Term insurance policy provides several benefits

By  Rahul Aggarwal

A life insurance policy provides mainly three benefits. It offers financial protection against pre-mature death, financial assistance in cases a longer than expected life span and helps to save for the foreseeable large expenses in the future. The priority of these benefits should also be in the same order.

The first and foremost benefit of a life insurance policy should be to provide financial protection against pre-mature death. A person can plan the expected expenses in the future, can plan the various sources from where the expenses will be met and can plan investment of savings in various saving instruments. But a person can neither plan postponing his death nor can substitute financial protection provided by life insurance with some other financial product. Hence, it becomes paramount that the first objective of life insurance should be to provide for the family in case of pre-mature death of the primary bread earner in the family.

If it is agreed that this should be the first objective of any life insurance portfolio, then the next step is to plan the creation a pool of money that can generate enough income to substitute the earning of the primary bread earner in the family. This can be best understood by an example. Let us use the example of a young man who has recently got married and is fortunate to have his parents. The spouse is a house wife and the parent’s pension income contributes 20% to the family income. If this young man were to unfortunately die the following scenarios can unfold. His spouse may re-marry or may continue to stay his parents.

In case the spouse remarries, his parents would need a steady and regular source of income for atleast 20 years which can be assumed to be their remaining life span. Assuming that the average bank Fixed Deposit (FD) rate would be 7.5% over 20 years, he needs to create a fund which is equivalent to 100 times his monthly take home income.

This corpus will be sufficient to give an income stream equivalent to his monthly take home income. Hence, if the take home income is Rs 20,000/- then a corpus of Rs 20 lakhs needs to be created. A term insurance policy with a sum Assured of Rs 20 lakhs can provide such a corpus in case of a pre-mature death.

A term insurance policy with a sum assured of Rs 20 lakhs for a person aged 30 years would cost around Rs 8000/- per annum or Rs 670/- per month. A similar sum assured under a savings linked insurance cover would be unsustainable in a salary of Rs 20,000/- per month. Hence, it becomes clear that term policy of adequate sum assured should be the first policy that a person should buy. As and when additional funds are available one can start saving through life insurance by taking either a traditional policy or a ULIP plan.

However, if a person buys a savings oriented life insurance policy before taking a term plan, all the funds allocated for insurance are taken up by such a policy leaving neither the money nor the inclination to take a term plan with adequate sum assured. This leads to inefficient purchase of several small policies. This not only deploys the money inefficiently but also causes gross under insurance which can cause financial hardship to the survivors in case of pre-mature death of the primary bread earner in the family.

Therefore, the conclusion is once again clear that a Term Policy of adequate sum assured should be the first policy that a person should buy.

Always remember, to create a sound insurance portfolio use term-life insurance as a foundation and then build on it. The motto should always be “First Protection and then Savings”.

The following table describes the various life stages and the suggested sum assured for a term life policy:

This author is CEO, Optima Insurance Brokers Pvt Ltd. He is an alumnus of the IIM,  Ahmedabad. The views expressed in this article are his own. He can be contacted at Rahul.a@optima.co.in