke or drink.
b) You should clearly and honestly tell your official age (the age mentioned in your certificates, aadhaar, etc).
c) You should clearly and honestly mention if you have any kind of disease or health issue or anything like that you had in the past.
Remember one thing, Term Insurance money is your backup plan for your family in case of your death. If you hide any information or give false information, your family will not get the money. Do not compromise on honestly providing all details as your family's well-being will depend on your honesty. For example, you smoke one cigarette a month, or maybe just one cigarette in the last 2 months. Still, while taking the policy, you have to mention that you smoke. Because when someone dies of any reason, the company does a lot of background checks to check if the person lied about any issue. If they find that you lied to them while taking the policy, then they will not pay the money to your family saying that you lied to them about your health conditions.
And in that case, your family will suffer ultimately.
3) Other important points to remember:
a) The premium (price) of term insurance increases with your age but once you buy the term insurance, it remains the same till the end. That means:
If you are 25 years old currently and you want to take term insurance of 50 lakhs for your family till your age of 65 years. So the price will be 12,000 per year.
Suppose you are currently 35 years old and you want to take term insurance of 50 lakhs for your family till your age of 65 years. So the price will be 15,000 rs per year.
If you are 45 years old currently and you want to take term insurance of 50 lakhs for your family till your age of 65 years. So the price will be 22,000 per year.
I hope you understood what I meant when I said-The premium (price) of term insurance increases with your age.
But once you take the insurance at any age, whatever premium is decided at that age will remain the same till the end. So suppose- you are currently 35 years old and you want to take term insurance of 50 lakhs for your family till your age of 65 years. So the price will be 15,000 rs per year. Now, till the age of 65 years, your premium will be 15,000 per year. It will not increase.
The important point to note is that in case you increase the amount or increase the end age, your premium also goes up. In case you smoke tobacco (cigarettes etc), your premium goes up. Let's understand with examples:
Suppose- you are currently 35 years old and you want to take term insurance of 50 lakhs for your family till your age of 65 years. So the price will be 15,000 rs per year. If you increase the amount from 50 lakhs to 60 lakhs, the premium will go from 15,000 per year to 16,500 per year. In case you increase the end age from 65 years to 75 years, the premium will also go up from 15,000 to 18,000 per year. In case you smoke tobacco, your premium will go up from 15,000 per year to 20,000 per year.
But one thing that you must remember is that whatever premium (cost) is decided at the purchase time of the policy, it remains the same. It will not change under any situation.
For example, the current real price of HDFC bank term insurance for a 35-year-old man till the age of 65 for the amount of 50 lakh rupees (who smokes cigarettes) is approximately 19,000 rs per year.
In case you do not smoke, the cost will come down. In case your age is less, the cost will come down. In case your age is more, the cost will go up.
Types of Term Insurance:
There are mainly 2 types of term insurance:
a) Normal term insurance.
b) Unit-linked insurance plan (ULIP).
What I explained above is Normal term insurance.
Let us understand Unit Linked Term Insurance with an example.
I will give you 2 options. And you have to choose 1 from these 2 options:
Option 1: Your age is 35. You pay 20,000 rs per year till the age of 65 and in case you die in between, your family gets 50 lakhs. If you do not die, your family gets nothing.
So in case you die, your family gets 50 lakhs, but in case you do not die, the total money that you paid for 30 years (till the age of 65) which is 20,000 *30 years= 6 lakhs is wasted.
Option 2: Your age is 35. You pay 90,000 rs per year till the age of 65 and in case you die in between, your family gets 50 lakhs. If you do not die, you get 30 lakhs in return.
So, in case you die, your family gets 50 lakhs and in case you do not die, at the age of 65, you will still get 30 lakhs. So, in this case, you paid 90,000*30=27 lakhs and you still get 30 lakhs, giving you 3 lakhs profit if you do not die.
Stop reading and decide which option are you going to choose.?
The majority of us will choose option 2. In India, the majority of Indians choose option 2 and that is why Life Insurance has become a such huge business in India while Indians have not been able to improve their overall financial condition. Because 95% of us end up choosing Option 2.
The fact is option 2 is the wrong choice. ULIP is a wrong choice. Always buy normal term insurance and not ULIP term insurance.
I will explain why below.
The concept of Normal term insurance is simple. You pay a decided amount every year. The amount gets decided at the time you buy the term insurance based on your age, your smoking habit, etc, as I explained earlier. In case you die, your family gets a big amount. In case you do not die, your amount paid as a premium is wasted. Simple rule.
But, the concept of ULIP is flawed and based on misusing the financial illiteracy of the majority of Indians.
Understand how ULIP works:
You are paying 90,000 per year which is a huge amount for the majority of Indians. You pay 90,000 per year for 30 years, which means you paid almost 27 lakh in 30 years. What does the company do by taking such huge amount from you? They invest your money in the share market and other investment plans. As the amount is big, they invest in plans which are not very risky and give safe good returns. For example, they will take your 90,000 rupees and invest it in the biggest companies in this country. We already learned in the previous article (refer to-Basics of the stock market), that investing in the biggest companies is very safe and your money will not go into loss while giving you a return of 12-14% every year. Similarly, your 90,000 will also be invested in big companies for 30 years and they will earn 12-14% money, and then at the end of 30 years, they will give you 30 lakhs out of crores of rupees that they would themselves have earned through investing your money.
Difficult to understand?
Let us take an example.
Reliance is India's biggest company currently. If you invest 90,000 every year for the next 30 years into Reliance stocks, you will get at least a return of 14% per year. So, 90,000 rupees every year invested in Reliance for 30 years at a 14% return will give you 4 crore rupees at the end of 30 years. You can check yourselves by using the compound interest formula or compound interest calculator.
This is what Reliance has delivered in the past. So, you give 90,000 rupees to the company for your ULIP term insurance. They invest their money in such companies. Then at the end, they earn a huge amount like 4 crores and then they give you a token amount of 30 lakhs.
This is why ULIP is a flawed idea. Also, at the end of 30 years from now, the 30 lakhs that you get will not be of that much value as inflation will bring the value down (refer to the article- why to invest money).
Now, if you understood this, you must remember that you have to buy normal term insurance and not ULIP term insurance. In case it was difficult for you to understand the above explanation regarding the flawed nature of ULIP, you should simply understand that you have to buy normal term insurance in which your family gets money only when you die. In case you do not die, you get nothing. This plan is the best thing to do. Also, normal term insurance has a very low premium compared to ULIP.
Other common doubts:
1) How to buy term insurance?
The easiest way to buy term insurance is through the Policy bazaar website.
2) How to decide the amount?
It is advisable to buy term insurance that covers the amount of 10-12 times your current yearly income. So suppose your current salary is 5 lakh rupees per year. So try to buy term insurance worth 50-60 lakhs. If your salary is 3 lakh per year, buy term insurance of 30-40 lakhs. If your salary is 10 lakh per year, but term insurance of 1 crore.
It is also advisable that you buy term insurance from 2 different companies diving the total amount into 2 parts. Suppose you want to take term insurance of 50 lakhs, then take term insurance of 25 lakhs from one company and 25 lakhs from another company. For example, take 25 lakhs insurance from TATA and 25 lakhs insurance from ICICI. This has one positive point and one negative point. The positive point is that in case you die and one company refuses to give money to your family citing any excuse or reason, you will still have a backup of a different company that will give your family the money. As a famous Hindi movie dialogue, even a backup plan should have a backup plan. As term insurance is directly related to your family's well-being due to your death, you must take extra measures to make sure, in case of your death, your family gets some financial help. So suppose you take 25 lakhs insurance from TATA and 25 lakhs from ICICI. After your death, if TATA says that they cannot give your family the money because of any XYZ reason, at least ICICI will be there as another backup to give them the money. Although, while taking the term insurance, you give all information correctly and honestly, such reputed companies like HDFC, TATA, ICICI, etc. do not refuse the money. (These are very reputed and trustworthy companies and the names taken here are just for example purposes).
The negative point about buying term insurance from 2 different companies is that it increases the cost. So suppose, if you took 1 term insurance of 50 lakh from ICICI, the premium comes to 20,000 per year.
But in case you take 2 term insurance from 2 companies for 25 lakhs each, the premium will come to 13000 and 13000 per year, making it 26000 per year.
But, for the sake of securing your family's future, it is advisable to divide term insurance into 2 companies.
3) How to decide when/what age should I buy the term insurance?
Term Insurance is a product that gives backup to your family and dependents in case of your death. So, you have to take term insurance for that period till you think your family will depend on you for their expenses. Suppose you are currently 35 years old. Your children are 2 and 4 years old. In the next 25 years, they will be able to earn themselves and not depend on anybody, right? So, you should take term insurance for the next 25 years.
The ideal age is 65 years of age because till this age, children are also grown up and will be earning while already having completed their education. Even if you are not married and no one depends on you, in the future, you will have dependents, so it is advisable to buy term insurance as soon as possible, as we already discussed that the premium increases as your age increases.
Final note:
Term insurance is one of the most important parts of personal/family finance that secures your family from sudden unforeseen deaths. It is like buying a property like land or real estate and paying a small premium every year for its maintenance so that in case something happens to you, your family has a backup in place.
To remember:
1) Buy Normal term insurance, not ULIP or any other plan which gives returns in case you do not die.
2) Always give 100% correct information about your health issues, smoking, and drinking habits honestly while buying term insurance. Your family's well-being depends on your honesty while buying term insurance.
*The government made a rule in 2015 under section 45 of the insurance act that after 3 years of policy purchase, the claim will not be rejected on any basis*
This means, if you took the term insurance in 2022 and you do not mention that you smoke while in reality, you are a smoker, and if you die of lung cancer in 2026 (after 3 years), the company will still have to pay the amount to your family. But this is valid only after 3 years are over. If you give any wrong information and you die within 3 years for any reason, the company might reject the claim. So, do not hide any information. ALWAYS GIVE CORRECT AND FULL INFORMATION.
*The companies' names used above are only for reference and used as examples.*
Subhav Samarth
+91-9015661671.
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