What options should you choose in your term plan?

Pure term plans from life insurers are, at their core, very simple products. You pay regular premiums to the insurer during your working years. The insurer promises to pay your beneficiaries a lumpsum in the event of your untimely death. This may lead you to believe that buying a term insurance policy is a cakewalk.

But even after selecting a term plan that suits you, you often find yourself flummoxed by the many MCQs (multiple choice questions) you need to answer before signing up:

• Would you like a limited premium payment or regular payment?
• Do you prefer level sum assured or rising cover?
• Do you seek lump sum or recurring payouts? 
• Would you like a return of premiums at the end of the policy?

Here’s our guide to what these options mean and how to navigate them. 

Limited or regular premium payment

When you sign up for a term policy, it’s clear that you should opt for a cover that lasts as long as your working life (we’ve talked about it here). But what about your premium payments? Should you pay them throughout the term of the plan, or be done with premiums in the first few years?

To give you flexibility on this, life insurers offer you a choice between a ‘regular’ premium payment option and a ‘limited’ premium payment in their term plans. In the regular option, you pay premiums for the entire period for which you seek the cover (if you are 45 and want to be covered until 75, you’ll pay premiums for the next 30 years). In the limited option, you can opt to pay premiums for say 5 years, 7 years, 10 years or 15 years. How do you choose between the two?

Let’s take the case of Kotak eTerm, a pure term policy offered online by Kotak Life. If you’re a 45-year old man seeking a Rs 1 crore term cover until age 75, the regular premium option in this plan requires you to pay an annual premium of Rs 26,078 (including GST) for 30 years.

If you opt for limited premium payment for 10 years, the annual premium shoots up to Rs 65,254. If your shrink the payment period to 5 years, the annual premium climbs to Rs 1.22 lakh.

From a financial perspective, regular premium payment (paying annual premiums throughout the policy term) costs you far less than limited premium payment. Discounting the above plans to present value to know your outgo in today’s Rupees, the regular premium payment option on Kotak eTerm (Rs 26,078 for 30 years) results in a net cash outflow of Rs 3.8 lakh.

But the 10-year limited payment option translates into a cash outflow of Rs 5.1 lakh and the 5-year option into an outflow of Rs 5.46 lakh in today’s Rupees. (We used a discount rate of 6% for these calculations).

While the savings on the regular premium option vis-à-vis limited premium options may differ for different insurers, regular plans are always less expensive. In the case of premature death at the middle of the policy term, the possibility of saving premium payouts on the regular option is higher than with the limited option. 

Limited premium payment may therefore be useful for specific categories of folks. If you are self-employed or in a job with limited security, you may prefer a limited premium payment period so that you can be done with your payments in your most productive years.

But if you are looking for cost effectiveness, regular plans should be your default choice.

Rising or level sum assured

A second choice that insurers offer you when selecting a term cover is whether you need a level or a rising sum assured. As we discussed earlier, your life insurance cover does need to change based on your age, life situation, number of dependants, assets and liabilities. To automate this process of updating your life cover, some insurers offer you the choice of a ‘step-up’ term cover.

Step-up covers automatically top-up your sum assured at specific milestones based on age, or life events such as purchase of a house, marriage, childbirth and so on.

The step-up option on Kotak’s eTerm plan offer an illustration of how these plans work. For a 30-year old man seeking a Rs 1 crore term cover until 75, Kotak’s eTerm plan charges a premium of Rs 8,925 (excluding GST) in the first year. If he opts for the step-up plan, this cover automatically rises by 25% in the 1^st and 3^rd policy years taking his sum assured to Rs 1.5 crore, pegging up his annual premium outgo to Rs 13,700 by the time he is 34.

At milestones such as marriage or home purchase, the cover is stepped up by 50% again, with premiums rising commensurately.

Automatic step-ups have many minuses too. They are somewhat rigid in defining the milestones at which you need additional cover.

The advantage of having such step-ups built into your term plan is that the size of your life cover gets topped up from time to time ensuring that your dependants get additional protection, even if you neglect to do it. You will also not be required to go through medical tests each time you enhance your cover, which you will need to every time you buy a new term policy.

However, automatic step-ups have many minuses too. They are somewhat rigid in defining the milestones at which you need additional cover. They add to your costs, as insurers may charge an additional step-up fee as a percentage of the sum assured. They may also attach conditions. Kotak for instance, does not allow step-up for eTerm plans bought online or for policyholders above 45 years of age.   

Rather than subjecting yourself to such conditions, opting for a level or fixed sum assured when you buy your first policy and buying additional policies as and when your life situation warrants it, is your best bet.  

Lumpsum versus staggered benefits

Traditionally, life insurance plans only offered a lumpsum payout of the sum assured to beneficiaries. But of late, many insurers have begun to offer staggered payout options, where your beneficiaries can get the sum assured paid out to them in fixed monthly instalments or even rising monthly instalments. 

Some plans allow you to opt for one portion of the sum assured in lumpsum and the rest in the form of monthly instalments.

Insurers usually offer substantially lower premiums on their term covers if you opt for staggered benefit payouts instead of a lumpsum.

Insurers usually offer substantially lower premiums on their term covers if you opt for staggered benefit payouts instead of a lumpsum. In the case of Kotak eTerm for instance, the premium for a normal lumpsum payout policy with Rs 1 crore cover for a 45-year old man is Rs 26,078 including GST.

However, if you choose a recurring (staggered) payout, the premium drops to Rs 21,712 a year. While filing a claim in the event of your death, your beneficiaries get to choose between receiving a lumpsum of Rs 10 lakh and Rs 6 lakh annually, or no lumpsum and Rs 49,320 monthly for the next 15 years. Rates for other insurers suggest even sharper discounts on premium when you opt for staggered benefit payouts.

So, here’s when staggered payments make sense:

• If you feel your dependants need regular income and are not adept at managing money, a monthly payout will suit them better than a large lumpsum that they may not to efficiently deploy.
• Staggered payouts are also better to replace the income of the earning member a family has lost.
• However, if you have outstanding loans that need to be settled immediately on your death, a lumpsum may be more useful to your beneficiaries.

Return of premium

Finally, many (misguided) folks think of term insurance as a wasteful product because if they survive the policy term, the premiums they’ve paid on the plan expire worthless. Savvy insurers have promptly capitalised on this thirst for ‘returns’ on insurance plans, to launch ‘Return of Premium (ROP)’ options on their term policies.

These term plans, marketed as “no cost” or “free” term plans, essentially promise to pay back all the premiums you’ve incurred on a term plan if you survive the policy term.

Far from being “free” or “no cost”, ROP plans are quite an expensive way to buy insurance cover, because insurers jack up their premiums substantially to pay back your money .

But a more careful look at such plans clearly tell you that, far from being “free” or “no cost”, ROP plans are quite an expensive way to buy insurance cover, because insurers jack up their premiums substantially to pay back your money!

A comparison of premiums on pure term plans without ROP with those that offered to give your money back, for a 45-year old man showed that on a Rs 1 crore policy,annual premiums shot up by anywhere between 75 and 100 per cent when you opted for ROP.

Effectively, you would be committing to pay nearly double the normal premium amount for the next 20, 30, 40 or 50 years, incurring substantial opportunity costs in the process.

Rather than buy ROP term plans, it makes better financial sense to opt for an ordinary term plan (without return of premium) and to invest the money thus saved in an alternative avenue over the years. Over a 20, 30, 40 or 50-year period, that can add up to sizeable sum.

Consider the case of a Rs 1 crore term plan for a 45-year old man which covers him until age 75.  In his case, a normal term cover would cost about Rs 35,000 a year in premiums for the next 30 years, while a ROP plan would cost about Rs 62,000 in premiums.

Let’s assume he opts for the plain vanilla option and invests the Rs 27,000 thus saved into a SIP in a debt fund earning modest returns of 6 % pa. Thirty years later he would be able to withdraw Rs 22.7 lakh from this fund, far more than the Rs 18.6 lakh he would have got back as return of premium on the ROP plan. This makes a good case for giving ROP plans a miss and sticking to plain ‘no-return’ term insurance products!    

This is fourth in a 5-part series that covers all you need to know about how to go about choosing a term insurance plan. Read the first three parts here:

1. How much life insurance do you need? – https://www.primeinvestor.in/how-much-life-insurance-do-you-need/
2. Until what age should your life insurance last? https://www.primeinvestor.in/until-what-age-should-life-insurance-last/
3. Who doesn’t need life insurance? https://www.primeinvestor.in/who-doesnt-need-life-insurance/