Splitting your term policy ensures that you have adequate cover at a reduced cost.
Term insurance provides the cheapest form of life cover for policyholders. Financial planners have been stressing on this point so that insurance seekers can keep their investment and insurance needs separate. While many have recently woken up to this fact, the strategy may still require some tweaking.
Many simply compare premiums of term plans with those of endowment or unit-linked insurance plans (Ulips) for a certain sum assured and come to the conclusion that this is the cheapest form of insurance. However, even the structuring of life insurance requirements through term plans can ensure that the insured pay less premium without any reduction in their life cover requirements. Let us look at how this works.
Typically, as the number of years in a policy passes by, the need for insurance goes down. This is primarily because insurance requirements will have reduced in the subsequent years because of savings and asset build-up that may have taken place during those years.
Also, if a person buys a term plan of Rs 50 lakh for 25 years, after 5 years, he needs insurance only for 20 years. As a result, as the number of years remaining in the policy decreases, so does the amount of life cover. Since insurance is a tool to cover the risk financially, the cover requirement keeps coming down, year-on-year, as the residual present value of future potential earnings keeps coming down.
One of the important facets of a term insurance policy is that premiums go up as the number of years increases. This is unlike any other policy, where they go down – that is, higher the term, lower the premium. If you were to look at the table, it will become clear.
Let us say Manish wants to take a Rs 20-lakh cover. For the same cover, Manish needs to pay a premium of Rs 6,313 for a five-year term, Rs 6,776 for a 20-year term and Rs 8,097 for a 25-year term. This is because the mortality charges go up year-on-year. The longer the term, the higher will be the average charges for all the years covered.
Given these facts, it makes sense to split your life insurance needs by buying a number of policies instead of just one. Let us understand this with an example. If one requires an insurance cover of Rs 1 crore for 25 years, the same policy can be split into, say, five policies of Rs 20 lakh each with terms like 5,10,15,20,25. This way, there will be two advantages.
First, after completion of the period, the premium for that policy stops, boosting cash flows. In this example, after five years, the first policy will mature and, consequently, premium need not be paid. Secondly, since these polices are of a shorter tenure, the policyholder will be paying lower premiums as well. This are the double benefits that can make a huge difference in the premium without compromising on the protection requirement of the insured.
Let’s take the case of Manish, who is 33 years old. Suppose he takes a Rs 1-crore policy for 25 years, the premium for ICICI Pru Lifeguard (WROP) comes to Rs 35,991 a year. However, if he splits the policy into five of 5/10/15/20/25-year terms, he will pay a total premium of Rs 33,812 a year (see table ), which is a difference of Rs 2,179 a year.
Now after 5 years, one policy would have matured and the premium of Rs 6,313 would not have to be paid. Over time, all the five policies keep maturing and premiums to be paid become go on reducing. If we were to calculate the premiums in the first scenario, where he takes one policy of Rs 1 crore for 25 years, he would pay a premium of Rs 8,99,775 (Rs 9 lakh) over the same period.
In the other scenario, where he takes five different policies, there will be a total premium outgo of Rs 5,27,335 (Rs 5.27 lakh). That is a staggering difference of Rs 3,72,440 (Rs 3.72 lakh). This is without compromising on the life cover requirements. It does make sense to have a clutch of policies with different terms, doesn't it?
The writer is a certified financial planner
