Plus and minus points of term life insurance & when should you buy it

TomorrowMakers ™

Plus and minus points of term life insurance & when should you buy it

22 December 2016
Term life insurance has certain advantages and also some limitations when compared to other types of life insurance. Let us examine these in detail to understand in what kind of situations you should consider buying term.
 
 

By C.Ramanathan, Rtd. Executive Director, Life Insurance Corporation of India

Term life insurance has certain advantages and also some limitations when compared to other types of life insurance. Let us examine these in detail to understand in what kind of situations you should consider buying term.

Advantages of term life insurance:

• Simplicity

Term insurance plans are much easier to understand than insurance plans such as endowment policies which combine risk cover with savings. Plans which comprise risk cover plus a savings component are also known as cash value plans. It is not always easy for a layperson to divide the premium he pays into risk cover cost and the amount actually being invested on his behalf as savings. Planning financial goals around a cash value insurance plan can get really complicated. There are rules governing things like the size of your cash value savings versus the policy death benefit and the repayment of policy loans etc. Term life, on the other hand, is the essence of simplicity - pay the premium and get covered for the term chosen.

 Competitive pricing

Term life policies can be easily compared with each other on the basis of price as they are structurally similar and also simple to understand. This has led to a very competitive market in which term life policies are rapidly becoming a "commodity". Buyers suffer fewer information problems with term insurance, thus rendering the term market more price-competitive than for cash value policies.

 Flexibility

Opting out of a term life policy is much easier than getting out of cash value policies. In term policies if you stop paying the premium the risk cover ceases and the policy ends. Nothing is payable to you as there is no savings element in the policy. However, cash value policies only give the full promised survival benefit if they are held for the full tenure of the policy. If you stop paying premiums mid-term there is financial loss as you cannot recoup your savings portion of the policy without certain deductions.

Further, many term life policies are "renewable" and "convertible." The former ensures that you can go in for another term policy without a medical exam at the end of the first term policy. The latter allows you to convert your term life policy into an endowment policy for the same sum assured with associated increase in premium, should this make sense during the term of the policy.

 Tax benefit 

It is often argued that if you buy endowment type of insurance, as the premium is more you get more benefit u/s 80C of the Income Tax Act while investing. Additionally, it also yields tax-free income when the maturity claim is paid. However, it needs to be pointed out that while premium paid for term insurance is much less it is also eligible for tax benefit u/s 80C. Further, the difference in premium between term and endowment insurance can also be invested in some other tax efficient schemes like PPF, ELSS which also offer front and rear end tax breaks similar to those offered by an endowment plan.

 Lowest premiums 

The premium for term insurance is much lower than that for comparative cash value policies. For example, currently it is possible for a 30-year old person to buy a level term insurance policy of 20 years for Rs 10 lakh sum assured for about Rs 3000 annual premium. For an endowment policy without profits, with exactly the same death benefit, the premium will be a little above Rs 30,000 annually. For an endowment policy with profits, the yearly premium will be about Rs 50,000.

Limitations of term insurance

• The premium for term insurance steeply increases with advancing age and hence insurance needs at higher ages cannot be economically met with term insurance.

• At older ages, say beyond 65 or 70 it becomes difficult to buy term insurance as most companies do not offer it beyond these ages. Even in cases where term insurance is offered at ages beyond this, several conditions, disadvantageous to the insured, are attached.

• Term insurance will not serve the purpose if you wish to save money for a specific need such as education of child, marriage, old age provision like retirement needs etc.

• It will also not help you provide for income or capital needs of your family while you are living.

• No surrender values or loans are available under term policies.

• Term insurance cannot provide a hedge against inflation as they are without profit plans.

• In case you become uninsurable at any point of time due to health or other reasons then new term insurance or renewal of an existing term policy will not be available.

• Wealth creation is not possible through term insurance.

So, having examined the advantages and limitations of term insurance let us look at situations when it may be useful.

Uses of Term Insurance

Term Insurance policies will be most appropriate for the following life situations and needs:

• If your budget is tight then term insurance is a better option as cash value insurance costs much more.

• Term insurance would also be suitable for a person with low income but requiring a large cover to protect his family's financial future in case of his demise. For similar reasons, this type of insurance would also suit a person who is the sole breadwinner in the family and has moderate income.

• Persons on the threshold of new careers or business ventures can save on costs by buying term insurance instead of a cash value policy so that they can utilize their balance income or capital to develop their career or business.

• Term insurance is also suitable if you have taken a large loan such as housing loan, car loan etc. Further, it is relevant persons who have invested substantially in new ventures by borrowing at high interest rates or by mortgaging their property. Such persons can cover the risk of their dying before repaying all loans by taking term insurance which is cheaper than the other types of insurance.

• It can be used to cover the risk of business loss due to untimely death of key persons by cash strapped enterprises as key man insurance at low cost. In fact, today IRDA stipulates that only term insurance cover should be purchased for Key Man and partnership insurances.

• It offers an inexpensive method of providing financial security for your domestic servants.

• Term insurance can also be used by employers to provide life cover to their employees - particularly the labour class - as a welfare measure at low cost. What is more, companies can claim the premium paid on such policies as a business expense.

• Term insurance can be used to ensure future insurability. A person who desires large amount of cash value insurance may be financially unable to pay for it immediately. Inexpensive term insurance can be conveniently converted to cash value insurance later on, when the capacity to pay improves. Generally, when a term plan is converted into an endowment plan, medical check-up is not required at the time of conversion. However, if a person not having any life insurance wants to buy an endowment plan at a late age a medical check-up would normally be required and may lead to the person being denied insurance.

• Term insurance can be a supplement to endowment and whole life policies in a well rounded financial plan designed taking into account the capital and income needs of an individual. For example, term insurance can be used as a rider to a cash value insurance policy in order to increase death cover for a specific time period e.g. when a loan has been taken and has to be repaid.

• Term insurance is the minimum required to provide financial security for your dependents in case of your untimely demise. It is the cheapest way to protect your future income from the risk of your dying before you have earned it.

• Term insurance will also be useful for those who do not wish to save through cash value insurance policies and believe in the 'buy term and invest the difference in other avenues' theory. Such people can buy term insurance for death cover and invest their savings in other avenues (such as mutual funds etc) to meet their income and capital requirements while they are alive. However, such an arrangement has to be very carefully planned and executed in order to yield desired results.

Finally, investors need to remember that life insurance is an essential part of a good financial plan. This is because it is superior to any savings scheme as it gives what one wanted to save rather what one has actually saved in case death overtakes the savings plan.

Source: Economic Times

 

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