Term Insurance: Secure Your Family's Future

What is Term Insurance?

A term cover is an extension of a very simple idea. What amount of money should your family receive in your absence? If you think 1 Crore fits the bill, then you buy a term insurance policy with a cover totaling 1 Crores. In your absence the family will receive this sum tax free.

However, choosing the right cover can be particularly challenging since different financial advisors swear by different methods. However, we won’t inundate you with complicated formulae. Instead we will use a few simple calculations to arrive at a figure that should do the job.

Why Should You Opt For A Term Insurance Policy?

Term insurance plans have become immensely popular over the last few decades. While a section of this can be attributed to the growing financial awareness among the millennials and Gen X, a few of the features of term insurance plans also deserve the share of the credit -

a. Financial protection: One of the primary concerns that you have when you think about your family’s well-being in the event of your unfortunate demise is their financial security. With your income being compromised, how will they achieve their life stage goals (think marriage, childbirth, home loans, etc.)? The answer to all this is a term insurance policy - a cover amount that will be your financial replacement, thus securing your family’s financial future.

b. Affordability: Let’s say you are a 25-year-old male who does not smoke and is looking for a ₹1 Crore cover for your term insurance plan till you turn 65. Your annual premium will range from ₹10k - ₹12k. This is probably less than your grocery bill for a couple of months! Considering this cover amount will be your income replacement during your unfortunate absence, doesn’t the premium seem affordable?

c. No risk involved: Term insurance plans are not market-linked and thus fetch no returns. In the event of the policyholder’s death during the policy tenure, the beneficiary receives the same amount (unless there is an inflation/life stage benefit-based boot in cover) as chosen during policy purchase. Thus, since there is no return involved and no market links, there are no market fluctuations to be worried about. The corpus (sum assured) remains a constant financial fund to fall back upon when needed.

d. Flexibility of customisation: Term insurance plans almost always come with a host of riders. The primary purpose of these term riders is to customise the policy per the policyholders' and their families' tailored financial and life stage goals. The riders include-

• Critical Illness Benefit: Insurers offer a list of critical ailments. If you are diagnosed with either of these ailments, the insurer offers you a substantial lump sum to be used at your discretion. This amount may be deducted from your base cover (Accelerated Critical Illness Benefit) or maybe over and above your base amount (Critical Illness Benefit).
• Waiver of Premium: In case you are diagnosed with a critical illness or are left totally and permanently disabled, your source of income will surely be compromised. Under such circumstances, how can you continue paying your premium to keep your term insurance plan active? To meet this financial crunch, the Waiver of Premium kicks in, wherein you don’t have to pay the remaining premiums to keep the policy active for the entire tenure.
• Accidental Death Benefit: If the policyholder's death is caused by an accident (within 90 or 120 days from the day of the accident—based on the insurer and the chosen policy), the insurer offers an additional amount over and above the base amount.
• Accidental Total and Permanent Disability: If you are left totally and permanently disabled due to an accident, your source of income becomes severely compromised. Thus, the insurer offers you a sum that will be disbursed as a lump sum or as monthly instalments to act as your income replacement to fund your daily expenses.
• Increasing/Decreasing Cover: Term insurance providers are usually very stringent about their regulations - this includes leaving the cover amount unchanged across the policy tenure. However, what if you purchased a term insurance plan when you were unmarried, and now you are married and have a child to plan for financially? This is where an Increasing Cover rider can come to use. Whether it's about an inflation-based boost in cover (in which case the cover amount increases by a certain % across the policy tenure) or a life stage benefit (wherein the cover amount increases at once by a certain amount) - this rider helps you boost your cover amount to cater to the changing financial requirements and goals.
• Terminal Illness Benefit: Say you are diagnosed with a terminal ailment, and the doctor offers a written declaration stating that you have a poor prognosis and only a few months to live. Under such circumstances, you are walking on a financial tightrope, and you don’t know if you should use your savings to set up a fund for your child or use it to try for better treatment or try and fulfil any bucket list wish. Subsequently, the insurer offers you a lump sum (from the cover amount or over and above it, based on the term insurer and the policy) to use at your discretion.

Please remember that you may not require all these term insurance riders; however, some of these are value-worthy add-ons that will customise your plan and increase the policy’s value. So, when choosing a term insurance plan, ensure that the policy offers at least some of these riders.

What Factors Influence Your Term Insurance Cover Amount?

Now that you know how to choose a term insurance plan, it’s time you learn how to decide the ideal cover amount. First of all, remember this - in the case of term insurance cover, “one size DOES NOT fit all.”

Your ideal cover is determined by a few factors -

• Number and Age of Dependents: The more the number of dependents and the younger they are, the higher your cover amount because you will need top keep funding them till they become financially independent. Thus, say Mr. A with 1 son (10 years) and a spouse (35 years) needs a cover of say ₹2 crores. Again, in that case, Mr. B, with 1 son (5 years), 1 daughter (2 years), and a spouse (35 years), will definitely need a cover of more than ₹2 crores. However, remember - this is JUST ONE of the factors influencing your ideal cover amount.
• Policy Tenure: In the case of term insurance plans, you have to choose a policy tenure when purchasing the policy. Policy tenure is the number of years or the age of the policyholder till which he/she stays covered under the policy. Now, think of the purpose of term insurance plans - they are your income replacement. So, ideally, the policies should stay active till your retirement age. However, in case you are anticipating that your dependent children might need a few more years to become financially stable, you can always extend the policy for a few yeras. However, remember that the average life expectancy in India is 70. So, if your policy tenure is stretched beyond you turning 70, your premiums will shoot up substantially. So, try to choose a term policy coverage until you are between 60 and 70.
• Monthly Expenses & Outstanding Loans: While term insurance policies require pocket-friendly premiums, you must analyse your financial bandwidth and ensure you can afford the premiums (if you skip a single premium, your policy will lapse). Thus, when calculating your term insurance coverage, it’s important to consider and acknowledge your monthly expenses, including your child’s fees, groceries, medical expenses, travelling costs, rent, etc and any outstanding loans that you have which require EMIs.
• Inflation: Inflation, i.e., the rising cost of commodities, the standard of living and the cost of living is a factor that should influence your term insurance coverage. Now, while term insurance base amounts can’t be altered during the policy tenure, you can always opt for an increasing cover perk (for life stage perks and inflation). Such term insurance riders will help you avoid complicated calculations that have to be made during choosing an ideal term insurance cover.

Ideal Coverage for Term Insurance Plans

Before we do that, we need to bust a quick myth on using a popular thumb rule i.e. Many people say that you can choose your cover by simply assigning a multiple to your current annual income. So if you were making 12 lakhs an annum then you can simply multiply that number by 10 and buy a term policy with a cover totalling 1.2 crores i.e. 10 x 12 lakhs.

This is very easy to do. Unfortunately, it’s not a very robust way to calculate the cover.

Why? Well, perhaps the problem can be best illustrated by using the example below,

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How to Calculate Term Insurance Coverage the Right Way

In order to calculate the term insurance coverage, let’s take the example of Rahul who is currently 26 and earning ₹12 Lakhs per annum. And his situation is very dynamic. He wants to get married next year, buy a house and even have kids soon after. He also knows that to cover these expenses, he needs quick promotions. He needs to double his salary over the next 2-3 years. And he will have to change his lifestyle considerably.

Harshad’s expenses at the age of 26 and what his dependents need

26 Year Old, Single, Living in a Metro City

While his expenses today are fairly limited, they could rise at least 5 times by the time he turns 30. And while his dependents include his parents who need a mere ₹1.5 lakhs every year, he will have a spouse and a newborn by the age of 30. Together his dependents will need ₹15 lakhs when he turns 30.

Harshad’s expenses at the age of 30 and what his dependents need

30 Year Old, Married, Living in a Metro City

So in the event of Harshad’s passing at the age of 30, his family will need ₹15 Lakhs per annum at the bare minimum. They may need even more as Harshad’s kids grow up. Unfortunately none of these details are captured using the thumb rule method. It doesn’t capture his changing lifestyle. It doesn’t capture his rapid increase in income. Nor the change in dependents. So it falls short in many ways.

Ideally what Harshad should be doing is this. At the age of 26, he should be projecting his future expenses. Now this isn’t easy to do and it won't always be super accurate. But it will give Harshad an estimate. Once you project the expenses into the future, you can see how much money Harshad’s family (and his dependents) will need in his absence.

At this point you ask yourself one simple question.

If Harshad’s family gets ₹1.2 Crores at the age of 30 (cover calculated using thumb rule). Then how many years can they sustain without Harshad?