Finer Nuances To Consider When Buying Life Insurance

Today most of us are aware of the basics of buying life insurance. This includes aspects such as :

1. Who should buy life insurance?

2. When to buy life insurance?

3. How much life insurance to buy?

4. Which life insurance product category is ideal for our needs?

I have myself covered these aspects of life insurance in one of my past articles, Once Your Time's Up, Then What? But beyond the basics, there are a number of nuances that do not receive as much of our attention. And these are just as important to our experience of purchasing and using life insurance. Therefore today's post will focus on these finer nuances of buying life insurance.

Today most of us have clarity on the fact that term insurance is the only viable choice for our life insurance needs. But many who buy term insurance still opt for coverage until the age of say 85 or more. This makes no sense at all.

We must first understand that term insurance is essentially a form of income replacement. It is meant to replace the income we bring into the household for our financial dependents. This would ensure that the lifestyle of our dependents is not affected even in our absence.

Therefore we must purchase life insurance only until the age at which we intend to retire or achieve financial independence. Past that point, our assets would provide for all our financial needs. So our dependents would no longer be dependent on our income. In such a case, the essential need for life insurance ceases to exist.

Term insurance with Return Of Premium (TROP) is a rider often used to attract customers. Attractive riders in life insurance policies are nothing more than bait used by insurers to hook customers onto irrelevant products. This is no different with a TROP policy. The way in which a TROP policy works is shown in the graphic below.

This may seem like an attractive proposition at first glance. But we must keep a few things in mind. The premium we pay on a TROP policy is significantly higher compared to a basic term plan. We would recieve the return of premium benefit a number of years into the future. So the real purchasing power of any money we recieve would be significantly reduced due to inflation.

Finally the differential amount of premium between a TROP policy and a basic term plan can be reinvested. The amount that is reinvested would have a reasonable chance of growing at a rate that matches or beats inflation over the long term. This is laid out in the graphic below. Please note that premium figures given here are illustrative and not actual quotes.

The same is true for most other riders. Take critical illness insurance for example. Critical illness is a risk we need to guard against throughout our lives. Purchasing critical illness cover as a rider would mean we are covered against critical illnesses only until retirement. So we would not have coverage against critical illnesses post retirement, when our health is at much greater risk.

We must remember that most riders are available as standalone policies from general insurers. Such standalone policies offer much more comprehensive coverage relative to the corresponding rider. So there is no need to look at riders when purchasing term insurance.

Another hotly debated aspect when purchasing life insurance is the choice between the regular pay or limited pay option. Under the regular pay option, we pay an annual premium over the entire term of the policy. Under the limited pay option we pay premiums for a portion of the term of the policy. (say the first 5, 10 or 15 years)

But the life insurance coverage under the limited pay option would run for the entire term of the policy. This makes the limited pay option seem like the better one. But it is the regular pay option that works out better for the insured individual. This is borne out in the graphic that follows.

The Claim Settlement Ratio (CSR) is another popular metric used to evaluate a life insurer.

The general perception about the CSR is that a higher CSR represents a higher probability that a claim will be honoured when made. But in truth, the CSR is a lot less important. This is because most life insurers today settle most claims that they recieve the only condition is that we must not withhold material information regarding our case when applying for the policy.

Also we must follow the relevant procedures appropriately when filing a claim. Apart from this, it is highly unlikely that the insurer would reject our claim. Insurers also cannot reject our claim under any circumstances if it is filed after a period of 3 years from the date of purchasing the policy. This is mandated by the relevant provisions of the Insurance Act. So a high CSR is not directly indicative of the chances that our claim would be settled.

We must ensure that the death benefit from the policy is paid out as a lumpsum. Insurers provide the option of paying out the death benefit in a staggered manner. This is advertised to serve as a source of periodic income for our beneficiaries. But this option must be avoided. The staggered payments are not inflation adjusted. Therefore the actual amounts recieved under a staggered payout option would not have the same purchasing power as a lumpsum received immediately.

Finally, assessing life insurance needs is not a one time exercise. It must be assessed periodically, say once every 3-5 years. Our coverage amount may then need to be increased to reflect growth in our income over time. This would ensure that we are not under insured at any point of time. This concludes the explanation of the finer nuances to consider when purchasing life insurance. I will do a similar article pertaining to health insurance next week.