While COVID 19 has taught a very important lesson to all of us i.e., the need for having a term insurance cover to safeguard the future of our family members, individuals are making number of mistakes while buying a term insurance cover.
In this article, we are making a small effort to educate on the common mistakes which needs to be avoided while buying Term Insurance.
1. Underinsurance due to unscientific calculation of Insurance Cover
Most of the individuals while availing term insurance go with the standard 1 crore cover due to the influence of advertisements by life insurance companies or by looking at what their colleagues might have taken. While this might provide sufficient cover for few individuals, it will result in underinsurance for others.
While purchasing the insurance cover, one needs to consider multiple factors listed below:
- Monthly expenses of the financial dependents
- Number of years for which, the term insurance amount should support the family
- Inflation rate which will result in rising monthly expenses for supporting the family
- Other financial goals like children’s education, Home Loan or other loans
- Financial assets of the insured
- Existing insurance cover (excluding the company cover)
Ideal term insurance cover should be sufficient enough to help the family lead the same life style even if the insured is not around. At the same time long term goals like kids higher studies shouldn’t be impacted. If an individual doesn’t pay attention to these factors, he/she might end up availing a term insurance cover which might not meet family needs completely.
You can use our proprietary calculator to calculate the ideal insurance cover required by inputting your data:
2. Opting for Hybrid Pay-out options
Plain vanilla term insurance contract provides the insured the insurance cover till the period of insurance term selected and the insured will be paying the premium on a yearly basis for the entire tenure of the insurance contract.
Example: If an individual has taken a cover of Rs 1.5 Crore for 35 years, insurance premium will have to be paid yearly for the next 35 years.
Nowadays, most of the Insurance companies have started providing various options while buying term insurance. To name a few:
- Return of Premium
- Limited Pay (Pay for 5/7/10 years and get a long period cover)
- Combination of Limited Pay and Return of Premium
These options come with higher premium in comparison with the plain vanilla term insurance contracts.
Even if the premium difference is invested in alternate investment options like Fixed Income products or Equities (Directly or Mutual Funds), return which you would get after the insurance term (usually ranges from 20 to 40 years) would be much higher than what the insurance company would have assured.
So it’s important that one stick to the plain vanilla term insurance contracts.
We have recorded a video and uploaded the same with an example of how big the difference can be. Please spare sometime to see the same.
3. Opting for incorrect pay out option
While the Plain vanilla term insurance contract pays a lumpsum amount on the unfortunate event of death of the insured, there are other pay out options, which have been made available by the insurance companies which comes with reduced premium cost. Some of the options are:
- Periodic Income
- Partial Lumpsum + Periodic Income
- Increasing Income
These options once again are something which the individuals shouldn’t consider and should be providing lumpsum payment to the nominees.
4. Inaccurate updating of Proposal Form
This is one of the primary reasons why insurance claims are rejected by insurance companies. Proposal form for term insurance coverage is pretty detailed and will try to collate numerous data points. This helps the underwriter in determining if the proposer needs to be provided with the cover and if yes, what should be the premium charged for the same.
Some of the factors which will increase the premiums are:
- Consumption of tobacco in any form
- Consumption of alcohol
- Any pre-existing ailment
- Nature of job
If accurate information isn’t provided by the proposer while availing the insurance cover, then insurance company has the right to deny payment during the claim period.
Example: If the proposer consumes tobacco or alcohol, but this fact has not been revealed in the proposal form, however in the unfortunate event of death, if the medical reports suggest presence of nicotine or alcohol in the body of the deceased, insurance companies have the right to deny the claim.
Some other factors which might not increase the premium; however, the proposer needs to give accurate information relating to the same are listed below:
- Income of the proposer
- Existing insurance policies of the proposer
5. Giving high importance to settlement ratio while choosing insurance provider
During my interaction with the clients, I have seen most of the clients only looking at settlement ratio declared in the IRDAI website while determining which insurance company to select for availing term insurance cover. While this information is an important parameter, one needs to understand how settlement ratio is calculated.
Insurance companies issue various types of insurance policies and not just term insurance. Apart from term insurance policies, most of the other policies provide an insurance cover of around 10-12 times of the annual insurance premium amount i.e., for an annual premium of Rs 50,000, one can get an insurance cover of around Rs 5 to Rs 6 lakhs.
Whereas with respect to term insurance, an individual aged 25 can get a cover of Rs 1 crore by paying as low as Rs 12,000 to Rs 15,000.
Let’s look at it with an example:
|Type of Policies||# of Policies||Claim Amount||Claims Paid|
In the above example, settlement percentage works out to be 94%, does it mean insurance company has cleared 94% of the claims towards term insurance claims?
Unfortunately, no. However, IRDAI is yet to publish information relating to claims at the product level. Until then you need to look at multiple parameters to narrow down your insurance provider. We have listed some below:
- How long is the insurance company in business?
- How many policies are being managed by the company?
- What is the average amount per claim? Very Important
- What is the solvency ratio of the company?
You can see the below video to understand the concept of how to calculate average amount per claim:
6. Not considering adding riders
Riders provide a cheaper way of increasing the insurance cover or cover multiple risk factors. But these aren’t usually considered by the individuals. Adding some of these riders to the term insurance cover would be definitely helpful.
- Accidental Death – Few individuals who spend good amount of time on the roads, they should definitely consider this rider.
- Critical Illness Cover – while the medical insurance takes care of the medical expenses, critical illness cover provides a lumpsum payment on the eventuality of an individual getting diagnosed with the listed critical illness in the policy like cancer, heart attack, liver failure, disability, blindness, burns, etc. Some of these critical illnesses can result in loss of income for some period of time. The lumpsum received via this rider, will assist the insured while dealing with this challenge in life.
7. Purchasing insurance for an unreasonable period
Some individuals try to avail a term insurance policy till the age of 80 or 85 as the probability of an individual succumbing to death will go up with the increase in age. But one needs to consider the optimal time period for which term insurance needs to be purchased.
This will take us to our original question, why should one avail term insurance. Its basically to provide financial assistance to dependents when an individual is not around.
Next question is, at what age an individual will not have financial dependents. By the age of 60 or 65, kids would have completed their education and would have become financially independent.
Age of 60 or 65, is also most likely the retirement age of the insured and if the insured has planned for his retirement either himself/herself or by way of engaging a Financial Planner, sufficient retirement corpus would have been created to take care of him/her and spouse.
So ideally term insurance cover, needs to be availed till the age of 60 or 65, once again, there can be exceptions to this rule and your Financial Planner would be the best person to advise in this regard.
Finally, India’s financial literacy rate is 27%, whereas the developed economies are standing at around 60%. We have made an effort from our end by sharing relevant information in this article to educate our fellow Indians. Please help us in spreading financial literacy by sharing this article with your friends and family and help them in becoming financially literate. Together we can help India move towards becoming a developed nation.
Disclaimer: Above published information is for education purpose only and the views expressed by the author is bases on his personal experience and knowledge. Please consult your Certified Financial Planner before taking any financial decision.